The concept of inheritance tax is fairly strange to our American cousins. In the UK, when someone dies, any amount in their estate above their available tax-free allowance is charged to tax at 40%. There are some exceptions to this rule, for instance if estates are passing to spouses or charities, but the result can sometimes be a hefty tax bill.
Individuals have an inheritance tax allowance of £325,000, known as the nil rate band allowance (NRB). This means that if their estate is worth £500,000, and is not passing to a spouse or charity, then there would inheritance tax payable of £70,000.
Other factors can affect whether the full NRB allowance is available, such as lifetime gifts within 7 years of the date of death. If the deceased had made large gifts to individuals within 7 years of the date of their death, not only do these reduce the available NRB but they can also bring earlier trusts into play. This is known as the 7-14-year shadow and is a subject for a blog of its own at some point in the future!
There are however a few ways in which the IHT allowance available to an individual can be increased.
When assets are left to a UK domiciled spouse, they pass free of inheritance tax, regardless of the value of the assets. Under the current inheritance tax rules, the spouse’s executors can then claim their £325,000 as well as the unused NRB allowance of the first to die. This can make for an inheritance tax allowance of £650,000 on the survivor’s death.
It should however be borne in mind that this relief is only available to married couples or those in a civil partnership. It is not available to cohabitees as there is no concept of common law marriage in England.
For many people, their home will be their main asset and can, particularly in the South East, exceed their available IHT allowances. To limit the need for the family home to be sold to pay inheritance tax, the Conservative Government introduced an additional inheritance tax allowance in 2017, known as the Residence Nil Rate Band (RNRB), which promised to increase the inheritance tax allowance available to couples to £1 million.
In theory this is possible if you die after 1 April 2020. There are however certain conditions that need to be met for the RNRB to be available to your executors. Firstly, your estate must include a property that has been your home at some point during your ownership. This property, or your estate including this property, must then be passing to your lineal descendants. This includes children, grandchildren and stepchildren but not, for example, siblings, cousins, nieces or nephews. Finally, your estate should not exceed £2 million. If your estate does exceed £2 million then the allowance is withdrawn by £1 for every £2 over that £2 million threshold. In real terms, this means that the relief is lost completely if your estate value exceeds £2.7 million. It should also be borne in mind that any business interests will be included when determining the value of your estate, even if business property relief would be available. There can also be complications if one party to a marriage has a much more substantial estate than the other and dies first. If that person’s estate exceeded £2m, even if the survivor is subsequently able to reduce their estate below that threshold, some of the allowance will be lost.
If your estate meets these vast and complicated criteria, then your executors can claim a further inheritance tax allowance of £175,000 for deaths after 1 April 2020 (in this tax year, that allowance is £150,000 making the current maximum allowance between a married couple £950,000). As with the NRB, this can be claimed by the executors of a spouse where the first to die did not make use of their allowance. This is the case even if the first person died before the RNRB rules came into effect. This can therefore enable executors to claim an additional £350,000. Combined with the standard couple’s NRB allowance of £650,000 this makes for a total inheritance tax allowance of £1million.
So, you see, it is possible to have a £1 million inheritance tax allowance, however the qualifying criteria for the RNRB are very strict and will simply not apply to everyone.
There are steps that you can take during your lifetime to mitigate the inheritance tax that may ultimately be due on your estate. Please contact any member of our Wealth Management and Taxation Team to discuss the options available to you.