Inheritance tax

As Benjamin Franklin said, the only things certain in life are death and taxes, and inheritance tax (IHT) touches on both.

Inheritance tax is the tax paid on assets (after inheritance tax allowances are deducted) left when someone dies. You can currently pass £325,000 from your estate IHT free. Gifts to each other and charity are exempt from IHT. Any business assets should qualify for business property relief in whole or in part on death depending on meeting the qualification criteria.  

Overview

When you die, the Government assesses how much your estate is worth, then deducts your debts from this to give the value of your estate. Your assets include:

  • Cash in the bank
  • Investments
  • Any property or business you own
  • Vehicles
  • Payouts from life insurance policies

Your estate will owe tax at 40% on anything above the £325,000 inheritance tax threshold when you die (or 36% if you leave at least 10% to a charity).

When you die, any assets left to your spouse or registered civil partner, provided they’re living in the UK, are exempt from inheritance tax. On top of this, your partner’s inheritance tax allowance rises by the amount of your allowance that you didn’t use, meaning together a couple can currently leave £850,000 tax-free.

New Residence Nil-Rate

The introduction of the new Residence Nil-Rate Band from April 2017 offers an opportunity for homeowners to pass an increased amount of assets to their children and other direct descendants on death free of inheritance tax as long as it includes a share of the family home.  Although the allowance can be up to £1,000,000 by 2021 for spouses and registered civil partners who combine their allowances, as with all new areas of legislation the rules are rather complex and require careful consideration.

The  Residence Nil-Rate Band (let’s call it the “RNRB” for short) will be phased in from April 2017 and will increase over 4 years to the maximum of £175,000. It will increase in line with the consumer price index thereafter.

The full RNRB is only available to an individual whose estate does not exceed £2,000,000 as after this point it tapers off until the estate reaches a value of £2,200,000 (2017/18) at which time the RNRB is not available. This limit will increase to £2,350,000 by 2020/21 when the RNRB rises to £175,000 per individual.  Although this sounds a lot, the value of a person’s estate for this purpose is taken as the value before any spouse exemption or other reliefs such as business property relief or agricultural property relief are applied.

For those that do qualify, the RNRB will sit on top of a person’s normal nil rate band for inheritance tax purposes (currently £325,000) so that where one owns a qualifying property and that property is left to direct descendants, one can pass up to £500,000 worth of assets,

including the family home or a share in the family home, to direct descendants. As hinted at by the use of, “direct descendants” this includes not just children but quite a list: stepchildren, adopted children, foster children, children for whom the deceased has been a special guardian, the lineal descendants of these classes of people and their spouses or registered civil partners, or surviving spouses or registered civil partners.

The RNRB can be transferred in a similar way to the normal nil-rate band so that spouses and registered civil partners can potentially leave up to £1,000,000 of assets including the family home to their descendants.

It is important to note that the RNRB is never set off against potentially exempt transfers (“PETs”) that a deceased made in the 7 years immediately preceding death although there are some planning opportunities around making PETs, whether a person survives them or not, if their estate is hovering around the £2m – £2.35m mark. There could also be planning opportunities around the use of a discretionary nil-rate band trust in a will to reduce the value of the estate of a surviving spouse or civil partner to increase the chance of attracting the RNRB on second death. They key is to take specialist advice from a legal or tax advisor on your own personal position.

The legislation setting out the terms of the RNRB is complex and detailed. It includes provisions for what happens as and when a person wishes to downsize or even sell their home, for example, they move into residential care.

There are of course several requirements for the RNRB to be available, the most important of which is that all or part of the family home must pass on to direct descendants.  This must be an absolute gift, an immediate post-death interest, a bereaved minors trust or an 18 to 25 trust. This throws up a difficulty for grandparents of grandchildren for whom this type of trust is unavailable as it seems to mean that a gift over to grandchildren, which includes all or a share of the family home, must be an absolute gift and not a gift contingent on attaining a specified age. Careful thought must therefore be given to this point when preparing your will.

Gifts

You can give any amount away to anyone you wish to give it to in your lifetime. However, you must survive 7 years from the date of the gift for it not to be counted as part of your estate for IHT purposes.

Exemptions

If you do die within 7 years of making the gift or wish to mitigate your IHT liability in other ways you can also:

  • give £3,000 away each tax year inheritance tax-free
  • make gifts to charities and political parties as they are inheritance tax-free
  • you can give £250 each year to everyone you know
  • make gifts in contemplation of marriage; and
  • make gifts out of surplus income.

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