Leave a tax-free legacy of (eventually) £1 million
You may have heard that the rules around inheritance tax (IHT) are changing with regard to family homes. Neil Adams of Drewberry Wealth shows you how to calculate your new IHT liability on your main residence – and so achieve a ‘successful succession’.
Do you know your transferrable nil-rate band (TNRB) from your main residence nil-rate band (MRNRB)? There are so many abbreviations in the law surrounding inheritance tax (IHT) (there’s another one) that it’s hard to keep track of them. Even trickier is working out how to apply them to your own affairs, so you can calculate what slice of your hard-earned worldly goods will end up in HMRC’s clutches when you die.
The labyrinthine IHT rules don’t stay static, either – just as you think you’re about to see daylight, the law gets amended and you’re buried under new thickets of regulation. One example is the new MRNRB, which will kick in from the start of the 2017/18 tax year. On the plus side, this is overall a welcome change.
To prevent you weeping into your calculator as you try and figure out your IHT liability, we at Drewberry have made our own inheritance tax calculator. It’s the first tool of its kind to take into account the new rules surrounding family homes (i.e. the MRNRB) to help you plan better for the future.
Banding together: the nil-rate bands
In the past 10 years alone, government tinkering has twice revised the rules surrounding how much you can leave your beneficiaries before IHT is due. This threshold, known as the nil-rate band, is currently worth £325,000 for a single person, but the rules were amended in 2008 with the introduction of the TNRB for spouses, followed by the more recent new MRNRB.
So what exactly are these new bands? Well, the TNRB lets you leave any unused percentage of your nil-rate band – so up to £325,000 currently – to your spouse or civil partner. That allows your partner potentially to double their nil-rate band to up to £650,000.
As for the new MRNRB, this offers an additional allowance for those passing a main residence to direct descendents. Take note of the narrow definition of ‘direct descendent’ – it covers children (including adopted children, stepchildren and foster children) and grandchildren only, but not other family members such as nieces or nephews.
Initially starting at £100,000 in the 2017/18 tax year, the MRNRB is also transferrable, so for married couples it’s worth £200,000 straight out of the gate. The full allowance will be phased in over the next three tax years, rising in increments of £25,000 until 2020/21, when it will be worth £175,000 per person or £350,000 for a married couple. Thereafter, it will increase with inflation.
Crucially, it can be combined with existing nil-rate bands to add up to a significant level of relief.
Benefitting beneficiaries: meet John and Susan
Imagine it’s the 2016/17 tax year, a pre-MRNRB world. John and Susan are a married couple with two children. They have a home worth £800,000 and other assets of £50,000 for a total estate value of £850,000.
Susan died in April 2016 and left her entire £325,000 nil-rate band to John by making no other bequests. When John passed away in December 2016, he was therefore able to pass on £650,000 to their children without having to pay IHT, thanks to the combination of his and Susan’s nil-rate bands.
However, that still left £200,000 of John’s estate as taxable, which resulted in a tax demand of £80,000 that had to be paid to HMRC. Probate could not be granted on the estate (to release the assets) until HMRC had issued a receipt for the IHT paid – a common catch-22. Nor was there enough cash in the estate to cover the bill, as most of it was tied up in the house.
As a result, John and Susan’s children had to find the money themselves and recoup it from the estate once it was released. This might mean either selling the family home or taking out a short-term bank loan with the estate as collateral. In certain circumstances, HMRC permits beneficiaries to spread the cost of an IHT bill on assets such as property with equal annual instalments over 10 years, but this incurs an interest charge.
So what’s changed?
Now fast-forward to the 2017/18 tax year and imagine the same scenario. This time, the MRNRB means Susan gets to leave an additional allowance of £100,000 to John on top of John’s own £100,000 allowance.
When this £200,000 is added to the couple’s combined £650,000 nil-rate band, John can leave a total of £850,000 to their children on his death in December 2017, without incurring IHT. As a result, his entire estate passes tax-free, so John and Susan’s children won’t feel forced into selling the home they grew up in.
Be aware, though, that this generosity isn’t inexhaustible. For the largest estates – those worth more than £2 million – the relief starts tapering off by £1 for every £2 the estate is over £2 million. So in the 2017/18 tax year, an individual’s estate worth more than £2.2 million can no longer benefit from the MRNRB.
Escaping the inheritance tax net
The nil-rate band was frozen at £325,000 in the 2008/09 tax year and hasn’t increased since, despite having previously enjoyed year-on-year uplifts between 1995/96 and 2008/09. As a result, surging property prices have seen a steep rise in the number of estates being hit by IHT. Between 2008/09 and 2015/16, HMRC’s IHT receipts have jumped by 64.1 per cent, from £2.85 billion to £4.67 billion.
The government introduced the MRNRB to try and remedy the situation. When fully in force in 2020/21, the combination of the TNRB and the MRNRB will let a home-owning couple pass £1 million to their children totally IHT-free. This will be made up of their £650,000 combined nil-rate band and their joint £350,000 MRNRB. This should lift a considerable number of estates out of IHT entirely. In 2013/14, the latest tax year for which such detailed data are available, only 5,120 estates passing on death were worth £1 million or more.
The main cause for concern now is pondering how the government will attempt to claw back the revenue it’s going to lose. Unfortunately, that’s a question no calculator can begin to answer. But watch this space.
Neil Adams is an IFA at Drewberry Wealth Management.