This article examines the recent UK changes to UK inheritance tax, and the vexed question of the residence nil rate band.
The rules governing UK inheritance taxes are famously complex. Last year, the UK government reportedly was looking to simplify the IHT system. A change introduced a few years ago contains a trap for the unwary – something called the Residence Nil Rate Band. The author of this item is Danjuma Mshelia, of BDB Pitmans.
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The history of the Residence Nil Rate Band dates back to the Conservative Party’s 2007 statement, where George Osborne (later becoming finance minister) promised to increase the nil rate band (NRB) from £325,000 ($416,022) to £1 million. What was eventually introduced in 2015 was a far cry from a simple increase of the NRB to £1 million. In reality, what was introduced was a set of complex rules (the RNRB), which has made it important for clients to review their wills in order to benefit from them.
Individuals are liable to inheritance tax (IHT) at 40 per cent on the value of their assets in excess of £325,000 on their death. For married couples, or civil partners, any unused NRB can be transferred to the surviving spouse’s estate. This can increase the NRB to £650,000 on the second death.
The RNRB is available where:
-- An individual dies on/after 6 April 2017;
-- The estate included a home, or a share of it; and
-- The home was inherited by a lineal descendant.
The amount of the RNRB increases in each tax year:
-- £100,000 in 2017/18
-- £125,000 in 2018/19
-- £150,000 in 2019/20
-- £175,000 in 2020/21
-- Thereafter it increases in line with the Consumer Prices Index.
An individual’s NRB can be £500,000 (£325,000 + £175,000) by 2020/21. The RNRB can be transferred in a similar manner to the NRB, so the NRB can be £1 million on the second death.
The home must have been lived in by the deceased at some stage for the RNRB to apply.
If the deceased owned more than one property, their executors can nominate one home to qualify for the RNRB, provided that the deceased lived in it at one point.
A property that has not been lived in (e.g. a buy to let property) will not qualify. However, if the deceased occupied job-related accommodation, but intended to occupy another home owned by them, the RNRB could apply.
Downsizing rules apply where individuals move to a less valuable home, or cease to own a home. Here, the RNRB can still apply, provided that the downsizing occurred on or after 8 July 2015 and some part of the estate is inherited by a lineal descendant.
The home must be inherited by a lineal descendant for the RNRB to apply. The definition of lineal descendants includes children, stepchildren, foster children, adopted children and their own lineal descendants - it does not include nieces and nephews.
Where an estate exceeds £2 million, the allowance is withdrawn by £1 for every £2 over this threshold. The result of this is that if the deceased had assets worth more than £2.35 million, in 2021/22, their estate cannot benefit from the RNRB at all.
The £2 million threshold does not include lifetime gifts made by the deceased, so in certain scenarios it may be tax efficient to make lifetime gifts to bring an estate below the threshold in order to qualify for the RNRB.
Impact on will drafting
It is necessary to review wills in light of the RNRB in order to benefit from the tax saving. Issues that could arise are:
-- Spouses will not benefit from the RNRB if they leave their estates to each other in their wills, so that by the second death the combined estate is above the £2m threshold. The wills could, instead, be structured in such a way that both estates benefit from the RNRB;
-- Certain trusts in wills (e.g. discretionary trusts) are excluded from benefitting from the RNRB; and
-- Gifts to lineal descendants subject to an age contingency (e.g. to children at the age of 25) will not benefit from the RNRB because the home will not be “inherited” by a lineal descendant.
The scope of the RNRB is greatly limited as it is of use to estates that are valued between £650,000 and £2.35 million (in 2020/21) only, provided that the RNRB conditions are satisfied. This, in turn, severely limits the scope of the RNRB. Nevertheless, it is important for clients to review their wills in light of the new rules, as it is does present a valuable tax saving if the conditions are satisfied.