Residence nil-rate band part 2

In part 1 we outlined the main rules for the new residence nil rate band, an additional threshold for inheritance tax planning. It is fair to say a simple concept has turned out to be a complex reality, which raises a number of planning questions and concerns for advisers and individuals.
Key facts
  • The residence nil-rate band was introduced from 6 April 2017.
  • It is available to estates where the person dies after 6 April 2017 provided certain conditions are met.
  • It is tapered away by £1 for every £2 if the estate is valued at £2 million or above.
  • Where there are two qualifying properties, the personal representatives must decide which one to nominate as the qualifying one for residence nil-rate band.

The current level of nil rate band, set at £325,000 from April 2009, has been frozen at that level ever since and is due to stay there until April 2026. Some 17 years of a frozen nil rate band and increasing property prices, even with the residence nil rate band, means many individuals will have an ever-increasing liability to inheritance tax.

Inheritance tax overhaul

Since the introduction of the residence nil rate band, potential inheritance tax liabilities will have to be recalculated for all individuals that are affected. Because the residence nil rate band is tapered away by £1 for every £2 if the estate is valued at £2 million or above, this can create a tax trap where the effective rate of tax is 60%. So, planning to restrict growth above this level can be effective.

If an individual dies within 7 years of making a lifetime transfer, it becomes chargeable. However, lifetime transfers are first of all set against the main nil rate band and inheritance tax could be payable if this is exceeded. But the residence nil rate band is not reduced by lifetime transfers and as result can still be used against the death estate.

For those who will not qualify, or where the estate is above the limit, which will be individuals with ‘net’ estates in excess of £2.35 million or last survivors with estates in excess of £2.7 million, they will need to consider alternative strategies to mitigate the inheritance tax liability.

It is important to consider whether an individual has direct descendants to whom they are able or want to leave a property. While not advocating that individuals start a family later in life, the residence nil rate band does seem to penalise couples who have made a lifestyle choice not to have children or have no direct descendants.

Child benefits

For co-habiting couples with children, common planning often involves leaving a share of a property on first death to utilise a nil rate band via a discretionary trust. This will not work in respect of the residence nil rate band. However, there are a couple of options: they may either leave the estate directly to their children via an absolute or qualifying interest in possession trust or even consider getting married so the estate automatically transfers.

Wills already set up for married couples will need to be reviewed as many properties are owned as tenants in common and utilise a discretionary or non-qualifying interest in possession trust in a will. New planning will need to be undertaken to make sure couples qualify for the residence nil rate band in the terms of the will.

Where there are two qualifying properties, the personal representatives have to decide which one to nominate as the qualifying one for residence nil rate band. Plus, if the combined value of the property is under the two residence nil rate bands, lifetime planning could be undertaken to leave one of the properties to children on first death to avoid one residence nil rate band allowance being wasted.

Trading up

Where a property is valued at less than the two residence nil rate band allowances available to a couple, it may be worth considering ‘upsizing’. It may seem bizarre to consider that an older couple may look to buy a more expensive property to make full use of all the available £1 million inheritance tax allowance. However, this could save them a large sum of money.

Certain equity release schemes create a debt on the property and the residence nil rate band is only available on the ‘net’ interest. Alternatively, a scheme where part of the property is sold to release funds could make use of the ‘downsizing’ provisions.

Information from HM Revenue and Customs

Inheritance tax - unused additional threshold

Inheritance tax - passing on a home

Inheritance tax thresholds

Note

The information provided is based on our current understanding of the relevant legislation and regulations and may be subject to alteration as a result of changes in legislation or practice. Also it may not reflect the options available under a specific product which may not be as wide as legislations and regulations allow.

All references to taxation are based on our understanding of current taxation law and practice and may be affected by future changes in legislation and the individual circumstances of the investor.

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The Royal London Mutual Insurance Society Limited is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. The firm is on the Financial Services Register, registration number 117672. It provides life assurance and pensions. Registered in England and Wales number 99064. Registered office: 55 Gracechurch Street, London, EC3V 0RL.