IHT and protection

IHT and protection

When former chancellor George Osborne announced the creation of the main residence nil-rate band in his Summer Budget 2015, he fulfilled one of the Conservative party’s manifesto promises.

However, while some couples will be able to leave £1m without worrying about inheritance tax (IHT), complexities in the rules mean protection advice will still be important.

Under the rules, as well as the standard IHT nil-rate band of £325,000, individuals will receive an additional allowance that can be used to pass on their residence.

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The nil-rate band is being phased in, starting at £100,000 in the 2017/18 tax year and rising in £25,000 increments to £175,000 in 2020/21. After this, it will increase in line with the Consumer Prices Index (CPI).This means that, in 2020/21, the effective IHT tax threshold for an individual will be £500,000.

Furthermore, as both bands are transferable between married couples and civil partners, it will be possible for the survivor to leave up to £1m IHT-free.

Terms and conditions

But, while £1m may be a nice, simple, round figure, there are plenty of catches that will mean that not everyone will benefit.

Ian Dyall, head of estate planning at Towry, explains, “The rules are overly complex. Although they will remove the need for IHT planning for some people, others will have to ensure their affairs are arranged appropriately, and some will not benefit at all from the new nil-rate band.”

Initially, the main residence nil-rate band will only apply to the home. Although this can include rental properties that the individual has lived in previously, a couple will need a property worth at least £350,000 if they die in 2020/21 to gain the maximum benefit.

As an example, take two married couples, both with joint estates worth £1m. One lives in a property worth £400,000, while the other property is worth £200,000.

The couple with the more expensive property will be able to take advantage of the full £350,000 main residence nil-rate band, thereby leaving their entire estate without an IHT liability.

Conversely, the couple in the lower value property will only be able to use £200,000 of the main residence nil-rate band to pass on their home. The couple’s standard nil-rate band of £650,000 can then be applied to the remaining £800,000 of their estate, leaving an IHT liability of £60,000 (40 per cent of £150,000).

Another potential catch is that the property must be left to direct descendants on death to qualify for the additional nil-rate band. As well as sons and daughters, these can be adopted, foster and stepchildren, and any of their descendants. However, those without children will not be able to benefit from the new legislation.

Taper tantrum

The main residence nil-rate band is also means-tested. If the net value of the estate exceeds £2m, the additional nil-rate band will be tapered away at the rate of £1 for every £2.

This means that an individual with an estate worth more than £2.35m in 2020/21, or a couple with an estate worth £2.7m or more, would see no benefit from the additional allowance.