A change to the rules about inheritance tax, which is due to come into force on April 6, could eventually allow married couples and civil partners to leave £1 million of assets to their children, tax free, on death.
The current rules
Under current rules, when someone dies the first £325,000 of their estate is free of inheritance tax (IHT), known as the nil rate band (NRB). However, if a husband and wife leave everything to each other in their wills, then on first death, all assets passing to the surviving spouse are exempt from IHT. This means that none of the NRB is used on first death, and can be transferred to the estate of the surviving spouse on their death. The estate on second death will therefore have a combined NRB of £650,000. Assets over this amount are then subject to IHT at 40 per cent.
The new rules
As of April 6, an additional NRB will be available to individuals, which can be offset against the value of their main residence if this passes to their ‘lineal descendants’, which includes children, grandchildren, step-children, foster children and adopted children.
This will be known as the residence nil rate band (RNRB) and will initially be £100,000. This will increase by £25,000 every financial year until 2020/21 when it will be £175,000.
Like the NRB, the RNRB will also be transferrable between spouses.
So, for example, Mr and Mrs Page have a house worth £350,000 and savings of £650,000. Mr Page dies in 2021, and leaves everything to Mrs Page. At this time everything passes free of IHT and Mr Page’s NRB and RNRB have not been used. Mrs Page then dies and leaves everything to their children equally.
At that time, the estate of Mrs Page will be able to claim her RNRB of £175,000 and Mr Page’s unused RNRB of £175,000, giving a total of £350,000. This means that the house will pass to the children free of IHT.
The estate will also have Mrs Page’s NRB of £325,000 and Mr Page’s unused NRB of £350,000, giving a total of £650,000. All of the other assets of the estate worth £650,000 will also pass to the children free of IHT.
Due to the change in rules, Mrs Page’s estate will have saved £140,000 of IHT.
By 2020/21 married couples and civil partners with children may therefore benefit from the long-awaited £1 million inheritance tax allowance.
A word of warning
The rules around the RNRB are not straightforward and, because of this, wills which have previously been prepared may now need to be reviewed.
For example, a child may predecease their parents. While current wills may anticipate this and include a substitute gift to grandchildren, depending on the wording within the wills, the substitute gift may not qualify for the RNRB. Current wills may also need to be reviewed if they include trusts, as the property may not pass to ‘lineal descendants’.
Difficulties can also arise if a decision is made to downsize, if more than one property is owned, or if unmarried couples have children from previous relationships.
While the rules provide for some of these things, given the potential IHT savings available with the introduction of the RNRB, it is important for people to review their wills and seek advice to ensure the new relief will be captured.
At Hay & Kilner our private client team has extensive experience in preparing wills and IHT planning, and is happy to provide advice and assistance in these matters.
Hay & Kilner
0191 232 8345