Inheritance tax, of all the taxes, is seen by many people as punitive in various ways but often because it is seen as a “second” tax. When advising clients, I often hear the phrase “I have paid tax all through my life and I have to pay it again when I die!” The government’s refusal to increase the amount an individual can leave tax-free on death has meant more people get caught by inheritance tax as a result of the rise in house prices. The number of estates liable to inheritance tax has almost doubled since 2008-09.
It was within this backdrop that in 2015 the government announced a threshold (by 2020) of £1 million under which inheritance tax would not be payable. The government at the time saw this as a triumph in meeting the demands of middle income families and gave the pledge to reach the magical £1 million tax-free figure. Economically, it was not possible to simply increase the existing nil rate band that exists for individuals and so a complicated new regime was introduced which comes into effect in April 2017.
The figure of £1 million will only be achieved by a combination of ownership of residential property being left to lineal descendants and by people who are either married or in civil partnership. This immediately limits its availability and will not apply to estates with more than £2.35 million in 2020.
The ability to claim a zero rate of tax on £1 million by 2020 requires the use of a combination of two nil rate bands of spouses or civil partners and ownership of qualifying residential property at some time before death. Each individual in the UK is able to claim £325,000 (nil rate band “NRB”) as a tax-free sum against the total value of various statement when they die. From April 2017, an additional rate band of £100,000 (increasing by £25,000 each year to £175,000 in 2020) can be added to the NRB (residential nil rate band “RNRB”) making a total of £425,000 in tax at 0%. The balance above this sum is, in broad terms, taxed at 40%.
If an individual dies in three years’ time owning a property used as their residence they will be able to leave their nil rate band (“NRB”) of £325,000 plus £175,000 residence nil rate band (“RNRB”) to their direct descendants, – children or grandchildren.
How then does the magical £1 million materialise? If a married couple or those in a civil partnership leave their whole estate to each other, on the second death the individual nil rate bands are combined because the spouse who died first had not utilised their NRB by leaving the estate to the survivor since between spouses and civil partners all gifts acquire a separate relief. This means that the NRB from the first to die can be added on the second death. The example below illustrates:
Mr and Mrs White own assets of £300,000 and £400,000 respectively. Mrs White dies leaving her estate entirely to her husband. The impact of the combined NRBs is set out below:
- £400,000 Mrs White
- £300,000 Mr White
- £700,000 owned by Mr White
On Mr White’s subsequent death, say in 2020
- £700,000 Mr White estate
- £325,000 less his NRB
less carried forward
- £325,000 Mrs White unused NRB
- £50,000 taxed at 40%
On the basis that Mr and Mrs White own their main residence and that increases their respective estate values by £250,000 each and Mr White’s will left the whole estate including the property to his children in 2020 an additional £350,000 of the estate is free of tax:
- £1,200,000 Mr White estate
- £ 325,000 less his NRB
- £ 175,000 less his RNRB
- £ 700,000
less carried forward
- £ 325,000 Mrs White unused NRB
- £ 175,000 Mrs White unused RNRB
- £ 200,000 taxed at 40%
It is by adding together the NRB and RNRB of both spouses that the magical £1 million tax free figure is achieved.
As much as this was trumpeted by the government at the time as benefiting hard working families, many will miss out. Mainly those without children, those unmarried or not in civil partnerships, those whose estates exceed, by 2020, £2.35 million and those who do not own property at all. It should be remembered that we are living in an age where the younger generation now see renting as the norm.
The impending changes in April should prompt many to review their wills and estate planning generally to ensure that they can take advantage of the new RNRB – for example, gifts to grandchildren with an age contingency will not allow the RNRB to be claimed. In addition, those with larger estates, over £2.2 million at present, could consider alternative steps in a will rather than leaving the whole estate to a spouse in order to bring the estate under that amount to allow the RNRB to be claimed.
- What if I have sold my home before the date of my death?
As long as such sale takes place after 8 July 2015 and part of your estate is inherited by a lineal descendant then a claim for RNRB relief can be made. This provision arose from a concern of elderly couples who may retain large properties that they could not maintain to ensure they did not lose the release. Similarly, if a property is sold and a less valuable property acquired by downsizing then a proportion of the relief can still be claimed again subject to the estate being left to lineal descendants.
- What if I move out of my home before my death?
This does not prevent the RNRB relief being claimed, as long as the property has been your residence at some time before your death.
- What if I own more than one property at my death?
As long as a property has been the deceased’s residence at some time, then any property can be nominated for RNRB purposes. It does not have to be a main residence and could include a holiday home.
- What if my children do not want to retain my home after my death?
This does not matter as the relief can be claimed regardless of a decision by qualifying beneficiaries to sell the property after your death.
The new rules should be welcomed but we must not lose sight of the limited scope of the new relief nor indeed of the importance of reviewing estate planning in general and the ongoing opportunities to minimise inheritance tax.
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