We are always being asked about ways to reduce the amount of inheritance tax that has to be paid on death. However, whilst tax-saving methods can make a lot of financial sense, they don’t exactly make a lot of headlines. Finding out about the various reliefs and exemptions can be difficult. Nonetheless, it is important to be aware of what is possible so that you can plan your financial affairs accordingly.
A new measure to be aware of is the Residence Nil Rate Band (RNRB), which is coming into force in 6th April 2017. The RNRB could reduce the amount of inheritance tax paid from your estate upon death, ensuring that your loved ones receive the largest possible proportion of your assets after you have gone.
Before going into any details about the RNRB, it is worth explaining what a Nil Rate Band is. A Nil Rate Band is a range of value, up to a certain limit, upon which no tax is paid. For inheritance tax, there is already a Nil Rate Band of £325,000, which applies to all estates. This means you do not pay tax on the first £325,000 of your estate (although technically speaking, it is taxed at the rate of 0% – a ‘nil rate’). A higher tax rate is only applied to the value of your estate which is above the Nil Rate Band – so, for an estate valued at £400,000, only £75,000 would be taxed at the normal inheritance tax rate (which is currently 40%).
What is the RNRB?
The RNRB is an additional Nil Rate Band, specifically applying to the value of your home. This is usually the most valuable part of a person’s estate. The RNRB is applied on top of the normal £325,000 Nil Rate Band, which means that, if your estate qualifies, the combined total can operate to reduce your inheritance tax bill.
When it first comes into force, the RNRB will be set at £100,000. This figure is planned to increase in each subsequent tax year as follows:
- £125,000 in 2018 to 2019
- £150,000 in 2019 to 2020
- £175,000 in 2020 to 2021
It must be made clear, however, that these are maximum amounts; if the value of your home, or the share you own of your home, is lower than the maximum amount, then it is this lower figure which is used. So if, for example, you owned a half share of a £120,000 house, the RNRB applicable would be £60,000 instead of the maximum amount at the time.
Will I qualify for the RNRB?
In order for the RNRB to apply to your estate upon death, the following requirements must be met:
- The date of death must be on or after 6th April 2017 (as this is when the provisions come into force);
- Your home must form part of your estate (so you must own it or a share of it);
- Your home, or a share of it, must be inherited by your ‘direct descendants’;
- The total value of your estate must be £2 million or less (but see below).
A few of these requirements need to be explained in a bit more detail:
What qualifies as a ‘Home’?
They say ‘home is where the heart is’ but, if anything, the rules are less restrictive than that. As long as the property is part of your estate and you lived it in at some point during your lifetime, the RNRB can be applied to it. There is no requirement for it to have been your ‘main home’ or for you to have lived there for a certain amount of time. However, if you own several properties which meet these criteria, the RNRB can only be applied to one of them – a decision made by the people administering your estate after your death.
What are Direct Descendants?
The RNRB rules allow any of the following to be considered your direct descendants:
- your children, grandchildren, great-grandchildren etc (lineal descendants)
- the spouses or civil partners of your lineal descendants
- any of your step-children (provided you were married or in a civil partnership with their parent)
- any children you have adopted
- any children you have fostered
- any children to whom you have been appointed as a guardian
As such, any nieces, nephews, siblings, and others not falling into any of the above categories, are not considered to be your direct descendants.
What happens if my estate is above the £2 million threshold?
Provided the other requirements listed above are met, a reduced RNRB may still be applicable. In general, the further above the threshold the estate’s value is, the more the RNRB will be reduced. With this in mind, if you are unsure as to whether the RNRB would apply in your situation, it is recommended that you seek legal advice.
Are there other ways in which the RNRB can be applied?
Transferring between Spouses and Civil Partners
Spouses and civil partners can transfer any unused percentage of their RNRB between them. If, for example, a husband dies without using any of their RNRB then the wife’s estate can benefit from 100% of the husband’s RNRB. This will be in addition to the wife’s own RNRB.
There are comprehensive rules on how this is applied in practice. However, the important aspects to be aware of are: firstly, that this transfer is possible; and secondly, that unused RNRBs are attributed retrospectively. This means that any spouses or civil partners eligible for the RNRB are considered to have an unused RNRB, even if they died before these measures came into force (on 6th April 2017). Furthermore, as it wasn’t possible to actually apply the RNRB before 6th April 2017, all of these retrospectively granted RNRBs will all be 100% unused.
Another way in which the RNRB can be applied relates to ‘downsizing’. The rules allow for some measure of the RNRB to be applied even if you sold your home or downsized to a less valuable home during the course of your life. To qualify for this, you must also meet the following requirements:
- The home you sold would have been eligible for the RNRB if it had been kept until your death;
- You downsized or disposed of your home on or after 8th July 2015;
- At least a share of your estate is to be inherited by a direct descendant.
The amount of the RNRB that could apply to your estate depends on a number of different factors. However, it cannot exceed the maximum RNRB that would have applied to your former home had no disposal or downsizing taken place.
What should I do?
As you may have gathered, the rules on the RNRB are complicated and the guidance contained in this post only covers the basics of how they are applied. However, the RNRB could make a significant difference to the inheritance tax payable on your estate after you’re gone.
Consider the arrangements you intend to make and, if you are unsure whether a RNRB could apply in your situation, seek legal advice. Doing so will also allow you to arrange your affairs so that maximum advantage can be taken of the RNRB and other tax-saving provisions.
On that note, whilst the RNRB can apply irrespective of whether you have a Will or not, truly effective tax-planning can only be accomplished if you have valid Will directing how your estate property should be handled.
Also, if your Will includes the creation of any trusts and you wish to take advantage of the RNRB, make sure that you obtain professional advice as trusts can affect the operation of the RNRB rules.