Inheritance Tax – can you escape the net?
In the Summer Budget 2015 George Osborne, Chancellor of the Exchequer, announced changes to the inheritance tax (IHT) regulations including a new inheritance tax allowance taking effect from 6 April 2017. He said in his budget speech that the wish to pass something on to your children is “about the most basic, human and natural aspiration there is. Yet today there are more families pulled into the inheritance tax net than ever before – and the number is set to double over the next five years. It’s not fair and we will act.” In this article we look at what the current rules are and the implementation of the new changes coming into force from 6 April 2017.
What are the current rules?
IHT is currently levied at a rate of 40% on the value of an estate above the tax-free Nil Rate Band, which is currently £325,000 per person. The Nil Rate Band has been frozen at this level since 2009. As such, if your estate is worth more than £325,000, any excess will be taxed at 40%.
Married couples and civil partners are entitled to combine their allowance, so they can pass on assets worth up to £650,000 before an inheritance tax charge is triggered.
What are the new rules?
From 6 April 2017, the Government will implement a “family home allowance,” in addition to the existing £325,000 tax-free allowance.
This means that individuals will eventually be able to pass on assets worth up to £500,000, including a family home, without their estate paying any IHT. For married couples and civil partners this adds up to a combined tax-free allowance of £1 million. The family home allowance will increase in line with the Consumer Prices Index measure of inflation from 2021/22 onwards. It is important to note that the underlying Nil Rate Band will remain frozen at £325,000 until 2020/21.
Do the rules apply to everyone?
If your estate is worth more than £2 million then the family home allowance available to you will be progressively tapered down at a rate of £1 for every £2 over this threshold.
The £2 million taper threshold will increase in line with the Consumer Prices Index from 2021/22 onwards, to keep pace with increases in the family home allowance.
At present, any unused Nil Rate Band can be transferred to a surviving spouse or civil partner. The same rules will apply to the new family home allowance, provided the second spouse or civil partner of a couple dies on or after 6 April 2017, irrespective of when the first of the couple died.
The family home allowance can only be applied to one residential property, although personal representatives will be able to nominate which property should qualify if there is more than one in the estate. To qualify a property must have been a residence of the deceased at some time, and as such the rules will not apply to most buy-to-let properties. Further, the property must be passed to a direct descendant in order to benefit from the relief. This includes children, stepchildren, adopted children and foster children, and also applies to later descendants such as grandchildren and later lineal issue.
What if I downsize?
The family home allowance will also remain available when a person downsizes to a smaller property or sells their home completely on or after 8 July 2015. Assets of an equivalent value can be passed on death to direct descendants. This flexibility is designed to remove any incentive for the wealthy to continue to live in large family homes just because tax rules make it more beneficial. It is hoped that the rules may lead to an increase in selling, which in turn will positively impact the supply of housing stock for young growing families, which is an increasingly important policy objective for the Government.
The downsizing rules are still subject to change as the Government is currently operating a consultation on this topic. The rules will be finalised in the Finance Act 2016.
How much will the new IHT threshold save you?
The new rules are best explained by considering an example.
Let us consider a couple with a home valued at £600,000, and with other assets valued at £750,000. Under the existing IHT rules, and assuming transfer of the full Nil Rate Band on the first death, the estate of the surviving spouse would suffer tax of £280,000 on death.
It is apparent that the new rules can significantly reduce the IHT payable on death, and perhaps more importantly this can enhance the assets that can be passed down to future generations. For many of our clients ensuring the financial stability of their children and families is a main priority. The new rules, when combined with sensible planning, can allow this objective to be achieved.