Finding a way through the Inheritance Tax maze
The ‘residence nil rate band’ can result in an Inheritance Tax saving even if, due to the size of your estate, the prospects for meeting its conditions appear unpromising at first glance.
Families are paying more in Inheritance Tax (IHT) than ever before. Official figures show that the amount collected this year exceeded £5 billion for the first time1; furthermore, the Office for Budget Responsibility predicts that receipts will climb to £6.2 billion by 2020/21.
“Property, asset and investment values have, in general, continued to rise and IHT liabilities with them,” says Tony Wickenden, Executive Director, St. James's Place.
That is not so surprising when you consider that the IHT nil rate band has remained at £325,000 per person since 2009 and will be fixed at this level until at least 2021. “Had the nil rate band been linked to the consumer prices index, it would be £385,000 today,” he says.
IHT revenues are expected to keep rising despite the new ‘residence nil rate band’ (RNRB) being introduced this year, initially at the level of £100,000 per person, increasing over the next three years to £175,000. This works on top of the standard £325,000 nil rate band and is an allowance for people who pass on a property to their children, grandchildren or other lineal descendants. But while the RNRB can ease an IHT burden, it is only useful to those who can satisfy its conditions.
“Aside from having to leave the interest in the qualifying residence to a lineal descendant, it is also important to note that the RNRB is cut back by £1 for every £2 by which an individual’s overall estate exceeds £2 million,” explains Wickenden. “Thus, currently there is no RNRB at all if the deceased holds assets of more than £2.2 million – and remember that business and agricultural assets count towards that threshold even if they qualify for 100% relief”.
However, he is keen to stress that, with some thoughtful tax planning, there are potential opportunities for estates to benefit from the full RNRB – even if, at first sight, that might not seem possible.
First things first?
Many couples choose not to make use of the standard nil rate band on first death, on the basis that, if unused, it can be transferred to their surviving spouse or registered civil partner and claimed on second death. However, leaving assets worth £325,000 to someone other than the surviving spouse on the first death can be beneficial if it keeps the survivor’s estate below the £2 million trigger point for reducing the RNRB on second.
“If you’ve left everything to your spouse, and this causes their estate to exceed £2 million, it may be worth using the £325,000 nil rate band on the first death to leave assets into a trust, so that they don’t consolidate with the estate of the surviving spouse, but remain accessible to them,” says Wickenden.
“Many couples do not realise that even if their estates are individually below £2 million, if the estate on second death is above that figure, all of the RNRB – including any transferable element – could potentially be lost”.
“It’s also worth noting that in determining the value of a deceased’s estate for the purpose of the £2 million trigger point, it’s not necessary to add back gifts made within seven years of death, as you do when calculating the Inheritance Tax liability on the deceased’s estate. This means that making a gift in excess of the £3,000 annual exemption could produce a substantial IHT saving even if the donor fails to survive for seven years”.
In circumstances where the IHT liability cannot be eliminated, it can be worth giving some thought to tax efficiently providing for it through appropriate life assurance held in trust. In addition, it’s important to remember that Wills should be reviewed regularly to ensure that they meet the desired outcome.*
The plan you end up with should be one that is aligned with your objectives in relation to who should benefit on your death and when; and, subject to this, for it all to be done as tax efficiently as possible. In seeking the best possible result for you and your family, it's vital to obtain professional advice.
The levels and bases of taxation, and reliefs from taxation, can change at any time. The value of any tax relief depends on individual circumstances.
* Will writing involves the referral to a service that is separate and distinct to those offered by St. James's Place. Wills and trusts are not regulated by the Financial Conduct Authority.
1 HMRC Tax & Receipts, 21 June 2017.