At 40%, inheritance tax (IHT) is one of the highest rates of any tax. IHT mitigation is therefore an important part of any financial plan and the new ‘residential nil rate band’ (RNRB) could play a useful part. However, this new relief is more complex than it first appears and it could lead people to change their wills unnecessarily.
The nil rate band (NRB) is the allowance that all UK domiciled individuals have to offset against their estate before IHT is payable. This has been fixed at £325,000 since April 2009. Prior to 2009, it increased in line with inflation for the previous 15 years, so freezing it has been a tax rise through the back door.
Since 2007, the NRB allowance has been transferable between spouses. A married couple will have an allowance of £650,000 to offset against their joint estate before IHT becomes payable at 40%.
The combination of a static NRB and rising house prices has led to many families selling the family home in order to meet the IHT liability, normally on second death. The Conservatives initially pledged to increase the joint NRB to £1 million, but this never materialised as the change was deemed unaffordable.
Rather than just increasing the NRB to a lower degree - which would have been clearer and of greater benefit to most people – the government introduced the RNRB. This is effectively a top-up allowance that will run alongside the existing NRB and is available solely to offset against the deceased’s residence.
How the new relief will work
The RNRB will phase in from April 2017. It will start at £100,000 per individual, increasing to £175,000 by
In simple terms, if an individual owns a property worth £400,000 and has savings and investments of £100,000, the estate would currently suffer an IHT charge of £70,000. By 2020, the IHT charge on this estate would reduce to zero.
However, this is not quite as straightforward as it seems.
The relief is only available if the property is left to direct descendants, that is, children and grandchildren - not to nieces, nephews or other beneficiaries. It will start to taper away on estates over £1 million, or £2 million for married couples - for every £2 over, you will lose £1 of relief. This means that couples with a joint estate of over £2.35 million will not benefit at all.
RNRB also incorporates complex rules around downsizing - those who move to a smaller property should still be able to claim the relief that would have been available had they remained in the larger property. Also, the relief can be applied to a holiday home rather than the main residence, if elected.
Typically, married couples choose to leave their assets to each other and thereafter to children. However, most well drafted wills provide for a trust to be established due to the added protection and tax planning opportunities they offer.
As the RNRB will only be available to those who leave their assets directly to their lineal descendants, the initial reaction may be to rewrite their will to remove any trust provisions. However, this could be a knee-jerk reaction as it overlooks the very valuable protection benefits of the trust. It is also difficult at present to predict exactly whether an estate will benefit from this new relief.
A possible option would be to retain the trust provisions but ensure that the trustees have the necessary powers to transfer the property out of the trust to the children or grandchildren after death if appropriate. Provided this is done within two years, the RNRB should still be available to offset without the need to rewrite the will completely.
It would be worth reviewing your will to ensure that your current arrangements are flexible enough to take advantage of this new tax allowance. It may be useful to consult a legal expert as they can explain all the legislation changes and help you best meet your objectives.
The information provided is based on our understanding of current rules and regulations, which may change. The impact of any tax changes will depend on individual circumstances.