Nov 20, 2015
The reform of inheritance tax (IHT) will allow homes of up to £1 million to be passed on tax free but only if you follow these rules.
The summer Budget brought good news for those whose wealth is tied up in their family home as chancellor George Osborne announced the introduction of an additional nil rate band for a person’s main residence.
The existing nil rate band of £325,000 per person or £650,000 per couple, on which 40% IHT is not paid, will remain the same. From 2017/19 an additional main residence band of £100,000 per person will be introduced, which will increase to £125,000 in 2018/19, to £150,000 in 2019/20 and to £175,000 in 2020/21.
In 2020/21 this means a house worth £1 million could be passed on tax free. But this doesn’t mean you no longer have to think about tax planning as there are a number of pitfalls you have to avoid in order to make sure you’re eligible for the full amount.
Ian Dyall, an estate planning manager at adviser Towry, said: ‘There is a lot of confusion out there and people think it is £1 million each, which it was initially billed as, and some think they need to have a £1 million house to benefit.
‘Most people have missed the fact that there is a whole series of hurdles.’
You need to be married
Under IHT rules spouses and civil partners can inherit their other half’s share of an estate tax free so the nil rate band does not need to be used up. This means the £325,000 nil rate band of a deceased spouse can transfer to their surviving spouse who will then have an IHT allowance of £650,000 when they die.
The additional rate band can also be passed on to a spouse or civil partner, meaning in 2020/21 a surviving spouse will have:
However, unmarried couples do not have the right to pass on nil rate bands, meaning cohabiting couples can only have:
Leave everything to your spouse
Just being married isn’t enough to qualify for the £1 million allowance. Spouses have to make sure they leave the entire estate to each other in order for the surviving spouse to inherit the deceased spouse’s nil rate band and main residence band.
If you left £100,000 to a charity in your will, for example, then your spouse wouldn’t receive the full nil rate band and wouldn’t benefit from the full £1 million.
Only your children can benefit
If you are married or in a civil partnership but don’t have children then you will miss out on the main residence band. The government’s aim is for family homes to be kept in families and if you want to make use of the main residence bands the property has to be passed to ‘lineal descendants’, such as children and grandchildren but not nieces and nephews.
Lucy Brennan of accountants Saffery Champness said: ‘These rules only apply on the home transferring to direct descendants, which include adopted children, children who were fostered by a foster parent, step children and children for whom someone has been a guardian when they were under 18, and their direct descendants.
‘Therefore care must be taken in planning to ensure that you are within the rules.’
The £1m allowance doesn't apply right away
Many are under the misapprehension that the £1 million IHT allowance comes in next year but actually it will be phased in over the next five years so the £1 million will actually apply just in time for the next election.
If a person, who is married and passes their full nil rate band on to their surviving spouse, dies in the 2017/18 tax year then a home of £850,000 will be able to pass on tax free to children or grandchildren.
In the tax year 2018/19 a house of £900,000 can be passed on, in 2019/20 that rises to £950,000 and in 2020/21 the total amount of £1 million can be passed on.
Don’t gift money
If you make large monetary gifts to family and friends before you die then it could erode your IHT allowance. Gifting money becomes a ‘potentially exempt transfer’, or PET, and the person giving the money has to survive seven years before the gift falls outside of their estate for IHT purposes. If you die within the seven years the money is potentially liable to IHT.
By gifting large sums of money, perhaps for a house deposit, this erodes the amount of allowance you have to play with, meaning the total £1 million will no longer apply.
‘You need to be married to get to [£1 million] and the person on first death needs to have left all assets to their spouse and not made any gifts that will have eaten away at the nil rate band,’ said Dyall.
Keep your wealth in your home
The additional band does not mean a total estate of £1 million can be passed on as it only applies to the family home. If you have a large investment portfolio rather than an expensive house, you can’t benefit from the additional allowance, only the £325,000 nil rate band.
While those with their wealth tied up in investment portfolios instead of bricks and mortar can’t benefit from the additional IHT band, if your total estate – including home and other savings and investments – is over £2 million the additional band will be tapered away.
An estate with a net value of more than £2 million will see the band withdrawn at a rate of £1 for every £2 over the threshold.