How do spousal Inheritance Tax exemptions work?
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My husband and I each have a child from previous relationships but no children of our own. We are concerned about the level of Inheritance Tax that might be payable on our combined estate: our house is worth about £900,000 and we have a number of other investments and pensions. The plan is to leave everything to each other, then split the estate between our children. We’ve been reading up about the various Inheritance Tax exemptions but are a little concerned how that works in our situation. Can you explain, please?
Douglas Bridges of Smith & Pinching responds:
There are three Inheritance Tax (IHT) exemptions that come into play in this instance – the exemption for spouses/civil partners, the standard Nil Rate Band and the Residence Nil Rate Band.
The spousal exemption means that anything you leave to a spouse or civil partner (but not to a co-habiting partner) is free of Inheritance Tax. In your situation, where you plan to leave your estates to each other when the first partner dies, no IHT would be payable on the first death and any potential IHT would become payable when the surviving partner dies.
You each have an IHT exemption, known as the Nil Rate Band (NRB), of £325,000. On top of that, you each have a potential further IHT exemption, known as the Residence Nil Rate Band (RNRB), of up to £175,000, depending on the value of the home – if you leave the value of your home to your direct descendants. The good news for you is that this includes not only your own children and grandchildren but also stepchildren. Adopted and fostered children are also counted as direct descendants.
Both the NRB and the RNRB, if unused, can be passed to a surviving spouse or civil partner. This means that as a couple you have a potential combined NRB of up to £1 million when the second of you dies. However, it’s important to note that the RNRB element reduces on a tapered basis for estates that are worth over £2 million. The exemption levels are as in the 2021/22 tax year and have been frozen at this level until April 5, 2026.
I strongly recommend that you get independent advice now about your potential future IHT liabilities. Planning now can help you manage what your heirs will be paying later. There are a number of different measures, including lifetime giving and trusts, that can be used to mitigate what may be due.
References to taxation are based on our understanding of current legislation and HMRC practice, both of which may change. Tax treatment depends on individual circumstances and may change if circumstances change. Any opinions expressed do not constitute advice.
For more information, please visit www.smith-pinching.co.uk