With the new financial year started, there are some inheritance tax changes from this month which could mean significant inheritance tax savings for some. But not everyone will benefit and the rules are (unsurprisingly) complex.
Major changes to inheritance tax (IHT) begin today (April 6, 2017) that could help people pass on the family home to their children without the tax becoming due.
It follows a promise made by former chancellor George Osborne to the Conservative Party conference in 2007 that, ‘The next Conservative government will raise the inheritance tax threshold to £1 million’. Of course this never happened because of the 2010 coalition.
However, the new planned changes will mean no tax is due on up to £1 million including the family home for some people from April 6, 2020. The change will be phased in over four years and this month sees the start of it.
In 2017/18, if a person dies and leaves their home to their children or grandchildren, their estate can be free of IHT up to £425,000. Where a widow or widower dies, the estate could be free of IHT up to £850,000. The change can mean a saving of up to £40,000 on the tax due and double that for the estate of a widow or widower.
How the inheritance tax change works
The first £325,000 of an estate is already free of inheritance tax. That amount is called the nil rate band.
If a widow or widower (including civil partners, of course) dies and their late spouse had left them everything, as is now sensible, then their heirs get a double nil rate band of £650,000.
Those rules are not changing, but from April 6 an additional nil rate band can be added to the £325,000. Another £100,000 can be added if the situation meets the following criteria:
- The home of the deceased is worth at least £100,000. If it is worth less, the nil rate band increases by the value of the home. The value is the market valuation at the date of death less any loan on the house such as equity release or a mortgage.
- The home is left to direct descendants: great-grandchildren, grandchildren, children – including adopted, step and foster children – but not nieces, nephews, brothers, sisters or parents.
The extra allowance is called the residence nil rate band (RNRB) and it will rise from £100,000 in £25,000 steps to reach £175,000 by April 2020.
How will the inheritance tax change affect large estates?
The new RNRB will be reduced if the value of the whole estate is more than £2 million. The reduction will be at the rate of £1 for every £2 above £2m. So the £100,000 RNRB in 2016/17 will disappear as the estate value reaches £2.2m.
If the deceased person owned more than one home the heirs will be able to choose which one is nominated for the nil rate band to apply to. But it can only be a home the deceased has lived in for some time.
This means buy-to-let properties cannot be counted. However, an overseas home can be nominated if it forms part of the estate and IHT is due on it in the UK.
Inheritance tax and downsizing
If the deceased sold their home to live in a smaller one or live with relatives or in a care home at any time from July 8, 2015 (when the new rules were announced), the value of the original home can be used in some circumstances.
This rule is complex – seek professional advice if you plan to make use of it.
Will the inheritance tax changes affect lifetime gifts?
This new rule is in addition to the existing ways to reduce the value of your estate by making gifts during your life. If you live seven years from the date of the gift, then it will not count at all.
Gifts of up to £3,000 a year in total do not count towards your estate even if you die within seven years of making them. If you made no gifts last tax year you can carry forward that £3,000 allowance and give £6,000 this tax year.
You can also give up to £5,000 for your child’s wedding, £2,500 for that of a grandchild or great- grandchild and £1,000 for anyone else’s. You can also give up to £250 a year to any number of individuals (but they cannot also benefit from other exemptions). All these are not counted in your estate.
If your income exceeds your needs, the surplus can be given away without coming into the calculation. Gifts to your children (not grandchildren) while they are in full-time education to pay for fees or maintenance are also free of IHT.
Get advice on the inheritance tax changes
These residence nil rate band (RNRB) rules are new and can be complex.
If they apply to an estate you are dealing with it is sensible to get professional advice from an accountant. If you pay the wrong amount of IHT you may be subject to penalties.
How and when is inheritance tax paid?
Someone who dies from April 6, 2020 when the changes are fully phased in may have a total nil rate band of £325,000 + £175,000 = £500,000. The same doubling up will apply for widows and widowers whose late spouse left everything to them. So when they die there will be a maximum total nil rate band of £650,000 + £350,000 = £1 million.
The tax saving will be up to £70,000 for a single estate and £140,000 for the estate of a widow/er and will help protect most family homes from IHT. By 2020/21 this change is expected to cost the Treasury – and save heirs – nearly £1 billion a year.