Inheritance Tax is a Voluntary Tax
In (Oct 07) announcements by the Chancellor Alistair Darling have given some married couples a false sense of security that they do not need to worry about planning for Inheritance Tax - and yet decisions made when writing a Will today, by individuals or couples, could impact the money being lost to the family for generations to come.
The change is often talked about as doubling the Nil Rate Band (NRB) for married couples - but, as you might expect with tax matters, it is not that simple. In any event, simply relying on the new rules misses the opportunities for protecting family inheritance against not just tax but also Care Fees and many other problems.
If you made Wills which exploited the old IHT rules they remain valid. However, as with all Wills, it will be sensible to review them in due course to see if they remain appropriate for your situation.
This is a complex area, and the best advice is to speak to a Will writer to analyse your situation and find the most appropriate courses of action, but if you really want to know more then read on.
After certain special assets (such as an appropriate business) have been ignored for IHT purposes each person can pass on an initial amount free of tax - we often call it the Nil Rate Band (NRB). Currently this is £325,000 (2019/2020), and tends to be increased roughly in line with inflation. However, anything passing to your legal spouse (or civil partner) is tax free and does not use the NRB. The same applies to gifts to charity.
Anything above the NRB is taxed at 40% - so leaving £326,000 to other family members this year you would be taxed on £1,000 giving a bill of £400.
The New Rules (beware if completing your own Probate on the first death)
Under the new rules, if the 1st to die of a married couple did not use all of their NRB allowance then the unused proportion can be claimed by the executors of the estate of their widow(er) as and when the 2nd one passes away. This will require good record keeping by the executors on the 1st death, and extra forms to complete on the 2nd death.
- An example:- The 1st member of a couple leaves all their estate to their widow(er) so the full amount exploits the spouse exemption, leaving the NRB completely unused. Then the widow(er) passes away 2 years later, and their executors can claim a full additional NRB (in 2 year's time the NRB is planned to be £325,000, so that will be £650,000 passing tax free).
- A different example:- On the 1st death gifts totalling £150,000 were made directly to family, using up half of the NRB allowance. Then suppose the widow(er) dies a couple of years later, the executors can claim an extra 50% of the NRB that applies at the time of the 2nd death (that is £150,000 passing tax free on 1st death, and then in 2 year's time the executors could claim an extra 50% NRB on top of £325,00 i.e. £487,500 giving a grand total of £637,500 having passed tax free)
These new rules only apply to those legally married (or in a civil partnership) at the time of the 1st death. It does not matter how long ago the 1st death occurred, but the 2nd death has to be on or after 9th October 2007 for the executors to be able to go back and make the claim for the unused portion. Should the widow(er) marry again at some point, the unused portion can still be claimed - but in order to achieve the most effective use of the NRB allowances both members of the new couple really should not leave everything to each other but should consult their Will maker about making more sophisticated Wills. If someone is unfortunate enough to be widowed multiple times their executors can claim multiple partial NRBs as available - but to a maximum of one full extra NRB.
If you simply live together the rules do not apply. If you were divorced before your ex-spouse died then there is also no benefit. Confused? Probably. As ever, the details of what is involved can catch out the unwary.
Confused? Probably. As ever, the details of what is involved can catch out the unwary.
Think that Inheritance Tax does not apply to you? Well, with the high price of houses plus payout from life insurance policies or death-in-service benefit from work then increasing numbers of families fall into this tax bracket. Remember, even if your estate is not hit by the tax, the way in which you set up your Will can reduce the tax that would be paid when money passes from your children on to your grandchildren.
Residential Nil Rate Band
Residential Nil Rate Band (Does Not apply if you have no children or grandchildren) ( other Conditions apply) The measure will take effect for relevant transfers on death on or after 6 April 2017. It will apply to reduce the tax payable by an estate on death; it won’t apply to reduce the tax payable on lifetime transfers that are chargeable as a result of death. The main residence nil-rate band will be transferable where 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 nil-rate band will continue to be £325,000 from 2018 to 2019 until the end of 2020 to 2021.
Current law Section 7 of the Inheritance Tax Act 1984 (IHTA) provides for the rates of IHT to be as set out in the table in Schedule 1 to that Act. The current table provides that the nil-rate band is £325,000. IHT is charged at a rate of 40% on the chargeable value of an estate, above the nil-rate band, after taking into account the value of any chargeable lifetime transfers. The chargeable value is the value after deducting any liabilities, reliefs and exemptions that apply.
Where an estate qualifies for spouse or civil partner exemption, the unused proportion of the nil-rate band when the first of the couple dies can be transferred to the estate of the surviving spouse or civil partner, sections 8A-C IHTA. The nil-rate band can be transferred when the surviving spouse or civil partner dies on or after 9 October 2007, irrespective of when the first of the couple died, so that the nil-rate band can be up to £650,000. There’s currently no specific exemption for a residence, or for assets being transferred to children and other direct descendants. Section 8(3) to Finance Act 2010 provides for the nil-rate band to be frozen at £325,000 up to and including 2014 to 2015. Section 117 and paragraph 2 of Schedule 25 to Finance Act 2014 extends the freeze on the nil-rate band until the end of 2017 to 2018.
Proposed Revisions Legislation will be introduced in Summer Finance Bill 2015 to provide for an additional main residence nil-rate band for an estate if the deceased’s interest in a residential property, which has been their residence at some point and is included in their estate, is left to one or more direct descendants on death. The value of the main residence nil-rate band for an estate will be the lower of the net value of the interest in the residential property (after deducting any liabilities such a mortgage) or the maximum amount of the band. The maximum amount will be phased in so that it is: • £100,000 for 2017 to 2018 • £125,000 for 2018 to 2019 • £150,000 for 2019 to 2020 • £175,000 for 2020 to 2021 It will then increase in line with CPI for subsequent years. The qualifying residential interest will be limited to one residential property but personal representatives will be able to nominate which residential property should qualify if there’s more than one in the estate. A property which was never a residence of the deceased, such as a buy-to-let property, won’t qualify. A direct descendant will be a child (including a step-child, adopted child or foster child) of the deceased and their lineal descendants. A claim will have to be made on the death of a person’s surviving spouse or civil partner to transfer any unused proportion of the additional nil-rate band unused by the person on their death, in the same way that the existing nil-rate band can be transferred. If the net value of the estate (after deducting any liabilities but before reliefs and exemptions) is above £2 million, the additional nil-rate band will be tapered away by £1 for every £2 that the net value exceeds that amount. The taper threshold at which the additional nil-rate band is gradually withdrawn will rise in line with CPI from 2021 to 2022 onwards. The legislation will also extend the current freeze of the existing nil-rate band at £325,000 until the end of 2020 to 2021. In addition, legislation in Finance Bill 2016 will provide that where part of the main residence nil-rate band might be lost because the deceased had downsized to a less valuable residence or had ceased to own a residence on or after 8 July 2015, that part will still be available provided the deceased left that smaller residence, or assets of equivalent value, to direct descendants. However, the total amount available won’t exceed the maximum available residence nil-rate band. The technical details of how the additional nil-rate band will be enhanced to support those who have downsized or ceased to own their home will be the subject of a consultation to be published in September 2015 ahead of the draft Finance Bill 2016.
Giving Money Away
Some people try to give money away during their lifetime, to reduce the eventual tax bill. This means that you can enjoy seeing your family have the benefit of it - but again, you should be very careful about leaving yourself worse off now just to save tax in the future. There are rules that can catch you out, such as a £3,000 annual limit and a 7-year claw-back. See Below.
Large or Complex Estates
Where an estate is especially large, or includes items such as a Business, specialist solutions may be required to maximise the tax benefits. Your Will maker works with appropriate financial advisors to create a solution specific to your situation - please ask for details.
Inheritance Tax Limits
The planned Nil Rate Band limits for coming years have been published in the Budget, and are shown here along with more recent years. The Nil rate band is Frozen.
If you give away money and other assets with the view of saving inheritance tax you need to be aware of the rules - otherwise it may all be in vain.
When you pass away, your estate is counted as including anything that you gave away in the last 7 years of your life, but with some elements omitted:-
- £250 - you can give up to a total of £250 within any one year, to any number of individuals without it counting towards your estate. But be clear - if you give someone £200 for their birthday and £200 for Christmas, then their individual total is £400 and so it may count towards your estate.
- £3,000 - where an individual receives more than £250 from you in a year, you can give up to an overall total of £3,000 within the year without it counting towards your estate. So, a gift of £1,000 to each of two children would not be counted, but a gift of £2,000 to each of two children totals £4,000 and will count towards your estate.
- There are special rules on marriage - you can give up to £5,000 as a marriage gift to your child, and up to £2,500 if it is your grandchild, or up to £1,000 to anyone else - beyond these limits the gift will count towards your annual limit and beyond would be caught in the 7 year count-back.
Each member of a couple has their own limits, so together you could be giving away £6,000 per year. If you do not fully use a limit in a given year it can be rolled forward, but only to the next year and no further. There is nothing to stop you giving more than these limits - it is just that if you die within 7 years the gift will count for tax purposes. However, for very large gifts there is a tapering of the tax payable after year-3 up to year-7. If the gifts are caught by this 7-year rule, even if they are not large enough to generate a tax bill in their own right, they would use up some of the available tax free allowance (the Nil Rate Band) and thereby reduce the amount of unused NRB that could be transferred to your widow(er). By the way, these limits have NOTHING to do with avoiding paying Long Term Care Fees - that is, there is no limit below which the authorities have to consider that gifts are not deliberate Deprivation of Assets. When making a gift it has to be genuine e.g. if you give your house to your children but continue to live in it rent-free then tax issues such as Pre-Owned Asset Tax (POAT) and Gift with Reservation of Benefit (GROB) will apply.