How to make sure you get the full £1 million IHT allowance

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Following the General Election, a score of media headlines were attributed to a new £1 million inheritance tax threshold. On the face of it, this sounded like a welcome tax relief policy, with many people thinking they no longer had to worry about passing on their hard-earned estates to their loved ones.

However, following the publication of the Finance Bill, it has become clear that many estates will not be entitled to such a significant level of relief, as there are a number of pitfalls you have to avoid in ensuring you’re eligible for the full amount.

Whilst nobody likes to think about themselves or their spouse passing away, planning ahead for this inevitability will ensure that your savings and estate are fully passed onto your family.

As it stands, everybody can leave up to £325,000 of their total estate tax free (£650,000 per couple), providing they haven’t used the allowance elsewhere. Anything over this is liable to 40% tax. Under new legislation announced by George Osbourne, an additional ‘main residence nil rate band’ will be phased in over the next five years. From 2017/18, an extra £100,000 per person will in introduced; this will increase by £25,000 every April until 2020, when the maximum sum of £175,000 will be reached. This means that in 2020/2021, a house worth £1m can be passed on tax free.

However there are a number of rules that must be met in order for the last remaining spouse who passes the estate onto their children to benefit from the full allowance.

Here are the key constraints:

  1. The new band will only apply to a property that is the main residence of the deceased
  2. You have to be married – spouses and civil partners can inherit their other half’s nil rate tax band; however unmarried couples cannot, limiting their total IHT allowance to £500,000 in 2020/2021
  3. One of the married couple has to pass away after 6 April 2020 for the full £1m IHT allowance to be available
  4. The surviving partner must own a home worth more than £350,000 when they die
  5. The property has to be left to children or grandchildren – anyone without children or grandchildren, or who wishes to leave their home to someone else, will not benefit
  6. You have to leave your entire estate to your spouse, not just your home. E.g. if you make a charitable donation in your will, then your spouse would not receive the full nil rate band
  7. Neither spouse must have made any gifts or settlements in the seven years proceeding their death e.g. if you gift a large sum of money, perhaps for a house deposit for your children, this erodes the allowance you have to play with
  8. The total estate must be worth less than £2 million

Whilst there are no doubts that many families will benefit from the new allowance, investors who hold large estates worth more than £2m, made up of more than just bricks and mortar, will see their entitlement to the main residence nil band scaled back, with the band being withdrawn at a rate of £1 for every £2 over the threshold.

Furthermore, those who don’t currently hold estates over the £2m threshold and thus don’t currently consider IHT be a concern, could see their estates grow in value over a fairly short timeframe, leaving them open to tax liability which they previously hadn’t planned for.

There are a number of options available to help you plan ahead for the 2020/2021 tax year, when the full allowance will finally be introduced. Investing in shares that qualify for business property relief (BPR), for example, is one alternative  as, unlike gifting money, you only have to wait two years for the sum to become free of inheritance tax and you can realise some or all of your investment after it has been made, something that gifting or trusts do not allow.

To find out how you can make the most of the planned inheritance tax changes, contact your adviser today.

Sources: Citywire and Octopus Investments.

The Financial Conduct Authority does not regulate taxation and trust advice.

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