How the £1m Inheritance Tax Allowance works

How the £1m Inheritance Tax Allowance works

From April 2020, there has been some good tax news in respect of inheritance tax (IHT), as the Residence Nil Rate Band allowance, which has been gradually increasing since 2016 has reached its intended limit of £175,000 per individual.

What does that actually mean?

It means that a married couple with a house and a Will in place that bequeaths this to their children/grand children will now be able to potentially pass a combined estate value of up to £1m, to their children or other non-exempt beneficiaries, before any tax liability would arise.

But there are some conditions and it will leave some families at a disadvantage if they do not have children.

The basics

Each individual has fixed amount of their estate that they can pass on to a non-exempt beneficiary before any inheritance tax liability will arise, referred to as the 'Nil Rate Band' (NRB). This has been set at £325,000 for some time now but unfortunately it does not look like it is going to increase anytime soon, unless the Government have a significant change of ideas..

Anything that passes to charity or to a lawful spouse can claim a relief and is entirely free of tax. There are some other reliefs available, but for a straight forward estate without businesses and farms to consider, Spouse and Charity reliefs are the most common. Spouses and Charities are considered exempt beneficiaries.

Since October 2007 executors have been able to claim to transfer the unused percentage of, nil rate band from one deceased spouse's estate to the estate of the surviving spouse. This allows a surviving spouse's estate to have a combined NRB allowance of £650,000 to pass on to non-exempt beneficiaries, such as children.

The government then in April 2016 introduced the new 'Residence Nil Rate Band' (RNRB) starting at £100,000 for each individual, increasing to £175,000 over four years to April 2020.

The unused percentage of the RNRB is also transferrable between spouses (TRNRB), where it was not claimed in full or used on the first death.

This means that where a couple, have on the first death left everything to each other and on the second death left everything to qualifying beneficiaries, the second estate will now have a potential allowance of up £1m, before any inheritance tax will be due.

Conditions

To claim the residence nil rate band, the main or sole matrimonial home will have to be passed to direct descendants, either as a specific gift or as part of the residue of the estate.This usually means being part of a Will for the married couple.

The definition of 'direct descendants' is wider than many might think, and includes step-children and grandchildren.

The allowance can also only be claimed up to the value of the property. A £200,000 property, therefore, passing to children will only be able to claim an allowance of £200,000 of the combined £350,000 potentially available.

Where a £500,000 property, however is being passed to children on the second death, the full RNRB and TRNRB will be available (£350,000) the remaining £150,000 value in the property will then be combined with the remaining estate using up the standard NRB.

Although not everyone will benefit, it does mean that those more traditional families will be able to pass up to £1m of assets and property on, before any tax liability will arise.

For more details tax planning advice and further advice on other exemptions and reliefs that may be available get in touch with us!

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