The Inheritance Tax (IHT) rules are going to be changing next month with the introduction of a new allowance, the RESIDENTIAL NIL RATE BAND (RNRB). Andrew Milburn, the Head of our Wills and Probate department, explains the changes, and offers an opinion on how it might work.
The good news is that, for some, the tax payable after their death with be reduced or even eliminated completely.
Unfortunately, the RNRB is far from simple. I suspect that in the years that follow, lots of estates are going to end up paying tax which could and should have been easily avoided.
What are the current rules?
When somebody dies, a calculation is made to determine whether their estate has to pay IHT. Everybody currently has a nil rate band (NRB) which is the amount they can leave to whoever they like without having to pay tax. The NRB is currently £325,000 and it’s set to stay at that level until at least 2021. Therefore, at present, an individual can leave a net estate of up to £325,000 without paying any tax. Anything over that is taxed at 40%. Anything left to a spouse, civil partner or charity is exempt so doesn’t use any of the NRB.
This is of course a very simplified overview of the rules. Things are a little bit more complicated when considering how married couples’ and civil partners’ estates are calculated and there are various types of assets and gifts that are exempt, which I won’t go into now but if you want to know more, please see here or give me a call.
So what is the RNRB?
The RNRB is an allowance which will be available in addition to the current NRB. However, unlike the NRB, the RNRB comes with strings attached.
Firstly, the RNRB can only be used against an interest in a residence. This doesn’t necessarily mean your current or main home; it could be a property you have lived in at some point. But it can only be used against one property and it is limited to the value of the interest in the property (i.e. the equity). There are a whole set of rules which deal with what happens if the person sold their home or downsized before their death. In short, it’s complicated.
Secondly, the RNRB can only be used if the interest in the residence is being closely inherited, which means the property must be left to lineal descendants. This definition includes children (including step-children, children adopted in or out of the family and foster children) and remoter descendants (grandchildren, great grandchildren etc.). It also includes spouses or civil partners of this class of people.
This means that somebody who has never had children, but who is very close to nephews and nieces and wishes to leave his estate to them, won’t be able to use the RNRB. This leaves him potentially having to pay more tax than somebody who had children. In short, it’s complicated and rather unfair.
How much is the RNRB?
Each individual will have a maximum available RNRB of £100,000 as of 6 April. This will then increase by £25,000 until 2020 when it reaches £175,000, after which time it is due to rise with inflation. Married couples and civil partners can transfer any unused RNRB to each other in a similar way to the current NRB. However, the amount you can actually use is limited to the value of the interest in the property at the date of your death. Therefore, if you have a £100,000 house with a £50,000 mortgage, you will only be able to use £50,000 of the RNRB.
If your estate is worth over £2,000,000, the RNRB reduces by £1 for every £2 your estate exceeds that figure.
What are the potential issues?
We don’t yet know precisely how things will work in practice. However, I think there are a few pitfalls that may catch people out:
If your ‘residence’ has a mortgage, you may be limiting the amount of allowance you can use. By reducing the mortgage (either from savings or, if you have more than one property, by shuffling around the equity) you could significantly reduce the tax bill of your estate.
Lots of people have trusts in their wills. The way in which the RNRB will work with trusts is complicated. Many trusts (including some discretionary trusts) won’t be able to use the RNRB, even if all of the potential beneficiaries of the trust are lineal descendants. This is because the beneficiaries are not directly inheriting.
If grandparents put an age limit on gifts to grandchildren (e.g. they don’t inherit until they are 21), the RNRB won’t be available. However, if there isn’t an age limit (meaning they are absolutely entitled to the gift but somebody has to look after it until they are an adult at 18), it can be used. The logic in this one really escapes me.
My biggest concern is that things which are overly complicated and, lets face it, a bit dull, don’t tend to get much publicity (a fact I’m very aware of whilst writing this article). The RNRB sits pretty firmly in this category. Therefore, I suspect the many intricacies of these rules will slip under a lot of people’s radars.
Is there anything I need to be doing?
For many, now is a very good time to review your will, or make a will if you haven’t done so already. I provide a free ‘will checking service’ which means I will take a look at you existing will for free and tell you whether I think you need to take any action. If I think you do need to amend the will, I will tell you how much it will cost and then you can decide what to do. Call me today on 0800 988 7756.