IHT Nil Rate Bands Explained

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Everyone in the current tax year has a tax-free inheritance tax allowance of £325,000. The allowance has remained the same since 2010-11, and will stay frozen until at least 2019.

Inheritance tax thresholds and rates
If you are single and die during the current tax year with an estate worth more than £325,000 (including money, property and investments, but after deducting debts and expenses such as funeral costs), 40% tax will become due on anything above £325,000.

For example, if you leave behind an estate worth £500,000 the tax bill will be £70,000 (40% on £175,000 – the difference between £500,000 and £325,000).

However, you may be able to leave more than this before paying tax if you are married or in a civil partnership. Married couples can combine their IHT allowances so that when the first spouse dies, his or her IHT allowance passes to the surviving spouse. This means that when the second spouse dies, they would have the combined IHT allowance, totalling £650,000.

Residence nil rate
The new IHT Residence Nil Rate Band (RNRB) was introduced in April 2017. It is in addition to an individual’s own nil rate band of £325,000, and conditional on the main residence being passed down to direct descendants (e.g. children, grandchildren).

It will be phased in over 4 years and the full £175,000 allowance will not be available until April 2020. The RNRB will start at £100,000 and will increase by £25,000 each tax year until 2020.

By 2020/21 families could escape IHT on up to £1m of their wealth. Each parent will have a nil-rate band of £325,000 plus a RNRB of up to £175,000.

Of course these are the maximum amounts. The available allowance will be reduced if the value of the property is less than this.

For example, a father dies in 2020/21 and his will gifts his 50% share in the family home to his children. If this share is valued at £140,000, the extra £35,000 of nil rate band will go unused (but may be transferred to his widow).

There are some pitfalls:

1. Tapering the residence nil rate band
Clients with large estates may not see any benefit from the extra nil rate band. The residence nil rate band will be reduced by £1 for every £2 that the deceased’s net estate exceeds £2m.

This will mean that on its introduction there will be no RNRB available if the deceased holds assets of more than £2.2m. This will rise to assets of £2.35m in 2021/22 when the full £175,000 allowance kicks in.

Reliefs such as Business Property Relief and Agricultural Property Relief are ignored when calculating the value of the estate.

2. Who can benefit?
The RNRB is only available where the main residence passes to children (including adopted, foster or step children) or linear descendants on death.

3. What if the family home passes into trust?
The residence nil rate band may be lost where, for example, the property is placed into a discretionary will trust for the benefit of the children or grandchildren.

4. Multiple Residences
Only one residential property will qualify. It will be down to the personal representatives to nominate which residential property should qualify if there is more than one in the estate.

A property which was never a residence of the deceased, such as buy-to-lets, cannot be nominated.

5. Joint tenants and the trap for large estates
Some clients may miss out on the additional nil rate band by not ensuring that their estates are shared in the most efficient way.

Many clients will hold the family home as joint tenants. On the first death this means the house passes to the surviving owner with no IHT because of the spouse exemption. The RNRB is not used on the first death, with the surviving spouse inheriting the full unused allowance. But if the combined estate on the second death is greater than £2m then both RNRBs could be lost due to tapering.

Switching property ownership into tenants in common will allow each spouse to control how the property passes on death, and potentially preserve their entitlements to the RNRB by keeping each partner’s assets below £2m. On the first death, the deceased could use their RNRB by leaving part of their share in the family home to their children.

In turn, this would reduce the value of the survivor’s net estate. And this could be further reduced if the deceased also gives more away up to their ordinary nil rate band of £325,000. So, in total, the survivor’s estate could be reduced by up to £500,000.

6. Reviewing wills
It makes sense to keep wills constantly under review to cater for changing circumstances. And that also includes ensuring legislative change does not adversely impact upon what the deceased would have wanted.

Missing out on the RNRB, by passing the family home into a discretionary trust, for example, could see their executors paying as much as an extra £140,000 in inheritance tax.

A deed of variation may come to the rescue for some where property is passed to an individual. But it can be near impossible to vary a transfer into a discretionary trust which has a wide class of beneficiaries as agreement will be needed from all possible beneficiaries.

For further information on ways to mitigate IHT, read our article on Inheritance Tax – The Basics.

The Financial Conduct Authority does not regulate tax or trust advice.

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