Inheritance Tax and the Residence Nil Rate Band
Updated: Jul 17, 2020
Your 2020 Update
The 6th of April sees the start of the new tax year and with a new tax year comes new tax rules, including the dreaded Inheritance Tax.
However, we have some good news! This year the residence nil rate band has been increased to £175,000 meaning that, as of 6 April 2020, most married couples will be able to leave £1 million without paying any inheritance tax.
What is Inheritance Tax?
Inheritance Tax is a hot topic, mainly with people not wanting to pay it, or more accurately not wanting their beneficiaries to pay it after their death. The great publicity which often surrounds Inheritance Tax is, however, surprising when you consider that only 5% of estates of people who die are subject to Inheritance Tax.
Everybody has a nil rate band of £325,000. This means that if your estate (the value of everything that you own) is less than £325,000 there will be no inheritance tax to pay.
If you are married or you have entered into a civil partnership, you can transfer your nil rate band to your spouse. This means that usually there will be no inheritance tax to pay on the first death. Then, when the second person passes away, their Estate can claim their spouse's nil rate band as well as their own. This means that their Estate could have up to a £650,000 tax-free allowance.
You must be married or have entered into a civil partnership. There is no such thing as a common-law husband/wife.
Any value over this would potentially be taxed at 40% if no further exemptions are applicable, such as the residence nil rate band.
The transferable nil rate band may be reduced in value if on the first death some gifts or part of the Estate were left to other Beneficiaries who are not exempt such as children, other relatives or friends.
So, if you are married and you have an estate worth up to £650,000 in most cases there will be no inheritance tax to pay.
The Residence Nil Rate Band
As of April 2017, if you own a property (or shares in the property) and you are leaving it to their direct descendants (usually children, grandchildren, step-children or foster children) are entitled to an additional tax-free amount. This is called the Residence Nil Rate Band and it effectively increases the threshold for Inheritance Tax.
As of 6 April 2020, the residence nil rate band is £175,000. You can add this to the nil rate band of £325,000.
Therefore, if you are leaving your property, worth at least £175,000, to a direct descendant you can leave £500,000 tax-free.
If you are a married couple, leaving a property worth at least £350,000 to a direct descendant, you can leave £1 million tax-free!
Can I lose the Residence Nil Rate Band?
Yes, this is why it is important to review your Will to make sure that it is as tax efficient as possible.
The residence nil rate band may be lost if:
you do not own a property at your death
your direct descendants do not inherit your property on death.
your property is left to some forms of Trust, for example, Discretionary Trusts (sometimes called a Bloodline Trust, Family Protection Trust or Wealth Protection Trusts) or trusts for grandchildren where they cannot inherit until a specified age, for example, 21
your estate is worth more than £2 million. Where an estate has a net value of £2 million or more, the residence nil rate band is withdrawn at the rate of £1 for every £2 by which the value of the estate exceeds £2 million.
A Case Study
Mr and Mrs Jones have a house worth £500,000, savings of £200,000 and other assets worth £50,000. Therefore, the total value of their estate is £750,000.
Mr Jones passes away on 7 April 2020 and leaves everything to his wife. As he leaves everything to Mrs Jones, his nil rate band of £325,000 and his residence nil rate band of £175,000, a total of £500,000 is transferred to Mrs Jones.
Mrs Jones passes away on 12 July 2020. His estate is still worth £750,000.
Her Will states that her house is being left to her children in equal shares.
Her family can use her nil rate band of £325,000 plus the £325,000 nil rate band of Mr Jones, a total of £650,000.
As Mrs Jones left her property to her children, her family is also entitled to use the residence nil rate band, of which she has £350,000 available.
This means that there is no inheritance tax to pay.
However, had Mrs Jones left her property to her grandchildren to be held on trust until they reached the age of 25, then the residence nil rate band would not have been available.
Her family would then have had a tax bill of £40,000 to pay!
(£750,000 - £650,000 = £100,000 x 40% = £40,000.)
Most people do not need to worry about inheritance tax or the residence nil rate band, however, if your estate is worth more £325,000 it is important to make sure that your Will is tax efficient so that you pass as much as possible to your loved ones.
If you have any questions about inheritance tax or if you want to check that your Will utilises the residence nil rate band, please get in touch.