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Canada Life Article - The £1 million nil rate band is almost here

As promised, the £1m nil rate band is here – well, almost…

 

The Summer Budget last year saw the Government announce that married couples or civil partners can pass on £1m without any inheritance tax (IHT).

 

But is this as good as it first appears?

The simple way of increasing the amount an individual could pass on would have been to increase the standard IHT nil rate band. This amount is currently £325,000 and allows a married couple or those in a civil partnership to pass on up to £650,000 before any IHT is charged. However the Chancellor decided not to increase this, preferring instead to introduce an additional Residence Nil Rate Band (RNRB) to run alongside the standard IHT nil rate band.

He also chose to extend the freeze on the standard IHT nil rate band, meaning that it will now remain at the current level of £325,000 until at least 5 April 2021.

New residence nil rate band

The RNRB will be introduced from April 2017.

Initially it will be set at £100,000 but will increase by £25,000 each year until it reaches £175,000 in April 2020. When coupled with the standard IHT nil rate band, the RNRB will potentially allow individuals to pass on a total of £500,000 before IHT becomes payable. Provided the necessary conditions for the RNRB are satisfied, a married couple or those in a civil partnership will therefore be able to leave £1m free of IHT between them.

The available nil rate bands will look like this for the forthcoming years:

Tax Year
 
Nil Rate Band
 
Residence Nil Rate Band
 
Total for an Individual
 
Total for a married couple
or civil partners
 2016/17
£325,000
 Nil
£325,000
£650,000
 2017/18
£325,000
 £100,000
£425,000
£850,000
 2018/19
£325,000
 £125,000
£450,000
£900,000
 2019/20
£325,000
 £150,000
£475,000
£950,000
 2020/21
£325,000
 £175,000
£500,000
£1,000,000

 

The Government has stated that from April 2021 the standard IHT nil rate band and the RNRB will increase in line with the Consumer Prices Index, rounded up to the nearest £1,000.

Previously, political parties have promised increases, but no increase has happened since April 2009 when the standard IHT nil rate band was increased from £312,000 to £325,000. Sceptical readers may want to wait until 2021 to see if it actually increases, but this freeze has meant that many more individuals pay inheritance tax, some just merely by the fact that they own a property that has seen a rise in its value.

Between 6 April 2009 and 8 July 2015 (when the RNRB was announced), the Halifax Property index had increased by 29.8%. A similar increase in the standard IHT nil rate band would have meant an amount over £420,000 could have been passed on by an individual. Over the same time, the FTSE100 increased by over 100%.

 

The small print

As you would expect, the new residence nil rate band does come with conditions attached and so may not be available or available in full to everyone.

 

Qualifying residential interest

  • The RNRB is available only to those who held a ‘qualifying residential interest’ immediately before their death. Simply, they needed to have owned or had part ownership of a property that was their main residence at some point during the period of ownership.
  • The RNRB cannot be offset against other properties owned by the deceased; for example, buy to let or investment properties. However if the deceased has two homes, then the personal representatives can nominate which property will utilise the RNRB.
  • Any individuals who do not own their home will be unable to utilise the RNRB as they will not have a qualifying residential interest (although a compensatory ‘additional’ RNRB may be available in some cases – for example where the deceased ‘downsized’ or sold a property and then moved into residential care).
  • It will also affect those that have released equity from their property as it is the net value of the home that will be used, so the value of any outstanding loan against the property will have to be deducted from the value to provide the net value to be used.

Descendants

  • In order to pass on a qualifying residential interest and use the RNRB, the property needs to be ‘closely inherited’.
  • This means that the property must either be passed to lineal descendants such as children or grandchildren (this includes adopted children, step-children, fostered children and those under the special guardianship as defined by the Children Act 1989 s14A or equivalent legislation for Scotland and Northern Ireland and their children); or to a spouse, surviving spouse or surviving civil partner of a lineal descendant who has not remarried by the time of the property owner’s death.
  • If an individual, a married couple or civil partners do not have any children or grandchildren that qualify they will be unable to use the RNRB.

Transferring unused allowance

  • Similar to the standard IHT nil rate band, any unused RNRB can be transferred between spouses and civil partners when the second of them dies. The transferable RNRB must be claimed by the legal personal representatives within two years from the end of the month in which the second death occurs.
  • Where the first death occurs before April 2017, an unused RNRB of £100,000 will be deemed to be available for carry forward when the surviving spouse or civil partner subsequently dies. This is the case regardless of whether or not the first to die owned a qualifying residential interest.

Large estates

  • There is a ‘taper threshold’ for large estates which from April 2017 will be set at £2m.
  • In determining whether the £2m threshold is breached it is necessary to ignore reliefs and exemptions. This is an important provision as it means, for example, that one ignores business property relief and agricultural property relief, even though they are taken into account to calculate the liability to IHT.
  • Where an individual leaves an estate in excess of £2m, the RNRB that can apply to their estate is reduced by £1 for every £2 the estate is over this threshold.
  • So, when the RNRB is introduced at its initial level of £100,000, an estate of £2.2m or higher will mean that the deceased will have no RNRB available. When the RNRB is up to its full level of £175,000 in the 2020/21 tax year, estates of £2.35m or greater will not benefit from an RNRB.
  • If the deceased has brought forward an unused RNRB from a spouse or civil partner then this can also be factored in, so some individuals may not see the RNRB fully disappear until the estate is worth in excess of £2.7m.

As you can see, not everyone will benefit from the RNRB.

Example

Now we have given an overview of the RNRB, let us consider an example.

Eric dies in May 2017 leaving a wife, Joan, and their adult son, Arthur. The family home was valued at £400,000 at that time and other assets, such as investments and cash, totalled £1,000,000. Everything was held jointly between Eric and Joan.

Scenario 1 - Eric leaves everything to Joan

  • The spousal exemption applies meaning that ownership of the family home and other assets passes to Joan without any IHT being due and Eric’s standard NRB and RNRB are unused
  • Subsequently, in 2020, Joan dies and leaves her estate to Arthur. At that time the house has increased in value to £600,000 and the other assets to £800,000, giving a total estate of £1.4m.
  • Joan’s executors have her unused standard NRB of £325,000 and as she owns a qualifying residential interest on death, the RNRB is also available to use against her estate. As Eric left everything to Joan, her executors can claim his unused RNRB in addition to his unused standard NRB
  • Joan’s estate can therefore benefit from a total of £1m in nil rate bands; two standard NRBs of £325,000 and two RNRBs of £175,000
  • If the value of the house had been less than £350,000 at the time of Joan’s death, the total amount of RNRB available to Joan would have been limited to the value of the house
  • After allowing for the available nil rate bands, the residual value of the estate of £400,000 and inheritance tax of 40% means a tax liability of £160,000 on the amount being inherited by Arthur.

But what if Eric had utilised his RNRB when he died?

Scenario 2

  • Eric left his share of the family home to Arthur, utilising his RNRB of £100,000. Joan therefore received the remainder of the family home; worth £200,000 and the other assets totalling £700,000.
  • On Joan’s subsequent death, Eric’s RNRB and £100,000 of his standard NRB have already been used, but her executors can claim Eric’s unused standard NRB of £225,000.
  • Joan’s estate consists of one-half of the family home, now worth £300,000, along with the other assets, now valued at £800,000, totalling £1,100,000.
  • The total amount of nil rate bands available to offset against Joan’s estate is equal to £325,000 (Joan’s standard nil rate band) + £225,000 (from Eric) +£175,000 (Joan’s RNRB) = £725,000.
  • A tax liability of 40% exists on £1,100,000 less £725,000 = £375,000, meaning that £150,000 is payable in IHT.


IHT receipts

The RNRB is an additional factor when considering estate planning. Despite the Treasury introducing this additional allowance, the effect of freezing the standard IHT nil rate band means that it still expects IHT receipts to increase over the coming years. Indeed the number of estates making a contribution to IHT will be higher at the end of the decade than in any year since its introduction.

Not only are IHT receipts expected to increase, even after taking into account the residence nil rate band (RNRB), but the number of estates suffering IHT is also expected to increase.

The following chart from HMRC was released with the 2015 Summer Budget and shows the anticipated increase in receipts.

Rate Band

The £1m nil rate band may sound like a great thing, and for the right client it will provide valuable IHT benefits, but not everyone will be able to take advantage of it. Tax planning and professional advice will be vital to ensure that estates and wills are structured in the most tax-efficient way and that clients understand the amount of nil rate band that will be available in their specific circumstances.

Neil Jones
Technical Support Manager
Canada Life Limited

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