The residence nil-rate band
The Summer Budget in July 2015 announced an enhanced nil-rate band to effectively exempt £1 million of assets from Inheritance Tax (IHT). The proposals have been around for a while and on the surface even sound quite simple, but we thought it would be worth considering them here because the detail is complicated!
The enhancement is coming in the form of a new residence nil-rate band and will be available from 6 April 2017, where a residence passes to a direct descendant on death. The residence part will apply on top of the usual nil-rate band to reduce the tax payable by an estate on death but will be introduced over time:
£100,000 in 6 April 2017 to 5 April 2018
£125,000 in 6 April 2018 to 5 April 2019
£150,000 in 6 April 2019 to 5 April 2020
£175,000 in 6 April 2020 to 5 April 2021
Beyond that the residence nil-rate band is set to rise in line with the Consumer Price Index (CPI). It will be a transferable nil-rate band so if it is unused on the first death, it passes to the surviving spouse to add to his/her own residence nil-rate band. This works in a similar way to the existing transferable nil-rate band of £325,000 although it is worth noting one important difference – it cannot apply to reduce the tax payable on lifetime transfers that become chargeable as a result of not surviving them by seven years.
By 2021 an estate could potentially benefit from two nil-rate bands of £325,000 and a further two residence nil-rate bands of £175,000 i.e. a total of £1 million. IHT is currently payable at 40% on the taxable value of an estate and so the tax saving of the new combined residence nil-rate bands could be worth up to £140,000 by 2020/21.
The legislation also aims to ensure that those who wish to downsize or dispose of their property are not discouraged from doing so. As a result Finance Bill 2016 (which is expected to receive Royal Assent in July 2016) also contains a provision that where the deceased had downsized or ceased to own a residence after 8 July 2015 their estate would still be eligible for the proportion of the residence nil-rate band that would otherwise have been foregone. The detail and mechanism by which this is to be achieved is complicated but should ensure that if an individual downsizes after 8 July 2015, assets of an equivalent value can be passed on free from IHT. This is not of much assistance to anyone who has already sold prior to 8 July 2015. There may even be scope for upsizing(!) to take advantage of the new rules although a whole host of other practical and tax considerations would of course need to be taken into account.
Alongside the proposals, it was also announced that where an estate has total assets of over £2 million the residence nil-rate band will be tapered so that £1 is taken away for every £2 in excess of £2 million. This means couples will need to plan carefully to try and ensure that the benefit of the residence nil-rate band is not lost. A transferable residence nil-rate band is clearly not of benefit if the second estate is so large that it would be wasted and therefore it may be better for the residence nil-rate band to be utilised on the first death. Existing wills may need to be reviewed and it may become more common for wills to provide for both the existing nil-rate band and the residence nil-rate band to be utilised on the first death to reduce the value of the assets passing to the surviving spouse. We consider an admittedly simplified example to illustrate this point.
On Thomas’ death in May 2020, he leaves his entire estate (worth £1.32 million) to his wife, Catherine. Included in Thomas’ assets is a half-share in the family home. The home is valued at £1 million and Thomas’ half-share is valued at £500,000. There is no IHT payable on Thomas’ death due to spouse exemption.
Catherine dies in January 2021 with an estate valued at £2.5 million. On her death Catherine's estate will benefit from her own nil-rate band of £325,000 and a transferable nil-rate band from Thomas of £325,000. However her estate will pay IHT on the balance so the calculation will look as follows:
|Transferable nil-rate band||325,000|
|IHT at 40%||740,000|
The important point is that with a chargeable estate of £2.5 million both the residence nil-rate band of £175,000 and a further transferable residence nil-rate band of £175,000 have been wasted.
If instead Thomas had left his interest in the property to his son, the total nil-rate band available to him (£325,000 + £175,000 = £500,000) would still have prevented an IHT charge but his residence nil-rate band would not have been wasted. Furthermore Catherine’s estate would be reduced to £2 million so she would now be able to benefit from the residence nil-rate band. The IHT calculation for her estate would be as follows:
|Residence nil-rate band||175,000|
|IHT at 40%||600,000|
The total IHT saving, therefore, as a result of the nil-rate bands being used on Thomas’ death is £140,000.
If you would like to discuss this in relation to your own circumstances, please do get in touch.
Date: 17th June, 2016
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