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New inheritance tax provisions explained
On 6 April 2017 the new inheritance tax residence nil rate band (RNRB) came into effect. The RNRB will be phased in over a three year period, with the RNRB this tax year being £100,000 per person, rising incrementally until 6 April 2020 when it will be £175,000 per person.
Whilst a welcome development for parents looking to pass their home on to their children, as is so often the case, the devil is in the detail. There are a number of qualification factors to the RNRB, these being, specifically, that the individual must have lived in the residential property at sometime during their life, that the property must be being passed to a direct descendant (which, for these purposes, include stepchildren) and that the estate must be below £2 million in value. If the estate exceeds £2 million in value, then for every £2 by which the estate exceeds this value, £1 of the RNRB is lost.
The introduction of the RNRB makes it very important that current arrangements are reviewed, particularly where trusts are involved and especially so for married couples. Trusts are a very popular and effective way of preserving assets and facilitating inheritance tax savings, but, generally speaking, where a residential property passes into a discretionary trust, then unless the trustees have specific powers, the RNRB will not be available.
Additionally, when the first of a married couple dies, it is most important that the executors of their Will takes professional advice, as it may possible to rearrange non RNRB compliant trust provisions in the Will, before the second death, by which time it will almost certainly be too late.
Taking advantage of the RNRB is particularly challenging for unmarried couples who have children from previous relationships. Often, they will be looking to ensure that the survivor of them has security of tenure in the family home, but that their own children will ultimately inherit. Whilst existing arrangements put in place to achieve these aims will still be effective for those purposes, it is more than likely that the RNRB will not be available unless changes are made.
As well as being challenging, the introduction of the RNRB does offer tax planning opportunities. It has always been difficult to assist individuals in estate planning where their life expectancy is short. As a general rule, for a gift to be effective for inheritance tax purposes, the person making it has to survive for 7 years thereafter. If they do not, then the gift is clawed back into their estate for inheritance tax purposes. However, this principle does not apply for the purposes of valuing the estate for qualification for the RNRB. So, for example, if a widow has inherited everything from her husband, but has an estate worth significantly more than £2 million, if she were to make gifts, even in the days leading up to her death, which result in her estate being worth £2 million or less on death, then on the current value of the RNRB, this will result in an inheritance tax saving of £80,000.
It has always been important to ensure that Wills and estate planning arrangements are kept up to date, but the complex rules surrounding the RNRB have made it especially important that arrangements are reviewed and that specialist advice is taken.
For further information, please contact a member of the Wills & estate planning team.
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