£1million IHT allowance – what is it worth to you?
The government’s promise to increase the inheritance tax (IHT) allowance to £1million for married couples and civil partners comes into effect next April.
It is to be achieved through the introduction of a new residence allowance which will be available in addition to the existing nil rate band (currently £325,000).
The new allowance will apply to estates where the main residence is left to certain members of the family.
It will start at £100,000 in 2017/18, increasing by £25,000 each year until it reaches £175,000 in 2020/21. So by April 2020 an individual will potentially be able to give away £500,000 of their estate tax free (£175,000 plus £325,000).
As with the existing nil rate band, married couples and civil partners (both referred to as spouses below) can transfer any un-used residence allowance to one another. This is how we arrive at the long promised £1million IHT allowance.
So far so good
The new regime has, however, caused much consternation amongst estate planning practitioners. The legislation dealing with the new residence allowance is complex and many have queried why the government hasn’t simply extended the existing nil rate band.
What follows is a brief summary of the new regime and the circumstances in which it might apply to your own estate.
Who will benefit from the new regime?
In order to benefit from the new residence allowance you must satisfy the four conditions set out below:
1. You must die on or after 6 April 2017;
2. Your estate at death must include a property used as your main residence.
You do not have to be living in the property when you die for it to qualify, provided it was your main residence at some point during your period of ownership. If you own more than one residence then your personal representatives will elect which one should benefit from the allowance.
The allowance may be available where the property in question was held upon a life interest trust for your benefit.
3. The property in question must be left on your death to a ‘lineal descendant’. In addition to children and grandchildren, the term ‘lineal descendant’ includes step-children, adopted and fostered children as well as certain other individuals. It does not include your spouse.
The residence allowance will only apply to gifts taking effect on your death. It will not apply to lifetime gifts.
4. The total value of your estate should not exceed £2million.
The allowance is tapered down for estates worth more than £2million. It is reduced by £1 for every £2 which exceeds this limit. If you die in the 2017/18 tax year with an estate worth more than £2.2million then your residence allowance will be reduced to £0.
The £1million IHT allowance for spouses
Your un-used residence allowance can be transferred to your surviving spouse regardless of when you die (i.e. even if you die before 6 April 2017) and regardless of whether you own a residence at death.
Whilst this is all good news, care should be taken to avoid ‘bunching’ of estates which would take the value of the surviving spouse’s estate over the £2million threshold and cause a tapering of the residence allowance.
Trusts arising on death
Care should also be taken if your residence is to be held on trust after your death.
The legislation permits gifts into certain types of trust. This includes life interest trusts and those which currently benefit from preferential IHT treatment. It does not include discretionary trusts even where the only people who can benefit fall within the definition of a ‘lineal descendent’.
You can still qualify for the new residence allowance if you downsize or sell up all together (for example to move into care) provided you did so after 8 July 2015.
The calculation involved is a complex one. Interestingly, if you die owning a less valuable residence (or no residence whatsoever) it may be possible to use the residence allowance to reduce the IHT on assets of any kind passing to a lineal descendant.
Needless to say it is important that full records are kept if you do downsize so that the information needed to take maximum advantage of the new regime is readily available.
So what is the £1million IHT allowance worth to you?
In many cases it won’t be £1million.
The strict requirements of the new residence allowance mean that is of limited use. This is especially true if you have an estate worth more than £2million or do not wish to leave your residence in the manner permitted by the new regime. For you the £1million allowance might be worth just £650,000 (or £325,000 per spouse). And for the moment, at least, there are no plans to reduce that.