Is the new family home tax perk all that it seems?

Don’t be misled by the new £1m nil rate IHT band warns Tony McGing, CEO at Downing LLP, who gives us some tax tips to consider.

Is the new family home tax perk all that it seems?

On the face of it, the new additional inheritance tax (IHT) Residence Nil Rate Band (RNRB), commonly known as the ‘family home allowance’, which came into effect this April seems like a generous perk that could help many families stay safely outside the IHT net.

The new rule works by giving individuals an extra allowance of £100,000 to offset the sale of a family home upon death, in addition to their existing £325,000 inheritance tax exemption. This allowance will be gradually increased each year until 2020, when married couples and civil partners will be able to pass assets to direct descendants worth up to £1m when they die, free of IHT.

This initially appears to be a very positive move, particularly when considering just how much the Government has collected through IHT in recent years – IHT receipts totalled £4.7bn during 2015/16, a 22% increase on the previous year, and without adjusting for inflation, the highest figure since the current system was introduced in 1986[1].

But while the additional RNRB may initially reduce the number of families that push past the threshold for IHT, a closer look at what has been driving the increase in IHT receipts during recent times reveals a potential sting in the tail waiting further down the line.

The freezing of the nil rate since 2009 is most likely the biggest driver behind the increased IHT liability, although rising house prices have also been a major factor. Residential property already makes up approximately one third of the total value of tax-paying estates each year[2] and house prices are becoming an increasingly important IHT trigger in areas such as London, where the average house price sits at around £478,782 compared to a national average of approximately £207,308[3].

It’s a similar house price issue which could sneak up on many families even with the new RNRB in place. Once we reach 2021, the family home allowance will rise in line with the consumer price index (CPI) instead of increasing by a fixed amount each year. This link to CPI could drag plenty of unwary families back into the IHT net if house prices rise faster than CPI, which has happened in recent years, with annual house price growth in March 2017up 3.5%[4] year-on-year compared to 2.3%for CPI[5].

Additionally, estates worth more than £2m will fall subject to a taper too; for every £2 above £2m the RNRB will be reduced by £1. The ultimate result of this is that joint estates worth £2.7m and over will not benefit from the family home allowance at all. And let’s not forget that there are of course families with non-property wealth who will also continue to be at risk of a large IHT bill on the death of a loved one, following the decision to maintain the current freeze on the Nil Rate Band until at least 2019.

If any of this is starting to sound a bit confusing it’s because IHT is far from straightforward already and these new rules, although carrying some benefits, only make things more complex. Talking to a qualified, independent, financial adviser is the best port of call for IHT planning but here are a few tips to help you find your way through the IHT maze:

Understand exactly how IHT is applied to an estate

Familiarising yourself with the basic principles for how IHT works is a good place to start. Here’s an example[6], based on the IHT liability of a single person:

Value of estate on death (sum of everything you own or share of anything jointly owned, including property, savings and investments once any debts, such as a mortgage have been paid off): £1 million

Nil rate band = £325,000

Taxable estate = £675,000

IHT bill at 40% = £270,000

Remaining to pass on = £730,000

Know how your personal circumstances may impact IHT

Single and unmarried individuals have a set of rules for IHT that are different for those who are married or in a civil partnership, so it’s important to understand exactly which IHT rules will apply to you and your loved ones.

Make a will

This may sound like an obvious step to some but leaving a will ensures that your estate is passed on in line with your wishes and it can also help guarantee that you don’t pay more IHT than you need to. This can be particularly important for couples that aren’t married or in a civil partnership. You can write your will yourself but it’s normally best to seek legal advice.

Consider all different routes for mitigating IHT

Gift and trusts are the most traditional options for mitigating IHT but individuals may lose control over their assets and will also have to wait seven years for both gifts and trusts to become IHT-free. And then there’s estate planning services that offer IHT relief through Business Property Relief investments, which become exempt from IHT after just two years and allow investors to maintain control over their funds at the same time. These, however, are higher risk.  To help reduce some of the risks associated with BPR investments, some providers offer additional benefits; it’s crucial to consider all of these options against your personal circumstances before deciding which route may be the right one for you.

Understandably, IHT is often considered to be one of the most sensitive and complex subjects to deal with as part of your finances. And with almost 30% of homeowners aged over 70 having not considered IHT mitigation[7] at all, it’s also potentially being ignored by many people who could fall into an IHT trap unnecessarily.

 

 

[1] HMRC IHT Statistics, 29 July 2016

[2] HMRC IHT Statistics, 29 July 2016

[3] Nationwide House Price Index Q1 March 2017

[4] Nationwide House Price Index Q1 March 2017

[5] Office for National Statistics: UK consumer price inflation March 2017

[6] This example is set out for illustrative purposes only and to demonstrate the effect of 40% IHT. IHT liability is subject to personal circumstances.

[7]Intelligent Partnerships BPR Industry Report 2016

 

Important notice 

This is for information only and does not form part of a direct offer or invitation to purchase, subscribe for or dispose of securities and no reliance should be placed on it. An investment should only be made based on the product literature or Prospectus. We recommend investors seek professional advice before deciding to invest. 

The value of an investment, and any income from it, can fall as well as rise. Investors may not get back the full amount they invest and target returns are not guaranteed.

Any personal opinions expressed are subject to change and should not be interpreted as advice or a recommendation.

Tax reliefs are subject to change in the future and are subject to personal circumstances.

Past performance is not a reliable indicator of future results. Downing does not offer investment or tax advice or make recommendations regarding investments.

Downing is authorised and regulated by the Financial Conduct Authority (Firm Registration No. 545025). Registered in England No. OC341575. Registered Office: Ergon House, Horseferry Road, London SW1P 2AL. 

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