Inheritance Tax: Unused Allowance Tapering Explained
A financial planner clarifies how rising estate values can erode transferable inheritance tax allowances, particularly the residence nil rate band.
Individuals may lose their late spouse's unused inheritance tax allowance on their home if their own estate value exceeds £2 million, a financial planner has explained. The residence nil rate band (RNRB), an additional tax-free allowance available when a home is passed to direct descendants, is subject to tapering if the deceased's estate is valued above this threshold.
Henrietta Grimston, a Chartered Financial Planner at wealth management firm Saltus, clarified that the transferred RNRB is not exempt from this tapering. This means that even if a husband died in 2013 and left his entire estate to his wife, his unused RNRB will be reduced if the surviving wife's estate is valued at over £2 million at the time of her death.
The standard inheritance tax (IHT) nil rate band is £325,000 per person. For married couples or civil partners, this can be combined to £650,000. An additional RNRB of £175,000 per person can be added if the home is left to a direct descendant, potentially raising the total tax-free allowance to £1 million for a couple.
However, the RNRB begins to be tapered away for estates valued above £2 million. For every £2 that an estate exceeds this £2 million threshold, £1 of the RNRB is lost. Consequently, an estate worth £2.5 million would see its RNRB reduced to £100,000. Estates exceeding £2.7 million will lose the entire RNRB.
Grimston highlighted concerns regarding upcoming changes to pension rules, which will bring defined contribution or personal pension pots into the estate for IHT purposes. This change, expected next April, could push more estates over the £2 million mark, potentially triggering the tapering of the RNRB and increasing the overall inheritance tax liability.
This situation illustrates a common pitfall where a surviving spouse may inadvertently lose not only their own RNRB but also the transferable allowance from their deceased partner due to the growth of their own estate. Financial planning is advised to navigate these complexities and mitigate potential IHT liabilities.