INHERITANCE tax – that's the tax on what you have been taxed on . . . . again and again.
To believe the fable that this is a tax on the rich to stop them passing their estates down and keeping them rich is time badly spent.
The ‘rich’ have this well taken care of in other ways, and as such the Office for Budget Responsibility calculate 30,000 families will be clobbered with an inheritance Tax bill (IHT) in 2016/17 for £4.7 billion rising to £6.2bn by 2021/22. In summary – that’s a lot.
And so the new changes in IHT will be of good news to some who take advantage of it, but not for others.
Currently you are allowed to pass a nil rate band of £325,000 free of IHT to beneficiaries, with the rest being taxed at 40 per cent. If you leave 10 per cent of your estate to charity, this tax is reduced to 36 per cent.
A new additional rate band on top of this was introduced in April called the residence nil rate band (RNRB). In 2017 to 2018 this nil rate band is £100,000 per person, which rises by £25,000 for each year up to a maximum of £175,000 for deaths in 2020/21. After that, it will increase with the consumer price index.
Those with estates in excess of £2 million will lose £1 of the allowance for every £2 over the £2m, so at £2.35m this additional nil rate band is lost.
The perception is that only joint estates with assets over £1 million will now have tax to pay. Unfortunately, it’s not as simple as that and there are a few items to be wary of.
The normal main nil rate band (£325,000), however, is now frozen until 2021, resulting in those who are unmarried, those who don’t leave to children or grandchildren, or those who don’t have a property, facing a tax hike.
Looking at the final year of the fixed increase – 2020/21, to take advantage of the new RNRB, your property will have to be worth at least £175,000 if single, or £350,000 if you are married as it solely applies to your home.
The RNRB is limited to one residential property rather than a spread across properties, so your executors will have to nominate one property, but remember, if you haven’t lived in a property (such as a buy to let) you cannot use the relief against this.
The RNRB can only be used with direct descendants, so nephews and nieces for example, do not count.
A direct descendant is a child or grandchild or any lineal descendant (e.g. great grandchild) but can also be a stepchild, adopted child, fostered child or a child you have guardianship over. Unfortunately, if you have no direct descendants you cannot use the RNRB.
The RNRB also only applies to transfer on death, so a property transferred before death cannot be used.
In normal IHT planning, a deed of variation is a clever tool used to vary a will after death, with the consent of all beneficiaries, so as to allow for good Inheritance Tax planning.
A deed of variation could therefore be used in this instance to vary the will to ensure the correct proportion of the estate (the family home) went to direct descendants and the remaining assets went elsewhere i.e. to non-direct descendants.
In the past, nil rate band discretionary trusts were commonly often used, but you should speak to your solicitor immediately about these.
Even if the beneficiaries of the trust were direct descendants, a will that passes the estate into a discretionary trust would not qualify for the new RNRB, effectively costing 40 per cent of the £175,000 in tax.
To leave the property into trust you must have a fixed entitlement to the property to a direct descendant rather than the aforementioned ‘discretionary’ trust. Examples of such a trust would be a trust for bereaved minors, a disabled person’s interest trust, a life interest for a qualify beneficiary, or an 18-25 trust.
Trustees of a discretionary trust could, however, make an appointment of the property to direct descendants, which would ensure the new RNRB could be used.
There are many complications, and a trip to your solicitor will be time well spent.
In the meantime there are many different methods to ensure you minimize your inheritance tax liability, for example leaving ‘IHT free’ money inside your pension and using up money outside your pension first. There’s always an answer!
:: If you have a question on inheritance tax or any financial matter, call Darren McKeever on 028 6863 2692, email dmckeever@wwfp.net or visit us on www.wwfp.net. Peter McGahan is the owner of independent financial adviser Worldwide Financial Planning, which is authorised and regulated by the Financial Conduct Authority.
