Inheritance Tax Update
Currently for Inheritance Tax (“IHT”) purposes, the first £325,000 of a person’s estate passes tax-free on death and any sum above this “nil rate band” is taxed at a rate of 40%. A spouse or charity inheriting is not liable to pay any IHT.
Payment of IHT only applies when your children or other non-exempt beneficiaries inherit your estate and the estate value is in excess of both your nil rate band allowance and, regarding your property, the “residential nil rate band” which we will explore further below.
Transferable Nil Rate Band
There is a limited exception where there is an unused allowance of IHT left over from the first spouse’s death to be transferred and used in the second spouse’s estate. In many cases this will mean there will be two nil rate bands available on the second death, meaning that estates with value of up to £650,000 will be free from IHT.
Any gifts to non-exempt beneficiaries made on the first death will be deducted as a proportion from the transferred nil rate band. Also, any lifetime gifts made may by either spouse to non-exempt beneficiaries will reduce the values of the nil rate band available. For example:
Mrs Smith died in late 2003. The nil rate band applicable to her estate would have been £250,000 at that time. Mrs Smith left £25,000 to her son under the terms of her Will and had also made a lifetime gift in early 2003 to her daughter (after annual exemptions) of £25,000. The rest of her estate was gifted to her husband, Mr Smith.
In this case, the estate passing to Mr Smith is exempt from IHT. However, 20% of Mrs Smith’s nil rate band has been used (i.e. £50,000 as a percentage of £250,000) so 80% of the nil rate band could be transferred to Mr Smith’s estate in the future and applied against the nil rate band at that time.
Mr Smith then died in 2015 leaving an estate of £600,000 in total. His own nil rate band is available at £325,000. The 80% of Mrs Smith’s nil rate band is also available to transfer and is worked out as 80% of £325,000, equalling £260,000.
The total nil rate bands available to Mr Smith’s Executors to offset against IHT would be £585,000 (£325,000 plus £260,000). As such the balance, over and above £585,000 being £15,000 would be taxed at 40% resulting in a IHT liability of £6,000.
It is important to bear in mind that if a married couple divorce or a civil partnership is dissolved the transferability of a nil rate band then ceases.
Residence Nil Rate Band (“RNRB”)
Since April 2017, there is also an additional RNRB of £100,000 (increasing to £175,000 by 2020) which now applies in estates where, broadly, a home is being left to children/grandchildren. As with the nil rate band (detailed above) this can also be transferred between spouses and used on the second spouse’s death. It is important to note that whilst the nil rate band can be applied to any assets, the RNRB can only be applied against one property in which the individual has lived in during their lifetime and is either owned at death or was sold after the 8th July 2015.
i) Who is Entitled to the RNRB?
The RNRB applies to deaths on or after 6th April 2017 where the individual has a “qualifying residential interest” which is to be “closely inherited”.
A “qualifying residential interest” is an interest in a dwelling which has been the deceased’s residence at some time during their ownership. This interest is limited to one residential property. It is therefore down to your personal representatives to nominate which residential property should qualify if there is more than one in the estate.
To be “closely inherited”, the qualifying residential interest must either pass to a lineal descendant outright or on certain types of trusts. A lineal descendant will be a child (including a step-child, adopted child or foster child) of the deceased and their lineal descendants, including their spouses. A child of a cohabitee is not a step-child for these purposes.
ii) What is the IHT Allowance Under the RNRB?
The RNRB was introduced from 6th April 2017 at an allowance of £100,000 and will increase as follows:-
2017/2018 £100,000
2018/2019 £125,000
2019/2020 £150,000
2020/2021 £175,000
2021/2022 onwards Increase in line with the Consumer Prices Index
NOTE: If the value of a person’s net estate exceeds £2m the RNRB is reduced at a rate of £1 for every £2 above the £2 million threshold.
iii) Transferring the RNRB
Where a person dies and their estate has not had the benefit of the RNRB then any unused RNRB can be transferred to the deceased’s spouse or civil partner’s estate. This even includes when the first spouse died before 6th April 2017, even though the RNRB wasn’t available at that time. This is irrespective of how long ago the death occurred, what the deceased owned and who inherited the estate at that time.
iv) When is the RNRB Not Available?
Some examples are where the RNRB will not be available include:
- Individuals without children or other lineal descendants or those who are cohabiting. For instance, leaving a property to a sibling or nieces/nephews will not qualify.
- Individuals who rent their home and have chosen to invest their money, for example into an investment portfolio / buy-to-let properties.
- Individuals leaving their estate, including a property, upon the terms of a Discretionary Trust, even if all of the potential beneficiaries are lineal descendants.
- Individuals leaving a property to grandchildren under a typical grandparent settlement such as “to such of my grandchildren as shall attain the age of 21” as this is not a relevant property trust.
If you would like to discuss any of the above issues then please feel free to contact us on 01245 504904 to book an appointment to discuss these in more detail. More information on these issues and IHT generally can also be found in our Guide to Inheritance Tax Planning and Solutions.
The author: Chris Kelly
