12 April 2017
More people than ever before are paying inheritance tax (IHT).
The Office for Budget Responsibility* (OBR), the Government's tax and spending watchdog, reckons just over 30,000 bereaved families will be hit with an IHT bill for the 2016-17 tax year, with the total owed amounting to £4.7bn.
Some 5.4% of estates in 2016-17 were subject to IHT, up from just 2.6% in 2009-10, when the amount raised was only £2.3bn.
In the years ahead, however, there’s good news and bad to come on IHT. On the downside, the OBR forecasts that the tax take will increase even further, to £6.2bn by the 2021-22 tax year. More happily, a new allowance, introduced today 6th April, will help many people, by taking more of the value of the family home out of the reach of IHT. Since the rapid rise in house prices, now 40% higher than at the end of 2008**, has been a major factor in rising IHT bills, the new residence nil rate band (RNRB) will be warmly welcomed by many.
Until the end of the 2016-17 tax year, IHT was typically payable at 40% on the value of all of someone’s estate above the “nil rate band”, which has been stuck at £325,000 since 2009. When one partner in a married couple or a civil partnership dies, they can pass on their assets and their nil rate band entitlement to their spouse, which effectively means the band is worth £650,000 to a couple.
There are no plans to change the nil rate band for the foreseeable future. However, between the 2017-18 and 2020-21 tax years, the Government is phasing in the RNRB in addition to the existing allowance – the RNRB is worth £100,000 per person this year and will rise to £175,000 by 2020-21. For many people, the total value of the IHT-free allowance will then be £500,000 per person; and like the nil-rate band, married couples and civil partners can pass it to one another, so the allowance will be worth £1m to them.
The RNRB in practice
To see how that works, imagine that Mr and Mrs Jones jointly own a house worth £750,000 and have savings and other assets worth £250,000 – so that their estate is worth £1m in total. Now imagine that Mr Jones had died in 2015 and left his entire estate to his wife. Under the pre-2017 rules, Mrs Jones’s death would have resulted in a £140,000 IHT bill for the couple’s children from the estate, since 40% tax would have been payable on the remaining £350,000 after their joint nil-rate band of £650,000.
Now imagine that Mr Jones doesn’t pass away until 2021. By then, Mrs Jones will be entitled to inherit a £500,000 IHT allowance from her husband – the nil-rate band of £325,000, plus the new £175,000 RNRB. She gets the same allowance in her own right, taking the couple’s total allowance to £1m. There is now no IHT at all for the children to pay from the estate they inherit from their parents.
In practice, the family’s tax saving is a two-stage process.
The couple’s new RNRB allowance of £175,000 per person takes £350,000 of the family home out of tax. The remaining £400,000 of their property and £250,000 savings is covered by their £650,000 nil-rate band allowance.
Caveats to beware
Firstly, the RNRB only applies to residential property you’ve lived in at some stage before your death and must be left to a direct descendant, which typically means children, grandchildren or their partners. So if your estate’s value largely consists of assets other than your home, including property you’ve bought as an investment, the new allowance may be less useful.
Also, the allowance may not be available on more valuable estates. Where a couple’s estate, including the value of the home, is worth more than £2m, the RNRB is progressively withdrawn at a rate of £1 for each £2 over this cap. This means that from April 2020 once a couple’s estate tops £2.7m on second death, there’s no RNRB at all to claim.
In addition, where the family home is held in trust for some reason – for financial planning purposes or to provide a home for a dependant, for example – it may not be eligible for the RNRB. In general, trusts that count towards the value of your estate will be included in the calculation, whereas trusts that fall outside of the estate won’t, but the rules are technical, and you’ll need to take advice on your individual position.
Still, despite the small print, there’s no doubt the RNRB will be useful to many people. The Government estimates around 20,000 families will be taken out of the IHT net each year once the allowance is available in full.
Plan for the future
However, don’t be lulled into a false sense of security – you will still need to think carefully about your potential IHT liability and you may need to take steps to plan for it. In practice, no-one’s position stays static for long – the value of your estate will change over time, even leaving aside changes to your personal circumstances and those of your family.
If you haven’t considered your own position for some time, now is the time to do so. At Chase de Vere, we can help you carry out regular reviews of your potential IHT exposure and work with you to plan ahead. We’ll work out your potential IHT liability right now, take the time to understand your future needs and objectives, and advise you on the best possible solutions taking all of these factors into account.
To request a free initial consultation with one of our local independent financial advisers, call us now on 0345 300 6256.