In 2017 the government introduced the Residence Nil Rate Band. The intention was to allow a person to leave a greater share of their home to their children without paying inheritance tax. Overall, the intention was that a married couple who wanted to leave their home to their children would enjoy a tax-free amount of £1m. This sum would consist of "nil rate band" of £325,000, and a "residence nil rate band" of £175,000, per person.
In practice however, the legislation to enact the allowance has proved complex and difficult to navigate. In this article we look at ways in which you could consider structuring your wills to obtain the maximum tax-free sum. A case study at the end highlights the tax savings that can be achieved.
Before we do so, we need to bear in mind a few key points:
- Married couples and civil partners can use each other's residence nil rate bands.
- The allowance is limited to estates worth less than £2m, but this limit is not transferable between spouses or civil partners. If the value of an estate exceeds this, the residence nil rate band is gradually withdrawn.
- Downsizing relief may apply if a person has sold their home and moved to a less valuable one, or has sold their home to pay for residential care fees.
- The allowance is currently worth £150,000, and will rise to £175,000 in April 2020.
Valuable Estates
The first thing to plan for is the value of your estate. Although spouses and civil partners can use each other's allowances, the value limit of £2m is not transferable. Usually, spouses and civil partners will leave their estates to each other on the first death. This causes "bunching" of assets in the estate of the survivor.
In addition, any lump sum death benefits paid out on the first death (such as pension lump sums, life assurance or death-in-service benefits) would normally accrue to the estate of the surviving spouse, where they would count towards the £2m limit.
In a nutshell, couples whose joint estates are likely to be valued at between £2m and £4m (and in some cases even higher) could amend their wills so that a share of the family home is left to the children on the first death. This secures one of the residence nil rate bands and should save up to £70,000 of IHT.
Widowed persons
The transferable element of the residence nil rate band applies to a person whose spouse or civil partner died before them without using some or all of their allowance.
People who have been widowed and who have remarried have further options and should take specialist advice, as it may be possible to make use of three or four residence nil rate bands per couple
Death-bed gifts
In assessing the value of an estate to compare it to the £2m limit, gifts made during lifetime are not taken into account. This offers an opportunity for death-bed planning. If your estate exceeds £2m, and if it is possible to give away sufficient assets to your children to bring your estate below the threshold, then last-minute gifts could ensure you are entitled to claim the residence nil rate band in full, potentially saving up to £140,000 in IHT.
Case Study
Robert and Grace are a married couple with two adult children. This is Grace's second marriage, as she was widowed at an early age; she had no children with her first husband. They own a property worth around £1m, and have savings and investments of approximately £1.5m. Robert has a pension fund worth £500,000 and life insurance of £200,000; in both cases these are due to pay out to Grace on Robert's death.
Robert and Grace have mirror wills. The survivor of them inherits the estate of the other and on the second death the estate is divided equally between their children.
Robert dies first (after April 2020); there is no IHT on his death as everything passes to Grace free from IHT due to the spouse exemption. Grace opts to take Robert's Pension as a lump sum and claims the insurance payment. At this point, Grace's estate is worth £3.2m.
On Grace's later death, she is not entitled to the residence nil rate band as her estate comfortably exceeds the £2m threshold, and is higher even than the £2.7m tapered limited. Inheritance tax of £1.02m is due on her estate, as follows:
- Property: £1,000,000
- Savings and Investments*: £2,200,000
- Total Assets: £3,200,000
- Less 2x Nil Rate Band: -£650,000
- Taxable Estate: £2,550,000
- Tax at 40%: £1,020,000
*Includes Robert's pension lump sum and the life assurance payment
Instead, Robert and Grace could have structured their estate as follows:
- Robert could have left a share in the family home worth £175,000 to the children on his death. His estate on death was valued at £1.25m, under the £2m limit and he is entitled to the residence nil rate band in full. No IHT is due on his estate as everything else passes to Grace, free from IHT.
- Grace, shortly before her death, transferred all but £100,000 of her cash and investments to her children in equal shares. As she did not survive 7 years from the date of the gift, the value of it remains subject to IHT, but does not count towards her estate for residence nil rate band purposes.
- Grace's executors claim the transferable residence nil rate band from her first husband's estate.
The IHT position in Grace's estate in this case would be:
- Share in family home: £825,000
- Cash and investments: £100,000
- Total Assets: £925,000
- Value of gifts made in the 7 years before death: £2,100,000
- Less 2x Nil Rate Band: -£650,000
- Less 2x Residence Nil Rate Band: -£350,000
- Taxable Estate: £2,025,000
- Tax at 40%: £810,000
In making best use of the residence nil rate band, Robert and Grace have increased the amount their children inherit by £210,000. A further tax saving of £130,000 could have been achieved if Robert gave as much as possible to the children on his death, as Grace's executors are likely to have been able to claim the transferable nil rate band of her first husband as well.
Our Advice
The structuring of tax efficient Wills and the drafting of such documents is a highly technical area of law that requires specialist advice. Making gifts late in life, particularly deathbed gifts need to be given careful consideration to ensure that there are no adverse tax charges and the transactions are completed in accordance with legal requirements. The Private Wealth team at Trowers & Hamlins is ideally placed to assist you and your advisers in respect of your estate planning.