Leaving home - 09 November 2015

Are new rules for Inheritance Tax a game-changer for estate planning?

Inheritance Tax (IHT) was once associated with the estates of the aristocracy, but today it’s a part of mainstream financial planning. The IHT nil-rate band for individuals has been frozen at ￡325,000 since 2009 (￡650,000 for couples) and, consequently, those liable to pay 40% on amounts above the threshold are not just the estates of the rich.

While IHT is not the biggest revenue-raiser for the government, it is arguably the most emotive. The main objection is that it is tax on wealth that has already been taxed. Some critics say it is a penalty for hard work and enterprise. Nevertheless there is no plan to abolish it.

The value of a property can itself often be enough to exceed the nil-rate band. If appropriate measures are not in place to mitigate the resulting tax bill, it can force the sale of a much-loved family home, which can be heart-breaking for surviving children.

Promising delivery

Some years ago, the government indicated it would look at raising the IHT nil-rate band; and the political pressure prior to the recent Summer Budget was sufficient for George Osborne to finally draw up plans. He announced that he would fulfil a long-standing commitment by lifting the family home out of IHT for all but the wealthiest individuals. He said: “You can pass up to ￡1 million on to your children free of IHT. No more IHT on family homes.”

Obi Nnochiri, tax and estate planning consultant at St. James’s Place, says that if you didn’t look beyond the headlines you could be forgiven for thinking that you now have a ￡1 million nil-rate band, or that your home is exempt from IHT. “Sadly, it’s not quite as straightforward as that,” he says. “The proposal isn’t to increase the current ‘basic’ nil-rate band. It is a new measure targeted at relieving those with wealth tied up in their home.”

House rules

The new ‘main residence nil-rate band’ will only apply to individuals who pass their residential property to direct descendants (a child, grandchild, step-child, adopted child or foster child) under the terms of their Will. If inheritors are not direct descendants, they cannot benefit from the main residence nil-rate band, with one notable exception: the spouse or civil partner of the direct descendant can benefit if the direct descendant has died.

Furthermore, it is being phased in over four years, starting from 6 April 2017. “It’s not yet in force – it won’t be fully implemented for another five years,” remarks Nnochiri.

Under the existing rules, the value of an individual’s assets and investments are added up in order to calculate IHT. That broader approach will continue, with the exception of the chancellor’s new tax-break extension, which will apply only to property left to a direct descendent.

How the main residence nil-rate band is being phased in

Like the existing basic nil-rate band, any unused allowance will be transferrable to a surviving spouse or civil partner. Nnochiri says: “The theory is that a widow or widower can potentially have a ￡650,000 basic nil-rate band and, from 2020, an additional ￡350,000 nil-rate band for their main residence if it forms part of their estate. This is how the chancellor gets to his ￡1 million figure.”

Those who have never married will only have a main residence nil-rate band of up to ￡175,000, as they have no allowance from a deceased wife or husband to transfer across to their own.

Where the main residence has been sold after 8 July 2015 because the deceased had downsized or had ceased to own a residence, any assets representing the proceeds of sale will still attract the main residence nil-rate band provided they in turn are left to a direct descendant. “This underlines the importance of keeping adequate records so that executors have evidence that the property was owned before 8 July 2015,” advises Nnochiri.

However, if the net value of the estate – not just the residential property value – is above ￡2 million after deducting any liabilities, the main residence nil-rate band will be tapered away by ￡1 for every ￡2 above this threshold.

Home truths

“The main thing to remember is that the main residence nil-rate band does not fully come into effect until 2020/21. A lot can happen between now and then. In the meantime, if you’re a married couple and your total assets including your home are worth more than ￡650,000, or you are a single person with more than ￡325,000, you probably have an IHT liability,” says Nnochiri.

“There are ways to cover your IHT liability, including various forms of life assurance which, when placed in trust, can pay out an agreed sum to descendants on death. The right policy could cover the cost of any IHT bill and make it easier for the people you leave behind. Alternatively, there are various ways to reduce the value of your estate,” he suggests.

A trust issue

Nnochiri also provides a word of caution to those who have placed their home in trust, perhaps for long-term care asset preservation or other IHT purposes. He says: “The new nil-rate band will only apply to those who leave their main residence as part of their estate. Individuals occupying a main residence under the terms of a ‘life interest trust’, or ‘immediate post-death interest trust’, may have to take appropriate action sometime in the future as their home would pass under the terms of the trust, not under the conditions of the Will.”

“It’s certainly not a simple area of financial planning, but your financial adviser will be best placed to give you the right advice,” he adds.

Details of the main residence nil-rate band are still being finalised and draft legislation is expected to be included in the Finance Bill 2016.