Utilising your Nil Rate Band to minimise Inheritance Tax

Tax on lifetime gifts 

If you live for a further seven years after making the gift, no IHT is due on gifts made during your lifetime (known as Potentially Exempt Transfers (PETs)). An exception to this is if the gift is given to certain types of trusts or in some instances companies (known as Chargeable Lifetime Transfer (CLT)). 

Setting up a trust 

Assuming you haven’t used any of your NRB, creating a trust during your lifetime up to the level of the NRB, currently £325,000, is an IHT free way of reducing your estate without increasing someone else’s estate. If you and your spouse/civil partner were to set up a trust together, this could potentially be twice as much (i.e. £650,000) if both NRBs are available. 

However, you may want to transfer more than £325,000 (or £650,000) from your estate(s) but are concerned about the potential IHT liability if you (and your spouse/civil partner) create a trust during your lifetime for more than these amounts. Sometimes, creating an IHT liability now to save a greater level of IHT in the future, is worth considering. For example, you may want to set up a larger trust to meet the future needs of your family, as well as for IHT planning purposes.

Setting up a trust during your lifetime is likely to result in a CLT. This means that, if the value of the assets you transfer to the trust (when added to the value of any other CLTs you’ve made in the previous seven years) is more than the current NRB, the amount above your available NRB will be subject to IHT at the lifetime rate (currently 20%) when it’s set up. 

How to use the NRB to minimise IHT liability

If you make a gift to an individual or a trust of an amount up to the NRB, after seven years have elapsed, that amount will no longer count and your NRB will be reinstated. This is known as the seven-year rule. So, assuming the NRB remains the same, by transferring up to £325,000 every seven years you (and your spouse/civil partner) could be saving as much as £130,000 of IHT (each), every time you use the NRB available to you. 

Taper relief 

Even if you didn’t survive another seven years after a gift, provided you survive at least three years, taper relief is available to reduce the IHT liability on the gift. Taper relief effectively reduces the IHT charge by 20% after three years, and then a further 20% for each of the following years that goes by (so 40% after four years, 60% after five years and 80% after six years), until you get the 100% relief after the seventh year.

Transferring more than the NRB to a trust

To minimise IHT in this case, you could create a NRB trust and then settle a further amount after seven years. The amount you transfer to the first trust will not count as a gift after seven years have elapsed and your NRB will be reinstated. This means that, depending on your age, you could potentially repeat this exercise several times over your lifetime without paying IHT on the gifts. So, by transferring up to £325,000 (or £650,000) every seven years, it could significantly reduce your (and your spouse/civil partner’s) estate(s) for IHT purposes.

Watch out for the 14-year rule! 

As mentioned above, if you make a PET at least seven years before you die, there’s no IHT to pay on the gift, even if the value is more than the NRB. However, in certain circumstances where gifts are made into a trust, the seven-year rule effectively becomes the 14-year rule.

If you made a gift to a trust but you’ve also made a PET within seven years of death, the PET becomes chargeable to IHT. Your NRB is set against the gifts you’ve made in a chronological order, so a gift that you’d made to a trust up to 14 years earlier could affect the IHT payable on your ‘failed’ PET (the PET made within seven years of death). 

If your PET becomes chargeable, any CLTs you made in the seven years prior to making that PET, are deducted from the NRB, which reduces your NRB that’s available to offset against the failed PET. 

Example

Sam died on the 20/06/2023. 

On 03/10/2009 Sam made a gift of £250,000 to a discretionary trust. 

Then on 15/08/2016 Sam gave Chris (their only child) £100,000. 

Sam’s gift to Chris was a PET, so no IHT was payable on 15/08/2016. However, as the PET was made within seven years of Sam’s death, it’s a failed PET that became chargeable to IHT on 20/06/2023. Sam’s gift to the discretionary trust was a CLT which was made within seven years of the gift to Chris, so it reduces Sam’s NRB that’s available to offset against the failed PET.

The requirement to take into account CLTs made within the seven years of another CLT or PET, means that gifts up to 14 years before death can affect the IHT payable on death. 

How to avoid getting caught out by the 14-year rule 

Whenever you can, leave at least seven years after making a CLT, before you make another CLT or PET, so that your NRB will be fully reinstated. 

What should you do? 

If you’re looking for ways to use your NRB to reduce your exposure to IHT, we recommend seeking professional advice tailored to your personal circumstances, which will enable you to consider all available options and make an informed decision. 

For professional advice on estate planning or to identify ways to reduce your overall exposure to IHT, please fill in the form below and one of our experts will be in touch to discuss how we can help.