A smart way to save Inheritance Tax
In April 2017 a new additional Inheritance Tax, IHT, free allowance was introduced known as the Residence Nil Rate Band or RNRB for short. For those that meet the criteria, this allowance is in addition to the main one which is known as the Nil Rate Band, NRB. This means that each person can potentially qualify for combined IHT allowances of £325,000 (NRB) and £175,000 (RNRB) on death. For the first time married couples can claim combined IHT free allowances of £1 million.
So what is the Residence Nil Rate Band and how do you qualify for it?
The government’s rules state that only ‘direct descendants’ of people who have died can benefit from the RNRB. Direct descendants are described as:
Children and their spouses or civil partners
Grandchildren and their spouses or civil partners
Great-grandchildren and their spouses or civil partners
Children who were under the guardianship of the people passing on their estate.
This means that nephews, nieces, siblings and other relatives will not benefit from the new allowance if a home is passed on to them.
Which properties qualify for the Residence Nil Rate band?
The Residence Nil Rate Band applies to only one home. It must be included in your estate (i.e. counted within the assets you owned directly, or via certain types of trust) and you need to have lived in it at some stage in your life. If you own more than one home, the executor of your estate can nominate which one should be used against the RNRB. The good news is that you don’t have to have lived in or owned the property for a minimum time – it can be any property you’ve lived in at some point. The home doesn’t even have to be in the UK, but whether or not your heirs pay UK Inheritance Tax depends on your ‘domicile’ at the time of your death.
Estates worth more than £2m.
If you have a larger estate, the Residence Nil Rate Band, and therefore the amount you can pass on tax free, reduces gradually, known as ‘tapering’. For every £2 that your estate is over £2m, the Residence Nil Rate Band is reduced by £1. So, if your estate is worth £2.4m in the 2020-21 tax year, you’ll lose the entire RNRB (assuming a single RNRB is available). The table below shows the size of estate when the entire allowance is lost.
How the Inheritance Tax allowance is reduced for estates worth more than £2m
Interestingly there is now a way to shelter potentially a further £350,000 (2 x £175,000 RNRB) from Inheritance Tax and avoid the tapering away of the RNRB.
If you settle a Business Relief qualifying investment into trust, or gift qualifying assets away, you can now utilise the once lost RNRB and gain up to an effective 60% Inheritance Tax saving.
Once an investment is through its 2 year Business Relief qualification window a company called Foresight has the in house capability to settle the investment into a discretionary trust free of charge.
Let’s use the example of a married couple whose estate is worth £2.7m. On the second of their deaths they will be entitled to two Nil Rate Bands of £325,000 each so £650,000 in total. IHT will be payable as follows;
NRBs (x 2) (£650,000)
IHT payable £820,000 (£2,050,000 x 40%)
If instead they were to invest £700,000 into a Business Relief qualifying investment and survive 2 years they would save £280,000 IHT (£700,000 x 40%).
If they were then to gift the asset away or settle it into a discretionary trust they would reduce their estate from £2.7m to £2m therefore fully qualifying for the two Residence Nil Rate Bands worth £350,000 which would save them a further £140,000 (£350,000 x 40%) Inheritance Tax.
This would mean a combined IHT saving of £420,000 reducing their Inheritance Tax bill from £820,000 to £400,000. It is equivalent to 60% tax relief on the £700,000 investment. Quite a large tax saving with just a couple of simple steps.
This is just one of a number of smart ways in which we advise our clients how to save Inheritance Tax. If you are interested in making similar tax savings, then why not get in touch with us?* You know it makes sense.
*The value of investments and the income derived from them may fall as well as rise. You may not get back what you invest. This communication is for general information only and is not intended to be individual advice. You are recommended to seek competent professional advice before taking any action. All statements concerning the tax treatment of products and their benefits are based on our understanding of current tax law and HM Revenue and Customs’ practice. Levels and bases of tax relief are subject to change.