In April, a major change to inheritance tax (IHT) law comes into effect with the launch of the Residence Nil Rate Band (RNRB). But this change will benefit some while others will lose out.
Here's what it all means.
What is the Residence Nil Rate Band?
More commonly known as the 'family home allowance', the Residence Nil Rate Band will work on top of the usual £325,000 Basic Nil Rate Band (£650,000 for married couples/civil partnerships), allowing people to pass on a property to their children or grandchildren and save them thousands in death duties.
The Residence Nil Rate Band is transferable and will be phased in over four years; starting at £100,000 in 2017/18, rising £25,000 a year to reach £175,000 by 2020/21.
Eventually, a couple will be able to combine their Basic Nil Rate Band and Residence Nil Rate Band allowances to pass on a property worth £1 million.
Siblings and other relatives
The new allowance is only available on property being passed to ‘direct descendants’, which includes children and grandchildren, as well as stepchildren, adopted and foster children.
That means brothers, sisters, nieces, nephews and other relatives aren’t eligible to benefit from the Residence Nil Rate Band, even if you have no direct descendants to pass your property to.
Homes in discretionary trusts
Discretionary trusts used to be popular because they allowed a couple to combine both their inheritance tax allowances, which at the time could not be transferred as they can be today.
Many still have them as a way to control what happens to assets after death, particularly if they have children under the age of 18.
However, the new main resident nil-band for inheritance tax explicitly excludes a home held in a discretionary trust from benefiting from the Residence Nil Rate Band allowance.
Discretionary trusts are excluded because assets held are technically owned by the trust and controlled by the trustee rather than the beneficiaries.
The government guidelines state: “The availability of the RNRB will depend on the type of trust. This is because the type of trust will affect whether HMRC treat the home as part of a person’s estate for IHT purposes.
"It will also affect whether HMRC treat that person’s direct descendants as inheriting the home."
It goes on: “If a home is put into a discretionary trust on death, the deceased’s estate won’t qualify for the RNRB even if the beneficiaries are direct descendants of the deceased.
"Whether the beneficiaries are entitled to use the home is at the discretion of the trustees, so the home won’t form part of any beneficiary’s estate and they’ll not be treated as inheriting the home.”
Lawyers are warning that hundreds of thousands of people could miss out on the allowance unless they dismantle these trust arrangements.
You should seek help from a solicitor or another professional adviser if you have a discretionary trust to find out your options.
Estates over £2 million
Estates worth more than £2 million will see the Residence Nil Rate Band allowance tapered even if a property is left to direct descendants.
The Residence Nil Rate Band will be reduced by £1 for every £2 the value of the estate exceeds the £2 million threshold.
So for an individual the Residence Nil Rate Band will be lost should their estate be worth £2.35 million (£2.7 million for a surviving spouse) in 2020/21.
You might want to consider how to reduce the value of your estate before you die to ensure this threshold doesn’t impact your family.
Only one residential property will qualify for the Residence Nil Rate Band, which your personal representative can choose to maximise the allowance.
However, you must have lived in a property as a residence at some point for it to qualify for the Residence Nil Rate Band.
So a buy-to-let property that has always been rented out won’t be eligible to benefit from the allowance.
Inheritance tax planning: what you need to do
With the basic inheritance tax nil rate band frozen at £325,000 until the end of 2020/21 the new Residence Nil Rate Band allowance will be important for planning a tax-efficient way to pass on your wealth.
However, you should think about how probate fees and rising property prices will impact your tax liability not just now but in the future.