A tax change with a snake bite

In Delhi, during the period of British rule, the Government, concerned at the size of the cobra population, introduced a bounty for every snake killed. Initially this was successful and the population declined, but then enterprising individuals began breeding cobras to claim the prize. The Government became aware of this and scrapped the bounty. With the snakes now being worthless they were released into the wild, thus increasing the population further.

A, possibly apocryphal, example of the law of unintended consequences, and other examples crop up everywhere, including in financial services. One that came to my attention recently concerns the NHS pension and the Residence Nil Rate Band. As with most pensions the NHS pays a lump sum benefit on death before retirement. Usually this is paid automatically to a spouse or civil partner and does not form part of the deceased’s estate, so is free of Inheritance Tax. But an NHS employee can nominate someone else if they wish, their children perhaps; however, unlike other pension schemes this nomination is binding and so does become subject to IHT.

The Residence Nil Rate Band (RNRB) is an additional amount of Nil Rate Band that is free of Inheritance Tax where a main residence passes to a direct descendent. Currently the RNRB is £125,000 but will increase to £175,000 by 2020/21. It is available on estates up to £2 million and tapers away above that amount at the rate of £1 per £2 of estate value over £2 million.

Now picture this. Miss Smith, a single consultant with adult children, has an estate valued at exactly £2 million, including her main residence. She thinks therefore that her children will benefit in full from the RNRB. With no spouse, she wants to be sure her NHS lump sum death benefit, worth £180,000, will be paid to her children on her death, so she makes a nomination to that effect. Because this nomination is binding the £180,000 would be added to the £2 million – assuming all else remains the same up to the date of death – making a taxable estate of £2,180,000. The tapering effect of the RNRB means that £90,000 of the RNRB is tapered away, and so would not be available to her executors.

The net effect of this is that the nomination of Miss Smith’s NHS pension death benefits for her children means they would pay Inheritance Tax at 40% on the £180,000, which is £72,000, and they would not benefit from £90,000 of RNRB, equivalent to a further £36,000 of tax, an effective tax rate of 60%.

The good doctor needs to review her IHT planning before this, surely unintended consequence of the highly complicated RNRB legislation, bites like a cobra.


Philip Chandler FPFS, CFPTM, Chartered MCSI

Chair of Aspinalls Technical and Investment Committee