Inheritance Tax (IHT) receipts have been rising over the last few years. Frozen allowances (you’ll find more about these in our latest blog) have led to fiscal drag and seen more estates caught in the IHT net. Upcoming changes to the IHT treatment of unused pension funds are expected to see the Treasury’s tax take rise again.
Office for Budget Responsibility (OBR) forecasts suggested that HMRC would collect £8.7 billion in IHT for 2025/26. According to the government’s Budget 2025 document, this figure is expected to reach £14.5 billion by 2030/31.
Meanwhile, the number of deaths that will result in an IHT liability will increase from 37,700 in 2024/25 to 66,600 by 2029/30, according to UK Parliament figures.
You’ll have read previous articles from us about IHT thresholds and the transfer of unused allowances between spouses and civil partners on the death of the first partner. In this context, we often speak of couples potentially having a combined IHT-free estate of up to £1 million.
But there are caveats attached to this, and it won’t always apply to you. Keep reading to find out more.
The potential £1 million Inheritance Tax threshold only applies in very specific circumstances
The nil-rate band is the threshold below which your estate has no IHT to pay. It currently stands at £325,000.
If you pass your home to a direct lineal descendant (including a child or grandchild, foster or adopted child, or a stepchild in certain cases), you might also be able to take advantage of the £175,000 residence nil-rate band.
Both of these thresholds are currently frozen until at least 2031. When combined, these give you an individual IHT allowance of £500,000. Any unused allowance can usually be transferred to a surviving spouse or civil partner on death, but crucially, the unused allowances don’t transfer automatically. A request must be made via HMRC within 24 months of the death.
You must be married or in a civil partnership
The first important point to note is that you can make as many gifts to your spouse or civil partner as you like, during your lifetime, and they will be free of IHT. You and your spouse or civil partner must be domiciled in the UK, and the rules do not apply to those who are cohabiting.
On death, unused nil-rate and residence nil-rate bands (if applicable) can also be passed to a spouse or civil partner.
Doing so allows your individual £500,000 IHT allowance to be combined with that of your partner, hence the £1 million figure. But again, this transfer of unused allowances only applies to married and registered civil partners.
Even if you live with your partner, have children together, and share household finances, the rule – and therefore the £1 million threshold – won’t apply.
You must make full use of the residence nil-rate band
For your estate to reach the £1 million IHT-free threshold, you would need to pass on your full unused residence nil-rate band to your partner.
The £1 million threshold might then apply on second death, but only if your surviving spouse or civil partner qualifies for the residence nil-rate band.
They will need to pass their main home to a direct descendant, usually a child, grandchild, stepchild or an adopted or fostered child. It follows that if you and your partner don’t have children, the residence nil-rate band won’t apply. If the home is left to another family member, such as a sibling, the allowance also won’t apply.
It’s worth noting that downsizing doesn’t remove the allowance. If your spouse sells the family home and downsizes, they may be able to claim a “downsizing addition”.
This can be complicated – assets of equivalent value must still be left to direct descendants, for example – so professional financial advice is strongly recommended.
Be aware the residence nil-rate band tapers for large estates
If your estate is large, you might trigger the residence nil-rate band taper. Doing so will also mean you can’t pass on £1 million of assets IHT-free.
For every £2 your estate’s net value exceeds £2 million, the residence nil-rate band decreases by £1.
Once your estate is worth £2.35 million, you are exceeding the taper threshold by £350,000. Your available residence nil-rate band drops by £175,000 and disappears altogether. Even if you leave your residence to a direct descendant, the residence nil-rate band will not apply.
If you are a surviving spouse or civil partner who has already inherited a full residence nil-rate band, your allowance is, in effect, £350,000 (on top of any nil-rate band inherited). The residence nil-rate band would disappear once your estate was valued at £2.7 million.
Get in touch
IHT rules are complicated, and errors can result in significant tax bills, so be sure to seek professional advice.
If you’re looking for an independent financial adviser in Milton Keynes or Olney, look no further. At Jane Smith Financial Planning, we’ve been helping clients for 30 years, so contact us at info@janesmithfinancial.com or call 01234 713131 to see what we can do for you.
Please note
This article is for general information only and does not constitute advice. The information is aimed at retail clients only.
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