Your guide to the new inheritance tax rules
But while it’s a nice round number, the new rules contain plenty of complexities that may require something of a re-think when it comes to your IHT plans. “It’s not as simple as it looks,” says Victoria Green, solicitor in the trusts and estates department at law firm Ashfords. “There are plenty of catches and conditions that will mean the £1 million allowance won’t apply to everyone.”
Under the rules, a main residence nil- rate band will be introduced from the start of the 2017/18 tax year. This will effectively top up the nil-rate band (£325,000), initially by £100,000.
The amount will increase each year by £25,000 until it reaches £175,000 in 2020/21. After this point, it will increase in line with inflation. As it will still be possible to transfer any unused main residence nil-rate band to a surviving spouse or civil partner, it could be possible to pass the full £1 million on without paying a penny in IHT.
“The surviving spouse or partner of anyone who dies after 6 April 2017 will be able to claim a late spouse’s or civil partner’s allowance regardless of the date of their death,” says Terry Hill, trust company manager at tax and financial planner, The Fry Group. “But if they weren’t married, they’ll only have their own allowance.”
Another important point to note is that the new main residence nil-rate band can only be used to leave property to direct descendants. But, as well as children and grandchildren, recipients can include adopted, foster and stepchildren.
Although it can’t be used to pass on buy-to-let properties, it does apply to any property you’ve lived in, including overseas homes. There’s also provision for anyone who may have downsized or sold their property to go into a care home. This allows them to claim the nil-rate band against the value of any property they may have owned since 8 July 2015.
Mr Hill says this is a sensible measure, which will discourage people from hanging on to large properties simply to claim the allowance. “If you do downsize, make sure you keep documentation of this so the allowance can be claimed when you die,” he adds.
When £1m isn’t £1m
As the main residence nil-rate band can only be used for property, not everyone will be able to take advantage of the full £1 million.
“A property would need to be worth at least £350,000 for a couple to be able to pass on £1 million IHT-free,” says Ms Green. “If it’s worth less than this, they won’t feel the full benefit.”
As an example, take a married couple with £800,000 of assets living in a property worth the UK average of £188,270, according to Land Registry figures published in January 2016.
Although their estate was worth less than £1 million (£988,270), if the second death occurs in 2020/21, and both of their two nil-rate bands were available, they would only be able to pass on £838,270 IHT-free (2 x £325,000 + £188,270 as it is within the £350,000 available from
two main residence nil-rate bands). The remaining £150,000 would be subject to IHT at 40%, generating a bill of £60,000.
Conversely, if their wealth was split so their property was worth £386,325 and their assets a more meagre £600,000, they would be able to leave their entire estate without paying an IHT.
A disappearing act
Due to a taper system, couples with larger estates won’t necessarily be able to take advantage of the full £1 million allowance, either. If the value of the estate exceeds £2 million, the main residence nil-rate band will be tapered away by £1 for every £2 above this threshold. This threshold is also set to rise in line with CPI from 2021.
Sarah Phillips, a partner at Thomas Eggar solicitors, says this means the additional allowance can disappear very quickly. “In 2020, a couple with an estate worth £2.7 million will get nothing from the main residence nil-rate band. They’ll only be able to use the standard nil-rate band, which would be £650,000 on second death.”
It’s also important to note what constitutes an estate for the purposes of the taper calculation. Although IHT is charged against the value of an estate after the deduction of any liabilities, reliefs and exemptions, the calculation is less generous for the purposes of the taper, ignoring any reliefs and exemptions, such as investments that qualify for business property relief.
Given this, where there’s a risk of the taper coming into effect, some forward- planning can avoid such a drastic hit. Ian Dyall, head of estate planning at financial planning and wealth advice firm Towry, explains: “Where a couple’s estate is in excess of £2 million, if their wills make provision for part of it to be given away on first death, they may be able to keep more of the main residence nil-rate band on second death.”
Take action now
Even if you’re not fortunate enough to be worrying about your £2 million-plus estate, it’s worth spending some time finding out how the new rules will affect you.
If you own a property, working out your liability is fairly straightforward. In terms of nil-rate bands, an individual will have £325,000 plus the lower of the property value or £175,000 for their home when the full allowance is phased in. A married couple can double these figures.
If the value of the estate falls within these figures then, other than making sure your will leaves your property to direct descendants, you won’t need to do anything else. If it exceeds the available nil-rate bands, it may be worth taking professional advice to see what steps could be taken to reduce a future liability.
These could be as simple as making full use of the allowances and exemptions (see box above) or it may require some more structured manoeuvring to maximise the nil- rate bands and keep a future liability to a minimum. But, with everything from the main residence nil-rate band to the value of your property and your estate set to fluctuate, keeping tabs on the figures will help you pass as much as possible to your loved ones.
Easy ways to cut your IHT liability
While the introduction of the main residence nil-rate band may give you a little extra allowance to play with, you can use a number of other IHT planning strategies to reduce a future bill.
- Give money to exempt recipients - Anything you give, or leave, to your husband, wife or civil partner is exempt from IHT. The same is true for gifts to charities, museums, universities, community amateur sports clubs and political parties with two or more MPs or one MP and at least 150,000 votes in a general election.
- Donate to charity to drop your IHT rate - The standard rate of IHT is 40% of everything over the nil-rate band but, if you leave at least 10% of your estate to charity or community amateur sports clubs, the rate your beneficiaries pay on the remainder drops to 36%.
- Take advantage of exempt gifts - As well as a £3,000 annual exemption, which can be carried forward for one year, you can give as many gifts of up to £250 to as many people as you like and these will be outside your estate immediately. Wedding gifts are also exempt, as long as you’re not overly generous. A parent can give £5,000 to a child, a grandparent £2,500, and anyone else £1,000.
- Give excess income - One exempt gift that is often overlooked but can potentially allow you to shift significant sums out of your estate is a regular gift from income. Providing you give income and not capital and, by doing so, your normal lifestyle isn’t affected, you can give away as much as you like.
- Use a potentially exempt transfer - If you want to make gifts that aren’t exempt, for instance large sums of money or valuable antiques or works of art, they will be considered as potentially exempt transfers, or PETs. This means you will need to live a further seven years before they’re outside your estate for IHT purposes.
- Use a trust - A trust can be used where you want to give away assets but retain some control over how they are distributed. This might be useful if you want to give assets to your kids, but you’re concerned they might not yet be mature enough to spend it wisely or their marriage is rocky and might end in divorce.
- Leave it in your pension - Since the new freedoms were introduced, the pension has become one of the most effective IHT planning tools. If you can afford to leave money in your pension, it can be left IHT-free to anyone you like.
- I’ve already downsized. Does that mean I’ve lost the allowance? - It depends when you moved. If it was before 8 July 2015, then unfortunately you won’t be able to take a previous property into account. But if it was on or after this date, make sure you document the move so your executors can use this previous property to claim the allowance.
- My husband died in 2001. Do I get his main residence nil-rate band? - Yes. Providing it has been introduced by the time of your death, your executors will be able to claim double the main residence nil-rate band.
- My partner and I have kids but we’re not married. How will this affect us? - If you’re not married, you won’t be able to able to benefit from IHT-free transfers between spouses or the transferable nil- rate bands. You should seek legal advice to enable you to take full advantage of all available nil-rate bands.
- I want to leave my estate to my nieces and nephews, as well as my stepchildren. How can I keep the tax bill to a minimum? - Although stepchildren can benefit from the main residence allowance, your nieces and nephews can't so ensure your wishes are expressed clearly in your will. Leave property to stepchildren and other assets to nieces and nephews where possible.
An increase in the general level of prices that persists over a period of time. The inflation rate is a measure of the average change over a period, usually 12 months. If inflation is up 4%, this means the price of products and services is 4% higher than a year earlier, requiring we spend and extra 4% to buy the same things we bought 12 months ago and that any savings and investments must generate 4% (after any taxes) to keep pace with inflation. Since 2003, the Bank of England has used the consumer prices index (CPI) as its official measure of inflation (see also retail prices index).
The tax levied on the total value of your estate after you die. IHT has to be paid by the beneficiaries of your estate before they can receive any of the money from it. The money can’t be taken from the value of the estate _– it has to be paid before any money can be released. There is an IHT threshold – known as the “nil-rate band” – below which no tax is levied (£325,000 in 2011/12). Any amount above the nil-rate band is subject to tax at 40%. If your estate totals £600,000, there is no tax on the first £325,000; however your estate will pay 40% tax on the remaining £275,000, a total of £110,000. Prudent tax planning can reduce your IHT liability, so always consult a specialist solicitor.
This is more usually a feature of car insurance but it can also crop up in contents, mobile phone and pet insurance policies. An excess is the amount of money you have to pay before the insurance company starts paying out. The excess makes up the first part of a claim, so if your excess is £100 and your claim is for £500, you would pay the first £100 and the insurer the remaining £400. Many online insures let you set your own excess, but the lower the excess, the more expensive the premium will be.
The Consumer Price Index is the official measure of inflation adopted by the government to set its target. When commentators refer to changes in inflation, they’re actually referring to the CPI. In the June 2010 Budget, Chancellor announced the government’s intention to also use the CPI for the price indexation of benefits, tax credits and public sector pensions from April 2011. (See also Retail Prices Index).
Capital gains tax
If you buy an asset – shares, a second home, arts and antiques – and then sell it at a later date and make a profit, that profit could be subject to CGT. You don’t pay CGT on selling your main home (which is why MPs “flipped” theirs so regularly) or any securities sheltered in an ISA. Individuals get an annual CGT allowance (£10,600 in 2010/2011) but if you have substantial assets it’s worth paying an accountant to sort it for you.
The catch-all term applied to investors who buy properties with the sole intention of letting them to tenants rather than living in them themselves, with the proceeds from the let usually used for the repayment of the mortgage. Buy-to-let investors have to take out specialised mortgages that carry higher interest rates and require a much bigger deposit than a standard mortgage. Other expenditure can include legal fees, income tax (on the rental profits you make), capital gains tax (if you sell the property) and “void” periods when the property is unlet.
Everything you own: all your assets (property, cars, investments, savings, insurance payouts, artwork, furniture etc) minus any liabilities (debts, current bills, payments still owed on assets like cars and houses, credit card balances and other outstanding loans). When you’re alive this is called your wealth; when you’re dead, it becomes your estate.