So, how does this actually work and who will benefit from this increase in the Inheritance Tax allowance ?
IHT was introduced in the UK in 1986 and applies on death with the potential to catch some transfers made by a deceased individual during their lifetime particularly in the 7 years before their death.
At present, each taxpayer has a "nil rate band" of £325,000, and no tax is paid where the value of an estate (including certain gifts made in the 7 years prior to death) sits below this threshold. Once exceeded however, the remaining estate is usually taxed at 40%.
There are some exemptions from IHT so that even where the value of an estate exceeds the nil rate band, no IHT is charged. Common examples include where estate passes to a surviving spouse or civil partner or to a charity.
Nil rate bands can be transferred between spouses and civil partners so that where on the death of the first spouse or civil partner, the whole estate is left to the surviving spouse/civil partner, there is a combined nil rate band of £650,000 available on the second death.
What is the new Inheritance Tax Allowance?
- The government confirmed its intention to introduce a new residence "allowance" as an addition to the standard nil rate band and this will apply where the deceased leaves his or her interest in a property which has at some point been his/her main residence (although not necessarily at the time of death) to one or more "direct descendants". For these purposes, it is understood that "direct descendants" will include children, adopted children, stepchildren, foster children as well as grandchildren.
- The new residence nil rate band will be the lower of (1) the net value of the interest in the residence and (2) the maximum nil rate band. The maximum nil rate band will start at £100,000 per person from April 2017 and increase by £25,000 for each year after that, up to £175,000 by 2020/21.
- The residence nil rate band can be transferred between spouses and civil partners and therefore combined for use on the second death if the property passes to the surviving spouse or partner initially, provided the other criteria are met, providing an effective combined nil rate band of £1 million.
How does this affect planning?
For those at a later stage in their lives contemplating downsizing, this is still possible. An inheritance tax "credit" would be given to cover the sale proceeds received, provided these are being left to a "direct descendant". It is recommended that provision is made in Wills to take account of this.
Families whose largest asset is the family home and whose other wealth (including the property) keeps them below the combined rate of £1 million, will from 2020/21, find themselves able to pass on their whole estate free of IHT; a potential maximum tax saving of £140,000.
For those who have already prepared tax efficient Wills, it is well worth reviewing these now to consider how these changes may impact and whether these need to be updated.
For others, is there any planning which can be done now in Wills or otherwise to take account of these changes? The likely answer is yes and we can help.
For those who may not be eligible for the allowance (for example if they do not have children or other qualifying "direct descendants") or for those whose estates are valued at over £2 million meaning that they may not qualify or only qualify at a reduced rate, advice should be taken to consider the IHT exposure and the planning which could be done now or in the future. The announcement that the standard nil rate band will remain frozen at £325,000 until 2021 makes this even more important.
We are expecting a consultation to be published later this year which will outline some of the finer detail. It is proposed that the new allowance will not come into effect until April 2017 and will not reach the highest rate until April 2020, so there is time to review existing arrangements and your IHT position to consider how these changes are likely to impact.
For further advice please contact Sue Hunter on the details below.