More and more quite ordinary families are being caught in the Inheritance Tax (IHT) trap. This is mainly due to the rise in the value of the family home. If you imagine the situation when there is an inheritance from two sets of “baby boomer” grandparents who own their own homes. When this inheritance is added to the value of the estates already owned by their children you can see how the value of their estates grows to a significant amount. To help with this, although the basic IHT allowance is not changing until April 2021, from April 2017 the new Residence Nil Rate Band (RNRB) comes into force.

IHT is a tax which can be mitigated with careful planning and without doing anything which could upset the Inland Revenue. Unfortunately many people leave it too late to start planning for what is the final tax on the estate they have worked hard to accumulate and on which they have already paid tax.

Below you will find an explanation of how the new allowance will work and when it will not. You should of course take advice before you take any steps to mitigate IHT. It goes without saying that IHT mitigation should not adversely impact on your life style or become the main focus of your financial planning. Taking the time to talk to an Independent Financial Adviser could be the answer.

The new residence nil rate band could increase the inheritance you can leave for your children by up to £80,000 from April, rising to £140,000 by 2020. There’s a danger you could miss out if you haven’t put the right plans in place to deal with the family home, or if you have a large estate. But with the right planning you could still benefit from additional nil rate band.

To benefit from this additional amount, the family home must pass to direct descendants – that is, children or grandchildren. And to be entitled to the full amount, you will need to keep the value of your individual estates below £2M. Beyond this, the allowance will be tapered, and lost altogether once values pitch beyond £2.35M. But there are planning strategies that may help you stay below the taper threshold, including lifetime gifting made at any time.

How It Works

The residence nil rate band is in addition to the standard Nil Rate Band, which will remain frozen at £325,000 until April 2021. The additional amount will be phased in starting at £100,000 and increasing by £25,000 a year until it reaches £175,000 in April 2020.

These are the maximum amounts. The available allowance will be reduced if the value of the property is less than this, or if the value of an individual’s estate exceeds £2M.

Just like the standard Rate Band, the residence Nil Rate Band will also be transferable between spouses and civil partners on death. So the allowance is not lost if the family home passes to the survivor on first death. This could mean if the second spouse dies after April 2020, a couple could benefit from a combined Nil Rate Band of £1M (2 x £325,000 plus 2 x £175,000).

It also doesn’t matter when the first spouse died or even if they owned a property at all. The first spouse may have died many years before the introduction of the RNRB and the property held in the sole name of the survivor. Even so there will still be allowance which can be transferred to the surviving spouse.

When You Might Lose It

There are two main situations where the residence nil rate band may be lost:

1. Passing the family home to someone or something other than a direct descendant;

2. The allowance is tapered if the estate is greater than £2M.

Planning is therefore important to ensure that an opportunity to claim the additional nil rate band is not wasted.

Who You Leave It To And How You Leave It To Them

The RNRB is only available where the main residence passes to ‘lineal descendants’ on death, which for most people means their children (including adopted, foster or step children) or grandchildren. It’s not, therefore, available for any lifetime planning with the family home. The property doesn’t necessarily have to pass directly to them to qualify – the RNRB will still be available if the property is left via certain types of trust. If the trust gives a child or grandchild an absolute interest or interest in possession in the home, the RNRB can still be claimed. Other trusts such as Bereaved Minor Trusts, 18 – 25 Trusts and Disabled Persons’ Trusts will also retain the additional Nil Rate Band.

However, the Residence Nil Rate Band will be lost where the property is placed into a discretionary will trust for the benefit of the children or grandchildren. Many wills contain discretionary trusts as means of controlling when and to whom benefits are paid. But even if the children or grandchildren are to benefit and actually end up benefiting, the additional Nil Rate Band will be lost.

It’s worth remembering that you don’t necessarily still have to own the property at your death to qualify. There are rules designed to help those who have downsized or may have sold their property and moved into residential care or with a relative since 8 July 2015. Any replacement property and/or assets must form part of the estate and pass to descendants to qualify. And once in the estate, the property does not literally have to be transferred to the children or grandchildren – the executors may choose to sell the property and pay out each beneficiary’s share of the house in cash.

Tapering For Estates Over £2m

The Residence Nil Rate Band will be reduced by £1 for every £2 that the deceased’s estate exceeds £2M.

This will mean 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 2020/21 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.

People with large estates which are likely to face some tapering may want to consider reducing the value of their estate to retain the extra Nil Rate Band. Lifetime gifting can help bring the net estate below the taper threshold. Schemes such as Discounted Gift Trusts or Loan Trusts can help people keep the value of their estates down while still giving access to a regular stream of payments from the trust or the repayment of the outstanding loan. This might ease concerns for people who are not in a position to give up complete access.

It’s also possible to make gifts right up to the date of death to reduce the value of the estate for the purpose of tapering the residence nil rate band. While chargeable transfers including failed PETS will be dragged back into the estate to calculate the taxable estate, they’re not added to the value used for tapering.

Example -Sheila, a widow, has an estate of £2.4M. Shortly before her death in 2017/18 she makes a gift of £400,000 to her son Daniel. On her death her estate is worth £2M and everything, including the family home, passes to Daniel. She has 100% of her husband John’s Nil Rate Band and Residence Nil Rate Band available.

While the gift to Daniel doesn’t reduce the value of the estate subject to IHT, it does allow Sheila’s executors to claim Residence Nil Rate Band for both her and her husband John. By making a gift to Daniel during her lifetime rather than waiting until after her death, there is an overall IHT saving of £80,000.

It’s easy to miss out on the additional Nil Rate Band by not ensuring that estates are distributed in the most efficient way. It’s quite common that on death everything is left to the surviving spouse either through the terms of the will or simply because assets are held as joint tenants. This could mean that the estate on second death is greater than £2M and the unused Residence Nil Rate Band could be lost as a result of tapering. In some circumstances, making gifts on first death to the children and grandchildren may reduce the value of the survivor’s estate and preserve their own RNRB.

 Summary

You may need to rethink how you plan to pass on their wealth including the family home if you want to get the greatest benefit from the additional tax free amount. It may mean you need to revisit your current wills to determine what happens to the family home on death and also start making some lifetime gifts if they may be affected by tapering.