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Making the most of the new family home allowance

The new ‘residential nil-rate band’ is most welcome and could save you £140,000 in inheritance tax (IHT). However, it’s not as widely available as some announcements may have lead you to expect.

Residential nil-rate band

The residential nil-rate band came in from 6 April 2017. It applies to transfers of a residence to direct descendants on death and is initially £100,000 for the first year, meaning that amount is inheritance tax (IHT) free. The band is to rise by £25,000 each year until it reaches £175,000 in April 2020.

For many estates this will be a welcome extra nil-rate band, particularly as it is transferable. This means that, on the second death of a married couple (or civil partnership), there could be two nil-rate bands and two residential nil-rate bands making £1,000,000 in total which is IHT-free from 2020. However, there are some points to be aware of:

  • For estates of more than £2,000,000 (before deducting any reliefs or exemptions), the RNRB will be reduced by £1 for every £2 above £2,000,000. This means an effective IHT tax rate of 60% kicks in on the first part over £2,000,000.
  • For estates likely to be over £2,000,000, some planning with lifetime gifts may be appropriate to avoid this. It may also be desirable to look at making transfers on a first death to ensure the estate on a second death is not above £2,000,000. With careful planning, a couple with a combined estate of £4,000,000 could pass their estates on death to their descendants with £1,000,000 being at nil rate and none at the effective 60% rate.
  • In such circumstances however it is likely that much more could be done, but it does illustrate the strange effects of these new rules that require careful consideration.
  • The additional nil-rate band has to be claimed.
  • The residence must be left to a descendant. This means that wills leaving the home to, say, a daughter-in-law or a brother may need reviewing to ensure that the estate will qualify for the relief.
  • If a home is sold before death, it will be important to check that the estate still qualifies. In some cases it will also apply where a home has already been sold on moving into a care home.

Wills with old nil-rate band trusts

Each spouse or civil partner is entitled to an IHT nil-rate band – currently £325,000, with the excess taxed at 40%. Only since 2007 has it been possible for the unused nil rate band on the first death to be transferred to the surviving spouse.

Prior to this, a transfer on death to a surviving spouse was exempt (and still is), but effectively the benefit of the nil rate band was lost as the combined estate ended up in the hands of the surviving spouse with only one nil-rate band available on their death. For this reason, it was common to include a trust in wills to ensure that the nil-rate band was used on death by transferring some assets into trust, thereby reducing the value of the surviving spouse’s estate. In general, this is no longer necessary and such a trust may complicate matters and hinder further IHT planning.

However, there are circumstances in which it may be good planning to have such a trust. One is to avoid the 60% band on the second death as mentioned above. Another is if the estate consists largely of a main residence which may rise in value faster than the nil-rate band (which is currently frozen), when it may be worthwhile having a part interest in the home pass to a trust on the first death.

Wills including clauses to create nil-rate band should be reviewed.

If you would like us to review your family’s wills and inheritance tax position with a view to maximising the benefit of the residential nil rate band and identifying other potential IHT planning opportunities, please get in touch with your usual Shipleys contact

Need more help? Please contact us at advice@shipleys.com or +44 (0)20 7312 0000