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8 things you need to know about inheritance tax

Increasing numbers of people might become liable for inheritance tax payments if property prices continue their historic trend. However, 2016’s new inheritance tax legislation and residence nil rate band may ease this problem for some. Legislation is constantly evolving, so you should be reviewing your will regularly – perhaps every five years.

 

1. The nil rate band has been frozen

Inheritance tax is a tax on the estate of someone who has died. There’s normally no tax to pay if the value of the estate is below the current nil rate band (NRB) of £325,000 – married couples and civil partners can have a joint allowance of £650,000 – but any assets above these thresholds are taxed at 40%.
 
The NRB, which was set in 2009, has now been frozen by HMRC until 5 April 2021. So, if assets increase in value during this time, more people will come to own estates worth more than the £325,000 limit, thereby making them liable for inheritance tax. “However, there are various exemptions that need to be considered,” says Paul McKie, Wealth Planning Director at Sanlam. “For example, if you leave everything to your spouse, civil partner or a charity, there is no tax to pay.”
 

2. Wills need to be reviewed and updated

It is a common misconception that having a will in place mitigates your inheritance tax liability. In fact, the main purpose of a will is to dictate who will inherit your assets. It also helps to speed up the probate process. “Legislation is constantly evolving, so you should be reviewing your will regularly – perhaps every five years, if there are no significant changes in the meantime,” advises McKie. “If the will contradicts the legislation, then you could end up paying unnecessary tax.”
 

3. Property will be treated separately…

Property is one area set to significantly eat into the NRB, or potentially exceed it. Because of this, many people consider giving away or ‘gifting’ their property to children, which may reduce their inheritance tax liability, but this does remove the security and control of owning a home in old age. To try to combat this issue, the Government is introducing a new residence nil rate band (RNRB).
 
“As the name suggests, it considers property specifically,” says McKie, “and will be phased in over a four-year period, starting from the 2017/18 tax year. It is available to everybody and does potentially solve some problems.”
 
The RNRB is only available where the main residence passes to children – including step, foster or adopted – or linear descendants on death. “It is important to note that RNRB could be lost if the property is directed into a discretionary trust,” says McKie, “so any existing wills should be reviewed to ensure that they benefit from the new rule changes. In London and the South East in particular, though, properties can be so expensive that they will go above the threshold and people will lose out anyway.”
 

4. … but large estate owners may not benefit

The RNRB will be reduced by £1 for every £2 that the deceased net estate exceeds £2m. So, when it is introduced in 2017, any estate worth more than £2.2m will lose all of the additional benefit. By 2021, when the full allowance of £175,000 is in force, estates worth more than £2.35m will lose all of the extra allowance. These individuals should consider some good-quality planning to mitigate the tax.
 

5. Both nil rate band types are transferable

Both the RNRB and NRB can be transferred between spouses and civil partners. In other words, the unused percentage of the NRB or RNRB can be transferred from the estate of one spouse to the other and then claimed on the second death. “You can do some planning to utilise the NRB effectively,” says McKie. “For example, you can give your NRB band to your children or grandchildren to avoid it being included in the spousal exemption.”
 

6. Downsizing can be accommodated…

The Government recognises that people may wish to downsize to a smaller property later in life, often with a lower value. If this happens, the RNRB that applied to someone’s former property can be retained and still be applied to their estate if the replacement property and assets form part of the estate, and if these properties and assets pass to direct descendants. This means that the family home doesn’t need to be owned on death to qualify.
 

7. … but multiple homes do not qualify

You can only elect one residential property to qualify for the relief, and it will be down to the personal representatives of the estate to elect the appropriate one. This cannot be a property that’s never been their main residence, such as a buy-to-let property. “It’s something to be aware of if you have two or three properties and have lived in them all,” says McKie. “One may be worth more than the others, because of the location for example, so you can elect that and make the allowances work more efficiently.”
 

8. Property ownership can make a difference

Many people own their homes as ‘joint tenants’, so they have equal rights to the whole property. This means that on the first death, the house automatically passes to the surviving spouse with no inheritance tax. In this scenario, the NRB and RNRB are also passed to the surviving spouse – so, if the estate is valued at more than £2m on the death of second person, the tapering rules will apply; but above £2.2m (in 2017), the full allowance will be lost.
 
“However, switching the property ownership to ‘tenants in common’ can add some flexibility,” says McKie. “This enables each spouse to own different shares of the property and then control who receives their share when they die. This could preserve both spouses’ RNRB by keeping each of their assets below the £2m threshold.”
 
Speak to your financial adviser to learn how inheritance tax regulation applies to you

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