Understanding Inheritance Tax Allowances and Taper Relief

The Inheritance Tax Nil Rate Band (NRB) is the amount of an estate that can be passed on without paying Inheritance Tax (IHT).  Currently, the NRB is set at £325,000 and is frozen at this level until 5 April 2030. 

If your estate is worth less than this threshold, there is no IHT to pay.  

For married couples and civil partners, any unused NRB can be transferred to the surviving spouse or partner when the first one passes away.  This means the surviving partner can potentially pass on up to £650,000 tax-free. 

In addition to the standard NRB, there is another allowance known as the Residence Nil Rate Band (RNRB).  

The RNRB applies when you leave a qualifying interest in a property (this is often your main home) to your direct descendants, such as children or grandchildren.  It currently stands at £175,000 per person. 

This allowance is also transferable between spouses or civil partners, meaning a couple can benefit from a total RNRB of £350,000.

When both the NRB and RNRB are combined, a married couple or civil partners could potentially pass on up to £1 million tax-free, as long as certain conditions are met. 

Important: IHT is charged at 40% on the portion of an estate that exceeds the total available allowance.  

IHT may also apply to gifts made during your lifetime.  Whether tax is due depends on: 

• Who you gave the gift to;
• When the gift was made;
• The value of the gift;
• And your relationship to the recipient. 

Some gifts are immediately exempt, including: 

• Gifts to registered UK charities;
• Gifts to a spouse or civil partner (if they live in the UK permanently);
• Annual gifts of up to £3,000 per tax year (this allowance can be carried over for one year if unused).

If a gift is not exempt, it may still become tax-free if you survive seven years from the date the gift was made.  This is known as the seven-year rule. 

If you pass away within seven years, the gift may be taxed.  The exact amount depends on the value of the gift and when the gift was made and valued.  If the value of the gifts exceeds your available NRB, the amount of IHT payable can be reduced using Taper Relief. 

Taper Relief is a reduction in the amount of IHT payable on gifts made between three and seven years before death, but only if the total value of the gifts exceeds the available NRB.

Taper Relief applies to the tax due, not the value of the gift.  Here is how it works: 

• 3 to 4 years before death - 20% reduction in tax (pay 32%)
• 4 to 5 years - 40% reduction (pay 24%)
  
• 5 to 6 years - 60% reduction (pay 16%)
  
• 6 to 7 years - 80% reduction (pay 8%)
  
• 7 years or more - no tax payable 
  

If the value of the gifts fall within the NRB, no tax or relief is applied, as there is nothing to reduce. 

If tax is due on a gift made before death, the recipient of the gift, not the estate, is responsible for paying IHT.  This could come as a surprise to many beneficiaries, so it is important to plan ahead and seek advice. 

However, a Will can specify who should bear the cost, and in some cases, it may be paid from the estate instead.

Even if you have made large gifts, Taper Relief only applies if those gifts exceed the NRB.  Since gifts are considered in order of the date they were made, earlier gifts may use up the allowance, and later gifts might then be subject to tax without any reduction.  

Let's consider an example: 

J passed away in 2023, leaving an estate worth £1 million.  Over the seven years before his death, J gave significant financial gifts to his children.  The total value of the gifts exceeded the NRB.

Tax Year 2016-17          Gift of £65,000          All within NRB, therefore no tax liability

Tax Year 2017-18          Gift of £20,000          All within NRB, therefore no tax liability

Tax Year 2018-19          Gift of £397,000        £240,000 within NRB, balance of £157,000 subject to IHT

IHT is ordinarily paid at a rate of 40% (which on £157,000 would be $62,800).  However, as the gift in question was made in the 2018-19 tax year, which was between 4 and 5 years prior to date of death, a 40% reduction in the rate of tax applies, meaning that the rate of IHT applicable to the gift is reduced to 24%.  The IHT due on the £157,000 would therefore only be £37,680, meaning a reduced IHT bill of £25,120.  

In this case, the use of Taper Relief saved the family over £25,000 in inheritance tax, a substantial saving simply through the timing of the gifts.  

Inheritance Tax can feel complex, but with the right advice and careful planning, it is possible to make the most of the allowances and reduce any IHT paid on your estate.  It may be that you also have assets which may be eligible for Agricultural or Business Property Relief, or pensions that need consideration.  In a recent article, we highlighted the changes to the application of Agricultural and Business Property Relief and pensions following the Autumn Budget as a useful reference.