The new IHT residential nil rate band – something to think about

IHT which has historically produced relatively low tax inflows to the exchequer has been quietly becoming more and more prevalent over the past few years with an increase of nearly a ¼ in IHT receipts in 2015/16 compared with the prior year.

From April of this year, in addition to the normal nil rate band for inheritance tax purposes (£325k per person), we now have a further nil rate band to consider – the residential nil rate band or RNRB, which once fully introduced in the next few years will be worth £175k per person.

RNRB similar to the normal nil rate band, is potentially transferable between spouses, in certain circumstances a couple may now have an effective IHT free estate of £1 million (or more if they have been widowed and remarried).

There are lots of complicated rules, for example if you don’t have children, you can’t benefit from it.

Due to the level of complexity in the rules, in particular the tapering of the RNRB for estates over £2million, without some thought, married couples who could potentially benefit from the RNRB will not.  

This is best illustrated by an example.  (Note the example is worked on the basis the full RNRB has been introduced and makes a number of assumptions, individual facts will vary):

Jack and Jill have worked hard, Jack sold his business 10 years ago which has left them comfortable and they own jointly:

  • Their home : worth £1 million
  • Other assets worth £1.4 million

Jack has a perfectly standard will which leaves everything to Jill, so no IHT falls due on his death.

On Jill’s death the house is still worth £1 million but the other assets have risen to £1.7 million.

Her IHT bill is therefore calculated as follows:

 

House 1,000,000
Other 1,700,000
  2,700,000
Nil rate band -325,000
Transferable nil rate band -325,000
RNRB and transferable RNRB -350,000
Reduced by 350,000
Chargeable to IHT 2,050,000
   
IHT at 40% £820,000

 

The RNRB taper reduces by £1 the RNRB for every £2 of estate over £2 million.

Suppose instead, in his will Jack left a half share in the house to his children. There would still be no tax due on Jack’s death, as the assets left to his children utilise his nil rate band of £325,000 and RNRB of £175,000 (no taper as his estate was £1.2 million) but on Jill’s death her IHT due is as follows: 

 

House 500,000
Other 1,700,000
  2,200,000
Nil rate band -325,000
Transferable nil rate band -
RNRB 175,000
Reduced by 100,000
Chargeable to IHT 1,800,000
   
IHT at 40% £720,000

 

A saving of £100k

However you can see that she has still not had full benefit of the RBRB as her estate exceeded £2 million.

When working out the taper, the estate value used for this purpose is the actual estate at the point of death, so what happens if shortly prior to Jill’s death she gifts her children £200,000 (it is all left to them in her estate anyway, so all she has done is advance the gift by a short period of time).

Whilst due to the need to survive lifetime gifts by 7 years, the value of her estate is unchanged, by making this gift, the test for the RNRB is against the value of the estate less the gift, or £2 million, so no taper is applied and instead the IHT due is:

 

House 500,000
Other 1,700,000
  2,200,000
Nil rate band -325,000
Transferable nil rate band -
RNRB 175,000
Reduced by -
Chargeable to IHT 1,700,000
   
IHT at 40% £680,000

 

A further £30k saving.

It is unfortunate that due to the complexity of these rules, quite substantially different IHT liabilities can arise depending on now aware and engaged in understanding these rules families are.  The scenarios set out above do not change anything materially in the inheritances made, but there can be £130k difference in the tax liabilities.

Unfortunately IHT is something many of us find difficult to discuss, and in particular “death bed planning” can understandably be the last thing on families minds at what is already a stressful and upsetting time.

We encourage our clients to discuss these matters at an early stage, and to set out at this time, when it’s not so emotional, how they would want their family to address matters at the time IHT is an issue.  An annual review of the IHT exposure is by no means a bad thing and can save a great deal of money.