Understanding How to Apply the Transferable Nil Rate Band
A popular topic for both R03 and AF1 exams, in particular, is the transferable nil rate band. It sometimes appears in R01 and R06 too. This article will help you to understand how you would answer a question regarding inheritance tax and transferable nil rate band on your CII exam.
THIS ARTICLE IS RELEVANT TO EXAMINABLE TAX YEAR 2017/18.
Changes to the IHT rules in 2007 mean that where the first spouse (or civil partner) to die does not use up their full nil rate band (NRB), any unused proportion can be applied to the estate of the second spouse on their subsequent death.
This is quite straightforward if the first spouse dies and leaves their whole estate to the second spouse. When the second spouse dies, the NRB that applies to their estate is:
- the sum of their own NRB (£325,000 in the current tax year) plus
- a further £325,000 which represents the first spouse’s unused NRB.
Where the NRB is partially used up on first death, the calculation is slightly more complex as there is an extra step to the calculation:
- The proportion of the NRB not used in the year of the first death has to be worked out, and then applied to the NRB in the year of the second death.
An Example of How Transferable Nil Rate Band Works
Let’s take a look at an example to see how this works:
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David died in May 2012. He left £130,000 to his daughter and the remainder of his estate to his wife Irene. David’s estate therefore used £130,000 of his NRB (the estate that went to his wife was exempt). £130,000 as a proportion of the NRB in May 2012 is 40% (£130,000/£325,000).
Irene dies in November 2017 with an estate of £600,000.
To calculate the inheritance tax, first the NRB for November 2017 is deducted from her estate:
£600,000 – £325,000 = £275,000.
Then the unused allowance from David’s estate can be deducted.
In this case it will be £195,000 (100% – 40% = 60% of the £325,000 NRB that applies in November 2017).
£275,000 – £195,000 = £80,000.
The tax charge will therefore be:
£80,000 @ 40% = £32,000.
How Transferable NRB Might Appear on an Exam
Here’s an example of what a transferable IHT question might look like in an exam. It’s taken from the most recent CII R03 specimen exam paper:
Albert died in March 2002, when the Inheritance Tax nil rate band was £242,000. With the exception of a £48,400 bequest to his daughter, he gifted his entire estate to his spouse. Her estate is currently valued at £800,000, which contains no property. If she died today, how much nil rate band, in effect, would be available to the estate?
As you’d expect, there’s one correct answer and three answers that you might end up with if you go down the wrong track.
£48,400 / £242,000 = 20%. This means that an additional £325,000 x 80% = £260,000 can be added to Albert’s wife’s own NRB of £325,000 making C) £585,000 the correct answer.
£518,600 is the answer you’d get if you mistakenly applied the 80% to the NRB at the date of Albert’s death rather than his wife’s. (£325,000 + (£242,000 x 80%) = £518,600)
£567,000 is the answer you’d get if you simply added the NRB from March 2002 to the NRB from the current tax year (£242,000 + £325,000 = £567,000)
£650,000 is the answer you’d get if you didn’t take into account the £48,400 bequest to Albert’s daughter and added the two full NRBs together (£325,000 + £325,000 = £650,000)
One Final Thing to Watch Out For
The estate of a surviving spouse can never be entitled to more than twice the full NRB in the year of their death. This entitlement could arise, for example, where an individual has married more than once and outlived both spouses. Where this is the case, the maximum NRB that could apply on the death of a surviving spouse in the current tax year would therefore be £650,000.
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