The Residence Nil Rate Band and Trusts: A Short Guide

How can you legitimately reduce taxes on your estate? In particular, inheritance tax (IHT) can loom over many individuals’ minds.

Two related topics often come up on this subject – the residence nil rate band (RNRB) and trusts. Could these tax planning “mechanisms” help to keep more of your wealth in the family when you die?

Below, we explain how the RNRB works, how it relates to trusts and ideas for integrating them into a wider estate plan with the help of a financial adviser.

What is the Residence Nil Rate Band?

When an individual dies, their executors (the people in charge of administering the will) must value the deceased’s total estate for tax. However, certain allowances complicate the process.

In particular, the “nil rate band” provides an IHT-free threshold of £325,000. To provide a very simple example, if an individual dies owning a £600,000 estate, then only £275,000 could be liable to IHT. The typical IHT rate of 40% is likely to apply, resulting in an IHT bill of £110,000.

The Resident Nil Rate Band (RNRB) is an additional IHT allowance on top of the nil rate band. In 2024-25, this stands at £175,000. To access it, the estate owner must meet certain criteria – i.e. the family home must be passed down to “direct descendants”, such as children.

Therefore, theoretically, an individual could pass down a £500,000 estate to his loved ones with no IHT, using the nil rate band and RNRB.

What are Trusts?

When you place assets in a trust (e.g. shares), they no longer belong to you. As such, many people assume that this means the assets will not be subject to IHT when they die.

However, this is not strictly the case. Rather, the settlor (the person who put the assets into the trust) must live longer than seven years after the trust was set up. Otherwise, a “tapered rate” of IHT may apply to the assets if the assets have exceeded the nil rate band- e.g. 32% if the settlor dies within 3-4 years of setting up the trust

With that said, any growth on the asset (since it was put into the trust) will not be subject to IHT. Only the asset’s original value, when it was committed to the trust, will be counted. Discretionary trusts may be subject to an IHT charge of up to 6% every 10 years, and when capital is paid out

Different types of trust exist, such as bare trusts and discretionary trusts. These cater to different estate planning needs, but they complicate the picture. It is generally wise to get financial advice to explore which option(s) might be best for your needs and goals.

How do I use the RNRB and trusts correctly?

Before committing to anything, it is important to check trust structures – and relevant tax rules. Remember, it will be difficult (if not impossible) to undo a costly mistake once a trust is set up.

A certain type of trust may deliver something other than what some people want. For example, suppose two spouses put their respective shares of the family home in trust for their children. If the law regards the trust as the beneficiary (not the children), then the RNRB may not apply.

However, the RNRB will apply to a trust set up solely for the benefit of the settlor’s children and grandchildren. For example, an interest “in possession trust” will qualify since the trust’s beneficiaries get immediate and automatic access to the trust’s income when the settlor dies.

This is why it is vital to seek professional advice to ensure you navigate the different types of trust properly. Other trusts can also be suitable in certain cases – e.g. Bereaved Minor Trusts, 18–25 Trusts and Disabled Persons’ Trusts.

Estate Planning for Spouses

If you are married or in a civil partnership, there are additional layers (and opportunities) to consider in your estate plan. In particular, asset transfers between you and your spouse or civil partner are IHT-free upon death.

Be careful to unify your individual estate plans to protect your respective and collective interests and goals. For instance, if you share children, you may want them to inherit as much of your wealth as possible. When one of you dies, the surviving person can receive any unused IHT allowance(s) without tax penalties.

This creates opportunities to “combine” allowances. As stated above, each person is entitled to a theoretical £500,000 IHT-free allowance (by combining the nil rate band and RNRB). If none of this is used, this can be passed to the surviving spouse or partner upon the individual’s death.

Combined with the surviving person’s allowances, this can allow for £1m estate to be passed down to beneficiaries without IHT.

This dynamic of the UK tax system should be factored into any plans to utilise the RNRB and trusts. Again, please see professional advice to ensure you explore the options with the best and most up-to-date information.

As always, it is important to stress the key role of a Will in your estate plan. This sets out your wishes for your assets after your death. Without it, your assets will be subject to the UK’s intestacy rules(these differ between Scotland, Northern Ireland and England/Wales), which may not distribute them efficiently or as you desired.

Keeping your Will up to date helps avoid this outcome. However, the Will must also correctly navigate the UK’s complex tax landscape – e.g. regarding trusts and the RNRB.

If you would like any help with your financial planning, please do not hesitate to get in touch.

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