Joan is 80 and has been a widow since her husband died 20 years ago. All of his assets passed to her on his death.
Her main home is worth £1 million and she has cash and other investments worth around £1.5 million, as well as receiving a state pension and a pension from her former employer.
She wants to know how to minimise her inheritance tax (IHT) exposure so her children and grandchildren receive as much of her estate as possible when she dies. She has heard the house might be exempt from IHT but is unsure of the rules.
Joan will have her IHT nil-rate band of £325,000 available on her death. She will also have another full nil-rate band, transferable from her husband, assuming he did not use any of his, which appears to be the case as spouse exemption would have applied to all assets passed to Joan.
The exemption Joan has heard about is the new residence nil-rate band. This was introduced on 6 April and provides for an additional nil-rate band of up to £175,000 per individual by 6 April 2020, increasing as follows for deaths after:
- 6 April 2017: £100,000
- 6 April 2018: £125,000
- 6 April 2019: £150,000
- 6 April 2020: £175,000
Keep it in the family
There are pitfalls with the new residence nil-rate band. In Joan’s situation, the house must pass to a direct descendant (such as a child or grandchild) on her death to be eligible.
The relief is also tapered where the deceased’s estate on death is valued at more than £2 million. £1 of relief is lost for every £2 of value above £2 million, so the relief can disappear quickly. If Joan downsizes, the maximum relief can still be available as long as assets of equivalent value pass to direct descendants on her death.
Joan’s estate is currently worth £2.5 million, so she would need to make gifts to her children or grandchildren before death to prevent a restriction of the relief, if she was comfortable doing so.
Such gifts are her most powerful estate planning tool, as the value of the gifts will not suffer IHT as long as Joan survives them by seven years.
Assuming she is in good health, she would be well advised to give away as much of her cash and investments as she is comfortable with as soon as possible, while retaining sufficient funds to maintain her security and quality of life. A gift of investments could give rise to capital gains tax charges, so she would need tax advice on this.
Joan would need to survive such gifts by seven years for their value not to suffer IHT on her death. But for the purposes of testing the value of her estate against the £2 million threshold for residence nil-rate band, the gifted funds would leave the estate immediately, so there would be an immediate lowering of her IHT exposure.
If Joan did not want to make direct gifts to the grandchildren, she could settle an amount up to her nil-rate band into a trust for them with no immediate IHT charges, perhaps with Joan and her children being the trustees. She would need to be excluded from benefiting from this trust for the value of the trust to fall outside of her estate.
A gift into trust would also allow any capital gains on the assets transferred to be ‘held over’ so no capital gains tax charges arise.
Joan could also claim a transferable residence nil-rate band from her husband’s death, and any carried forward relief would be tested against the same £2 million threshold. In this way, from April 2020, Joan could benefit from total IHT nil-rate bands of £1 million, with only any value left above that suffering IHT.
Mike Hyland is senior manager for national tax at Grant Thornton UK.