Inheritance Tax Made Simple: Understanding the Nil Rate Band & Residence Nil Rate Band

When planning your estate, it's important to understand how Inheritance Tax (IHT) works - and how to reduce it. Two key tools that can help your loved ones pay less tax are the Nil Rate Band (NRB) and Residence Nil Rate Band (RNRB). Here's what they mean in simple terms. 

What Is Inheritance Tax? 

Inheritance Tax is a tax on the value of your estate when you die - including property, savings, investments, and possessions. The standard rate is 40%, but it only applies to the value of your estate that exceeds certain thresholds. 

The Nil Rate Band (NRB) 

The NRB is the main tax-free allowance for everyone: 

For the 2024/25 tax year, it's £325,000. 

This means the first £325,000 of your estate is not taxed. 

Any amount above this may be taxed at 40%. 

Married couples or civil partners can combine their NRBS, potentially allowing up to £650,000 tax-free. 

Example: 

If your estate is worth £400,000, only £75,000 would potentially be subject to Inheritance Tax. 

The Residence Nil Rate Band (RNRB) 

If you leave your main home to a direct descendant (such as a child or grandchild), you may also benefit from the Residence Nil Rate Band. 

The RNRB is currently £175,000. 

It applies on top of the standard NRB. 

This means you could pass on up to £500,000 tax-free. 

Married couples or civil partners can combine their NRB and RNRB, potentially passing on up to £1 million tax-free. 

If your estate is worth over £2 million, the RNRB is gradually reduced. 

Example: 

A mother leaves her main residence worth £600,000 to her son. She qualifies for the £325,000 NRB and the £175,000 RNRB giving a total tax-free allowance of £500,000. 

This means £500,000 of her estate passes tax-free. The remaining £100,000 is potentially taxed at 40%, leading to an Inheritance Tax bill of £40,000 (unless further exemptions apply). 

Tax-Free Gifts Between Spouses 

One of the most important exemptions is that assets left to a spouse or civil partner are completely tax-free, regardless of the amount - provided both individuals are permanently UK domiciled. 

This also means that your full NRB and RNRB allowances can be transferred and used by your spouse when they pass away. 

Example: 

A husband leaves his entire estate worth £800,000 to his wife. This is entirely tax-free under the spousal exemption. When the wife later passes away, she can use her own NRB and RNRB plus the full unused NRB and RNRB from her husband - potentially giving her estate £1 million in tax-free allowance. 

Transferring Unused Allowances Between Spouses 

When someone dies and leaves everything to their spouse or civil partner, they won't use any of their NRB or RNRB. 

However, if they leave part of their estate to someone other than their spouse or civil partner, the value of that gift will use up part of their NRB or RNRB, and only the unused portion can be transferred to the surviving spouse or civil partner. 

Example: 

John dies and leaves most of his estate to his wife, which is exempt from Inheritance Tax. However, he also leaves £100,000 to a friend. 

This £100,000 gift uses part of John's £325,000 NRB, meaning only £225,000 of his NRB remains unused. His entire £175,000 RNRB is still unused because the family home passes to his wife.  

When his wife later dies, she can inherit John's unused allowances - £225,000 NRB and £175,000 RNRB and combine them with her own full allowances of £325,000 NRB and £175,000 RNRB. 

This gives her estate a total tax-free threshold of £900,000 before Inheritance Tax is due. 

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