Are your family going to benefit from a £140,000 Inheritance Tax reduction?

Back in the summer budget of 2015 a new residence nil rate band (RNRB) was introduced which has been designed to exempt from Inheritance Tax (IHT) family homes up to the value of £1 million. The Bill has passed through Parliament and the new rules are due to come into effect from April.

The eye catching headline of a new £1 million IHT free allowance is not as simple as it sounds. The rules are complex. However, they do provide opportunities to reduce the IHT burden in the right circumstances.

The RNRB, which can apply on a person’s death, will start at £100,000 for 2017/18. It will then increase during the next three tax years by £25,000 per annum, until it reaches £175,000 in tax year 2020/21.

Like the standard nil rate band of £325,000, the RNRB will be transferable between spouses if unused on first death. This means that where none of the standard rate band or RNRB is used on the first death, and if the second death occurs after 6 April 2020, married couples with a main residence worth at least £350,000 will be able to potentially leave a total estate of £1 million before any IHT is payable.

This is good news but there are several pitfalls for the unwary, and the main ones are covered below.

  • The RNRB will only be available if the main residence passes to children (including stepchildren) or grandchildren; and or surviving spouses of those children/grandchildren. Property left to a discretionary trust will not qualify for the RNRB even if all the beneficiaries of the trust are children/grandchildren.

  • There are some trusts that do qualify – often referred to as immediate post death interest and absolute trusts – providing the beneficiary is a spouse, child or grandchild.

  • Care needs to be taken when deciding the age at which children inherit the main residence as any entitlement beyond the age of 25 is likely to render the estate ineligible for the RNRB.

  • The RNRB is reduced by £1 for every £2 if the deceased’s net estate exceeds £2m. Net estate means everything the deceased is beneficially entitled to after deducting all liabilities such as loans. It is important to note that property that qualifies for business property relief and agricultural relief is included in the estate for this purpose. Pensions are excluded as they do not form part of someone’s estate.Tapering will apply to reduce any transferable RNRB where the estate of the first to die exceeds £2m. For married couples, if the estate on the second death is sufficiently large, both the RNRB of the survivor and any transferable amount could be lost altogether.

  • For married couples who are leaving everything to the spouse on first death, the practical effect of this is that in the 2017/18 tax year the RNRB will be lost altogether on second death where the estate exceeds £2.4m, rising to £2.7m from April 2020.

Considerations to preserve entitlement to the RNRB could include:

  • For married couples there is the option, where appropriate, to transfer assets between each other to reduce each individual’s estate to below £2m.

  • Leaving a share of the main residence to children or a discretionary trust on first death; or other assets up to the value of the standard nil rate band (£325,000). The RNRB will not be used and will be available for transfer to the surviving spouse.

  • Making lifetime gifts of assets. There is no requirement to survive seven years so there is scope to make gifts even a short time before death and reduce the net estate to a level where the RNRB will not be lost.

Those who have downsized or disposed of their property before death will not lose out on the RNRB, providing there are other assets in the estate that are broadly equal to the lost RNRB and are inherited by children or grandchildren.

While the RNRB will help people to reduce their IHT liability who are planning to leave a main residence to direct descendants, it is important they are informed of the ways they can maximise its use and not take action (or inaction) unwittingly that may result in it being lost. The starting point should be to review wills made before the changes were announced to check whether they are tax efficient.

For wealthy individuals it is unlikely their IHT liability will disappear, so other planning will still be necessary.