How to Protect £1m of Your Wealth from Inheritance Tax
Last year the Government announced measures designed to tackle the growing number of estates being drawn into an inheritance tax liability through house price inflation.
The “residence nil-rate band” (RNRB) will eventually allow up to £175,000 of property wealth per person to be passed on with no IHT liability. Added to the existing £325,000 nil-rate band, it means as a couple you can expect to pass on up to £1m free of IHT.
The rules in brief
The key features of the new nil rate band are as follows:
The allowance only relates to your primary residence if you die on or after 6th April 2017 and the family home is transferred on death to your direct descendants.
The transfer on death can be by will, under intestacy or by some other means eg. transfers into trust in limited circumstances
It is fully or partially transferable on first death of your spouse or civil partner in the same way as the standard NRB, provided it is available.
The RNRB will be phased in gradually between 6 April 2017 and 6 April 2020 on the following basis:
£100,000 for the tax year 2017/18
£125,000 for the tax year 2018/19
£150,000 for the tax year 2019/20
and £175,000 for the tax year 2020/21
In subsequent tax years, the RNRB will increase in line with the CPI. The extra allowance will be known as the “residential enhancement”
It will apply to properties sold on or after 8th July 2015 and, importantly, owned prior to this date.
Downsizing and the RNRB
Special rules have just been announced to protect you if you downsize. Broadly speaking, the RNRB will still be available where a sale or downsizing means that equity locked in your property might otherwise be ‘lost’ from the allowance. Providing certain conditions are met the estate will still benefit from the maximum RNRB as if you had died while owning the original property.
The calculations are complex, but here’s one simple example of how this might work in practice:
Let’s assume you sell your home for £250,000 in 2020 and move into residential accommodation.
£500,000 property value / £175,000 available RNRB at time of sale = 285%. The sale of the property is 285% of the RNRB. You would therefore be treated as having entitlement to 100 per cent of the available RNRB on death.
On your death the full £175,000 RNRB is added to the standard £325,000 nil-rate band allowance, giving you a total allowance of £500,000.
Many examples are more complex than this simple one, so get in touch if you would like advice on your individual circumstances.
Other factors to be aware of
As with all such measures, the devil is in the detail and there are factors to be aware of:
Where your main residence is downsized to a lower-value property or sold so the full RNRB can no longer be claimed, the new property – or at least an interest in the new property – must be left to direct descendants on death. If not, the allowance will not apply to your estate.
It is not necessary for your new home to be inherited by direct descendants, however at least some assets must be passed directly to them.
For example, if your estate was worth £1m and assets totalling only £100,000 are passed to direct descendants, only £100,000 of the RNRB can be added to your standard NRB. For a couple, this would take your total IHT-free amount from £650,000 to £750,000.
If the value of your estate on death exceeds £2 million then, broadly, the RNRB will be reduced by £1 for every £2 excess value. This means, for example, that by 2020/21 there will be no RNRB available on first death if the net value of your estate exceeds £2.35 million (£2.7 million on the death of a surviving spouse when a full transferable RNRB is available to your surviving spouse).
This new allowance could become increasingly important, as the Government has announced that the current nil-rate band will now remain frozen at £325,000 until 5 April 2021.
As always, just give me a call if I can help you to better understand what these rules could mean for you.