Who wants to be a Millionaire: A guide to the current rules on Inheritance Tax (IHT)

It is hard to believe that back in 2015, the initial IHT guidance for the Residence Nil Rate Band (RNRB) was announced. This provided a gradual increase in the RNRB exemption from 2017 and over the following years. Now with the start of the 2020/21 tax year, we are in the final phase of this increase. So why is this significant?

What are the current starting Inheritance Tax Exemptions?

Before considering the importance of this recent change it is essential to understand the two basic IHT exemptions and how they work.

Individuals are exempt from paying any IHT upon death if their total taxable estate is below £325,000. This is known as the “Nil Rate Band” and the availability of the full figure will also depend upon whether an individual has used any of this exemption in making gifts during the last 7 years of their life.

If a person’s taxable Estate exceeds £325,000, IHT of 40% will be applicable on the sum that exceeds this Nil Rate Band exemption. For example, an estate worth £400,000 on death will result in an IHT bill of 40% on the additional £75,000 over the threshold (i.e. £30,000).

Another exemption in the case of couples who are married or in a civil partnership and who are domiciled in England & Wales, is that any inheritance from one to the other upon death is entirely exempt from IHT. However, on the surviving spouse’s death IHT could be due unless their estate passes to an exempt beneficiary e.g. a charity.

Whilst this seems unfair to the beneficiaries of any surviving spouse/civil partner, any unused Nil Rate Band from the first estate can be transferred to the surviving partner’s/spouse’s estate upon death. This means that for example, if a wife were to die and leave everything to her husband, his executors would be able to use his Nil Rate Band of £325,000 and his Wife’s £325,000, creating a total exemption of £650,000 on his death.

So what is the RNRB?

The Residence Nil Rate Band is an additional exemption afforded to individuals who own property that they are passing on to their direct descendants upon their death. From 6th April 2020, the full exemption from IHT for a person is now £175,000 and to utilise this full figure, all beneficiaries of the property must be a “direct descendant”.

This exemption is only applicable to a person’s “main” residence in which they live and is not applicable to any other homes that they may pass on. A persons “direct descendants” are also strictly limited to a child, grandchild, adopted child, a child being fostered at the date of death, a child whom the deceased was a guardian of at the date of death or any other lineal descendant and their spouse, civil partner or widow.

It is important to note that this exemption is subject to tapering for any estate worth over £2 million. This means that £1 of the RNRB exemption is lost for every £2 of estate that exceeds this threshold. Subsequently estates worth £2.35 million pounds or over are unable to benefit from the RNRB exemption.

The Million pound inheritance

This is an important increase and much like the transfer or the Nil Rate Band between spouses and civil partners, any unused RNRB can also be passed upon death.

This means that if a man leaves his property to his spouse/civil partner, no IHT will be due and no RNRB can be used as the spouse/civil partner is not their direct descendant. This will also be the case with a lot of jointly owned properties where spouses and civil partners register their home as a Joint Tenancy allowing for an automatic transfer of ownership to the survivor, also known as a “right of survivorship”.

However, on the death of the surviving spouse/civil partner and if the property is left to their direct descendants, both RNRB exemptions of £175,000 can be utilised providing a total £350,000 exemption. Combined with both Nil Rate Band exemptions of £650,000, this is the first time £1 million pounds can be inherited without paying IHT.

What about the future?

Whilst the gradual increase in the RNRB has been a welcome step, with soaring property prices in London there is a still high demand for IHT exemptions to be increased to mirror realistic estate values at death. So what can be expected to change beyond this tax year?

It is currently set that any further increase of the RNRB will increase in line with the Consumer Price Index from tax year 2021/22 and that the freeze on the Nil Rate Band exemption will also be reviewed at this time. However with the current pandemic ongoing, the future of the economy is uncertain and we don’t know what the government might do to raise funds.

If you would like advice on tax and estate planning, please contact the private client team at Hodge Jones & Allen by email hja@hja.net or ask to speak with the private client team on 0330 822 3451.