Inheritance Tax (IHT) is payable mainly on the estates of deceased individuals but can also apply to certain lifetime transfers of assets into trust.
The IHT nil rate band has been frozen at £325,000 since April 2009 and there have been calls to increase this amount given the impact on relatively modest sized estates. Unsurprisingly the total receipts from IHT collected by HM Revenue & Customs has almost doubled from £2.4 billion in 2009-10 to £4.7 billion for 2015-16.
Transfer of Nil Rate Band
For married couples and civil partnerships most estates are left to the surviving spouse or civil partner resulting in a nil IHT liability on the first death. From October 2007 a change was made to allow any unused nil rate band (NRB) on the first death to be used in calculating any IHT due on the subsequent death of the second spouse or civil partner.
This welcome new rule applies even where the first spouse died prior to October 2007 with the amount available being determined by applying the percentage of the NRB unused on the first death to the amount of the nil rate band at the time of the second death. Given that many years could pass prior to the death of the surviving spouse, it is recommended that a full record of the estate of the first spouse is filed with the will and supporting estate documents of the surviving spouse.
Albert died in June 2002 with a total estate of £500,000. He left £125,000 to his son Graham and the remainder to his widow Pat. At the time of Albert’s death the IHT nil rate band was £250,000. Pat died in June 2015 leaving a total estate of £600,000 to her son Graham.
- On Albert’s death in 2002 there would have been a nil IHT liability as the legacy to his son of £125,000 was less than available nil rate band of £250,000, only 50% having being used at that time. The remaining estate left to Pat his widow would have been exempt from IHT.
- On Pat’s death in 2015 the IHT on her estate would have been calculated as follows:
Total estate of £600,000 less £325k own NRB + 50% x £325k unused NRB
= Taxable estate of £112,500 @ 40% = a £45,000 Inheritance Tax liability
Main Residence Nil Rate Band
In 2016 it was announced that from 6 April 2017 a transferable ‘Residence Nil Rate Band’ (RNRB) was to be phased in over 4 tax years as follows:
2020-21 £175,000 (and then increased in line with the consumer price index)
Note that the above maximum amounts are available to EACH spouse or civil partner.
Rather than increase the existing nil rate band (which will continue to be frozen at £325,000 until the end of the 2020/21 tax year) the Government has decided to provide an additional residence nil rate band which will only be available where an individual’s main residence is bequeathed (either under a will or on intestacy) to their direct descendents on death.
There is therefore a maximum potential IHT saving of £140,000 (2 x £175,000 = 350,000 @ 40%) where the family home eventually passes to children on the death of the surviving spouse. By 2020-21 a family could therefore avoid IHT on up to £1 million of wealth as each parent will have a nil rate band of £325,000 plus a RNRB of up to £175,000.
The detailed rules of the RNRB are complex but the following list covers the main points:
- A direct descendent is determined as a child (including a stepchild, adopted child or foster child) of the deceased and their lineal descendents.
- Only one residence per estate will qualify for the new RNRB. Note a property which has never been a residence of the deceased, such as buy-to-let or other investment properties, will not qualify.
- Where the value of an estate (net of any liabilities) is greater than £2 million the RNRB will be tapered away by £1 for every £2 of estate. The relief is therefore lost completely when an estate reaches £2.35 million (£2.7 million for a surviving spouse).
- Existing IHT reliefs such as Business Property Relief are ignored in determining the value of the net estate for this purpose.
- If a qualifying residence is worth less than the available RNRB then any unused allowance cannot be offset against other assets within the taxable estate.
- Where the RNRB is unused on the death of a spouse or civil partner then this will be available on the second death in the same way that the unused percentage of the existing general nil rate band can be transferred and claimed.
- Complex rules exist to ensure that an individual is not disadvantaged where they downsize their main residence in later life.
- Where a residence or the related sale proceeds are gifted within 7 years of death, whether to a direct descendent or not, the RNRB will not be available to set against that particular gift.
As with all estate planning, individual circumstances, potential lifetime gifts and the make-up of an estate will need to be considered carefully to ensure the most effective use is made of the existing nil rate band and particularly the new residence nil rate band when it comes into force in April 2017. Existing wills should certainly be carefully reviewed in light of the proposed changes. A deed of variation following the death of either spouse can also be useful in IHT mitigation.
Possible Changes in 2016 Autumn Statement
Note that the above article is subject to any changes announced in the 2016 Autumn Statement which the new Chancellor, Phillip Hammond, will present on Wednesday 23 November 2016.
A summary of all the key announcements from the Autumn Statement will be available to view on our website from 9am on 24 November 2016 at www.marshvision.com