Inheritance tax: new residence nil rate band
At last it has arrived. From 6 April 2017 there is a new residence nil rate band. More and more families have to pay inheritance tax (IHT) when a relation dies. Simply as a result of higher house prices, many estates are now over the £325,000 IHT free allowance. This allowance is called the nil rate band. The Government is forecasting that inheritance tax across the UK as a whole will increase from £2.9 billion in 2011/2012 to £6.2 billion in 2021/22. The new residence nil rate band will help some families who face the risk of paying IHT. It will increase the individual IHT free allowance by £100,000 upon death, provided you plan to leave a family home to children or grandchildren. This definition includes adopted children, step-children and foster children. The allowance will rise by £25,000 annually over the next three tax years. So in 2018/19 it will be £125,000 per person, £150,000 per person in 2019/20 and £175,000 per person in 2020/21.
Married couples or registered civil partners can pass assets and property to each other during their lifetime or on death without incurring IHT, no matter whether they pass on £50,000 or £50 million. Also, if one spouse died without having used his or her nil rate band or residence nil rate band, the surviving spouse can claim up to 100% of the deceased’s allowance. Therefore a married couple has a combined nil rate band allowance of £650,000 and by 2020 when the full residence nil rate band has come into force, couples will have an additional £350,000 available. So they can pass on a £1 million house to their direct descendants without incurring any IHT.
The rules are incredibly complicated and also of course penalize people who have no direct descendants. It would have been far easier and fairer to simply increase the £325,000 to £500,000. But our tax system is neither fair nor simple and every year it gets worse.
Continuing the analysis the new band will be gradually withdrawn for an estate which is worth more than £2 million even if a home is left to direct descendants. It will be reduced by £1 for every £2 that the value of the estate is more than the £2 million taper threshold.
If the estate includes more than one property, the executors can decide which property should qualify for the residence nil rate band. It seems that the only requirement is that the property had been owned and lived in by the deceased at some stage during their lifetime. But a buy-to-let will not count.
There is also so called “down-sizing relief”. If on or after 8th July 2015 the deceased down-sized or sold his or her home in order to pay, for example, for care fees, provided the previous home would have qualified for the residence nil rate band, and that the deceased left the down-sized property or equivalent assets from the sale to direct descendants, the allowance will still be available.
The new relief does not apply to homes held in discretionary trusts even if direct descendants are included in the beneficiaries.
It is certainly a good idea to review your will to make sure that the wording is going to be consistent with obtaining the new residence nil rate band. Not all trusts disqualify the relief. Some life interest trusts, trusts for bereaved minors, trusts for beneficiaries between the ages of 18 and 25 and trusts for disabled persons may still be worth considering in certain circumstances. Specialist advice will be needed.
One of the complexities in the new arrangement relates to larger estates. If the estate is worth more than £2 million the allowance will be gradually reduced and lost completely with estates over £2.7 million. Couples whose combined estates are around £3 million will no doubt consider diverting certain assets to beneficiaries other than their spouse so that the survivor can still get the benefit of the residence allowance.
At the other end of the scale if the value of your home is less than the maximum available residence nil rate band the allowance is restricted to that value which, for these purposes, is the open market value less any liabilities secured on it, such as a mortgage.
An early tip for 2020 election manifestos – ban this new irritating complexity and instead increase the ordinary IHT allowance from £325,000 to £500,000.