The Residence Nil Rate Band
By Michael Roberts – 18th October 2017
It was the Conservative government’s long held intention to raise the Inheritance Tax threshold to £1m. During the time of the coalition with the Liberals, this was not achievable however the Tories have, finally, just about achieved this policy objective with the introduction of the Residence Nil Rate Band on 6th April 2017.
In this first article of a two part exploration of the Residence Nil Rate Band (RNRB), I shall explain more about how this new measure is being introduced, and the basic qualifying criteria. As legislation often dictates, however, the RNRB is not as straightforward as it might be, therefore in part two I shall consider some of the pitfalls to look out for that must be considered as part of any Inheritance Tax (IHT) planning strategy. If you are mindful of IHT, you may also find it helpful to reference my other IHT article, IHT Planning; start with the basics, which can be found here.
At present, when an individual dies, they are entitled to a Nil Rate Band (NRB) of £325,000. This means to say that the first £325,000 of their estate which is passed on death, is taxed at a Nil Rate; no IHT applies. Assets passed in excess of this NRB are taxed at 40%. Where assets are passed to a UK domiciled spouse or a registered charity, this is exempt from IHT. Where at least 10% of the estate is left to a registered charity on death, any IHT applying to the remainder of the estate is charged at a reduced rate of 36% rather than the usual 40%.
In addition to the standard NRB outlined above, an individual’s estate is now able to claim the RNRB enhancement when the deceased owned a property, and passes this to direct descendants. The RNRB will initially be £100,000 for the 17-18 tax year, and will increase by £25,000 per year until it reaches the full amount of £175,000 in the 20-21 tax year, after which it is due to increase in line with CPI inflation. However, the RNRB will also be gradually tapered where the total estate exceeds £2m. This new measure will ultimately allow a couple to pass on £1m of assets free of IHT, as per the Tories’ policy objective, as can be illustrated by the example below.
Example – John and Elaine
John and Elaine are both married, and have two Daughters aged 40 and 45. John and Elaine jointly own their main residence free of mortgage, valued at £500,000. In addition, they have cash and investments worth £500,000.
John and Elaine both die in the 20-21 tax year, within a few months of each other. Their wills are very straightforward, and leave their assets equally to their two Children. As such, between them John and Elaine are able to claim two NRBs totalling £650,000, and two RNRBs totalling £350,000. As such, all of their assets are within their available Nil Rate Bands, and consequently no IHT is payable.
As with the standard NRB, the RNRB will be transferable between spouses. This means that in the common scenario where the first of a couple to die leaves all of their assets to the surviving partner, when the surviving partner subsequently dies their executor will also be able to claim the unused standard NRB and RNRB of the first of the couple to die.
The rules for the transfer of the RNRB are surprisingly generous, because it is the unused percentage RNRB that is transferred to the surviving partner. This means that if the RNRB increases between the death of the first partner and the death of the surviving partner, the surviving partner’s estate will be able to claim the unused percentage of the RNRB in force at the date of the second death. Furthermore, the first partner to die need not have owned a property at the date of death. The first partner may also have died before the introduction of the RNRB.
Example – Ralph and Victoria
Ralph and Victoria were renting a property when Ralph died in 2002, having never owned a property. He left all of his assets to Victoria. After Ralph’s death, Victoria used some of the money from Ralph’s life cover to purchase a property to live in. Victoria dies in April 2020 leaving everything to her Children. She is able to claim a transfer of Ralph’s standard NRB and RNRB, which means she will be able to leave up to £1m to her Children when she dies, without an IHT liability.
It is important to note that the RNRB is only available where an individual leaves their main residence to a direct descendant, for example Children and Grandchildren, but this also includes step children, adopted children and foster children, spouses and civil partners of direct descendants, or the widow/widower of direct descendants provided they have not remarried. This is a point of criticism of the new provisions as it unfairly discriminates against those who do not/cannot have Children.
Where an individual owns more than one property when they die, their executor will be able to decide which property is their main residence for the purpose of the RNRB. However, the property must have been the main residence of the deceased at some point. A buy to let property which the deceased has never occupied as their main residence will not qualify.
There are also provisions to allow for situations where an individual has either downsized or sold their main residence altogether. The individual must have owned a property at same point which would have qualified had they still owned it, and the proceeds from sale must still be within the deceased’s estate and left to direct descendants. The property in question must have been sold after 8th July 2015 to qualify.
It is commonplace for individuals to include trusts within their will. As a trust is not a direct descendant, leaving a gift of your main residence into a trust may not qualify for the RNRB, depending upon the type of trust involved. However, there are circumstances when it would be desirable to retain a trust within a will. This is quite technical in nature and it is not always obvious what type of trust is contained within a will, therefore it is recommended that you have your will checked by an estate planning specialist if you are unsure.
These new rules are most welcome in helping to mitigate Inheritance Tax, especially considering the standard Nil Rate Band has not been increased for many years, whilst property and other asset prices have been rising sharply, causing more and more people to be caught by this tax.
However, as you can see from this simple summary of the new rules, careful planning is required to ensure the benefits of the new provisions are maximised. In my next article, I will look at some examples where, in the absence of proper planning, this generous allowance can easily be jeopardised.
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This article is intended for information purposes only and should not be considered to be a recommendation. This article is based on our understanding of current and draft pension and tax rules as at the date of this article. Please note that tax and pension rules are subject to change; if you are at all uncertain about the suitability of any option for your circumstances we strongly suggest you seek regulated personal financial advice. You should not take action solely on the basis of this article without seeking advice specific to your circumstances. Please get in touch to find out more.