A new allowance introduced on 6 April 2017 will significantly increase the inheritance tax threshold for married couples and registered civil partners.
The changes mean that eventually some parents and grandparents will be able to pass on assets worth up to £1m, including a family home, without any IHT being charged.
However, qualifying for the allowance is not straightforward. It is important to be prepared for what is in store.
What is the position now?
When an individual dies, the value of their estate over the nil rate band is liable to IHT at 40% unless it is passed directly to a spouse or registered civil partner. The estate is the value of everything you own including your home.
The nil-rate band threshold means you do not have to pay tax on the first £325,000 of your estate whoever you leave it to. Married couples and registered civil partners can share their thresholds, transferring the unused element of their IHT-free allowance to their living spouse when they die. Doubling up the allowance means a married couple or registered civil partnership can pass on £650,000 tax-free before 40% IHT becomes due.
How will the new allowance work?
As of 6 April 2017 an extra nil-rate band applies when a main residence is passed on to your children or grandchildren.
The main residence allowance will be introduced gradually starting at £100,000 this tax year and rising to £175,000 in April 2020. So, from 2020 a married couple with children will be able to pass on £1m in total - two lots of £325,000 (£650,000) and two lots of £175,000 (£350,000).
Like the standard nil-rate band, the allowance will be transferable to a surviving spouse or registered civil partner. So from 2020 a married couple will be able to pass on assets, including their home, of £1m in total.
||Value of extra allowance
||Total potential IHT allowance per person
Source HMRC: Inheritance tax: residence nil rate band, 8 November 2016
The new relief will only be available if assets are left directly to descendants, which means children, grandchildren, stepchildren, adopted children or foster children. The allowance has no benefits for those without children, grandchildren or direct descendants.
You may have to redraw your will in order to benefit. A lot of older wills hold assets in trust meaning family members are ‘trustees’ rather than direct owners of the assets. You could lose out if your will is not updated.
This is not the only complication of the main residence allowance which may make it less attractive than it first appears. The new allowance will be tapered to withdraw the tax break for estates valued over £2m.
Can you pass on any property?
The main residence allowance only applies to a family home passed to direct descendants.
In theory estates will be exempt up to £1m, but there will be many families whose circumstances mean they won’t benefit from the residential nil-rate band.
What can you do to mitigate IHT?
Fortunately there are lots of exemptions that can help mitigate IHT including gifting assets during your lifetime.
If a gift is regular, comes out of income and does not affect your standard of living, any amount of money can be given away and ignored for IHT.
Investing in small businesses or agricultural property may also offer some relief and pensions can now continue in the bloodline almost in perpetuity.
Life assurance can also be used to reduce a prospective IHT bill. Trusts are another option, and can be used for asset protection purposes as well as estate planning. For example, trusts can be used to protect your family wealth in the event of divorce or if you fear misuse of funds by a future partner, child or in-law. It is also possible to set up special trusts for disabled people or children who have lost a parent.
If you would like to discuss any of the issues raised in this article, please call 020 3201 3900 or contact your local Brewin Dolphin office.
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Please note that this document was prepared as a general guide only and does not constitute tax or legal advice. While we believe it to be correct at the time of writing, Brewin Dolphin is not a tax adviser and tax law is subject to frequent change. Tax treatment depends on your individual circumstances; therefore you should not rely on this information without seeking professional advice from a qualified tax adviser.
Any tax allowances or thresholds mentioned are based on personal circumstances and current legislation, which are subject to change.
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