What is my ‘nil-rate band’ for Inheritance Tax?

Q: What does ‘nil-rate band’ mean if passing on money when you die?  My wife died 10 years ago. I have a house, ISAs, pension which is unlikely to be used and money in the bank. All will be passed on to my two daughters.

A: Thank you for your question. ‘Nil rate band’ refers to an amount - or ‘band’ - of an individual’s estate that can be passed on to beneficiaries without Inheritance Tax (IHT) applying.

Note that this only refers to money being passed to people other than a spouse (or civil partners). Spouses can inherit from their partner without worrying about IHT.

Each person’s nil-rate band depends on their circumstances, but the starting point is that we can all pass on £325,000 to beneficiaries without IHT applying.

If the estate includes a primary residence an extra £175,000 of ‘residence nil-rate band’ is available per individual, as long as the home is being passed to children and the estate overall is worth not more that £2million. That would take the nil-rate band to £500,000 per individual.

What’s more, spouses and civil partners can pass any unused nil-rate band between them when the first partner dies.

So - in circumstances where one spouse dies and passes their entirely unused nil-rate band to their partner, and the surviving spouse then passes on their home as part of their estate, a nil-rate band of £1m could apply.

Anything being passed on above that could fall within the scope of IHT and be taxed at 40%.

One other thing to consider is the treatment of pensions for the purposes of IHT. The rules in force at the moment allow money held in defined contribution pensions to be passed on without IHT applying. If death occurs before age 75 then the beneficiary pays no tax at all, if it happens after 75 then the recipient pays tax on it at their marginal rate of income tax.

However, the rules are due to change in April 2027. After that, IHT will apply on pensions that are passed on at death. The exact detail of how the change will work - including whether spouses being passed pension money will have to pay IHT - are still being decided by the government.

Don’t forget that there are important allowances and exemptions that can reduce an IHT liability. Notably, there are several instances when gifts can be made without the tax being an issue.

You can gift any amount of other assets with no IHT to pay if seven years pass without you dying. If you die within seven years, a reduced rate applies to any amount above your nil-rate band.

If death happens before three years has passed the full 40% rate applies, then 32% if you die after three years, 25% after four years, 16% after five years and 8% after six years.

You can also give away £3,000 per year of assets or cash, divided between one or more people, without IHT applying at all. What’s more, you can carry forward one preceding year of annual exemption - so you can gift £6,000 if you haven’t used the exemption from the year before. On top of this you can give £250 per person, per year to as many people as you like without IHT applying - although not to someone who has already benefitted from your £3,000 annual allowance.

There are some allowances for gifts made for specific purposes. You can give £1,000 to anyone you like to help pay for their wedding, and this rises to £2,500 for a grandchild and £5,000 for a child. The gift has to happen before the big day, not after.

You are allowed to give money to pay for the living costs of a child under age 18, or in full time education. That includes a child at university. It may have to be shown that this money was not excessive and only enough to cover living costs and tuition fees.

Finally, you can give regular amounts away that you don’t need from your income without IHT applying. That means your salary, rents from property, investment and savings income after tax - but not capital itself.

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Important information - investors should note that the views expressed may no longer be current and may have already been acted upon. Tax treatment depends on individual circumstances and all tax rules may change in the future. Withdrawals from a pension product will not be possible until you reach age 55 (57 from 2028). This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to one of  Fidelity’s advisers or an authorised financial adviser of your choice.