Inheritance Tax (IHT) planning can save your loved ones thousands of pounds in tax following your death. To be effective though, actions need to be taken in advance, so it is essential to keep up-to-date with the tax legislation surrounding IHT so you can ensure you are making savings. In 2015, a new tax relief for IHT on family homes was announced, to be available from 2017.
Inheritance tax – a recap
Inheritance tax is charged on the value of your “estate” when you die. This includes all your assets; your home, car, jewellery, savings, investments, other valuables such as art pieces and any overseas land or property.
There is a tax-free allowance of £325,000 per person and £650,000 for a married couple or those in a civil partnership. This limit has been frozen since 2009.
After the assets are valued and the allowance deducted, tax is then applied at 40 percent.
IHT can sting even those with moderate wealth
Some people are caught in the trap of thinking that only the very wealthy are affected by IHT.
These days this isn’t the case. If you consider property, which is just one item taxable under IHT, the recent rise in property prices alone gives property owners significant wealth in their bricks and mortar.
If you own a mortgage-free house worth over £325,000, you have already reached the tax-free threshold. Subsequently, the latest change to the IHT regulations, factors in the growing wealth stored in property.
Nil rate of IHT for your family home
In the 2015 Budget, the government recognised the growing wealth of a family home and have taken measures to adapt the tax system accordingly.
From 2017, there will be a new, separate nil-rate band just for family homes, referred to as Residence Nil Rate Band (RNRB).
As the tax-free allowance for IHT has been frozen until 2020/2021, it will be important to utilise the new RNRB allowances available.
By 2020, the RNRB allowance will be £175,000 per person. Therefore, along with the IHT tax-free allowance of £325,000, an individual with assets that include equity in a family home, has an overall tax-free allowance of up to 500,000. For a married couple or civil partners it is up to £1 million.
This new tax-free allowance will be phased in as follows:
“Family Home” Nil Rate tax bands
Rules and regulations:
- The value of the Residence Nil-Rate Band (RNRB) will be the net value of the interest in the property (i.e. after deducting the mortgage), or the maximum amount of the nil-rate band, whichever is the lower of the two.
- Only one property can qualify as your “main residence” in cases where an estate contains more than one property – it is possible to nominate which property though
- If a property was never your residence, such as a pure buy-to-let investment property, this won’t qualify for a RNRB
- The allowance can be transferred between spouses, but a claim needs to be made within two years
- If the net value of the estate is in excess of £2 million, the RNRB is tapered; £1 for every £2 above £2 million.
- There is also the option for pensioners that downsize to claim an IHT tax credit if they pass-on their larger property to growing families.
Inheritance Tax savings with the new relief
The table below shows the IHT savings that could be made when the allowances are available to claim on the main residence:
Inheritance tax planning for contractors
Contractors can earn high levels of income over their working lifetime and subsequently many can afford a good size family home. Subsequently, this new allowance will be of value in the future to reduce the value of your estate for tax purposes.
Wider IHT planning is also essential to attempt to reduce the size of your estate throughout your life.
One popular way to do this is by regularly “gifting” money to your children, or other family members.
Many people these days take the attitude they would rather see their loved ones enjoy their wealth during their life, than necessarily leave it as a legacy in their will.
For a gift or transfer to be exempt from IHT, the “gifter” must survive for seven years following the transaction. This is not a new rule, but remains an integral part of tax planning for IHT.
It is also possible to gift wealth to your spouse or civil partner. Here the seven year rule doesn’t apply, however, when the surviving partner dies, the IHT will be applied if the estate exceeds the taxable threshold for married couples, currently £650,000.