Generally, inheritance tax (IHT) is payable on death at a rate of 40% of the value of the assets in a deceased person’s estate exceeding his or her available nil rate band allowances (subject to any exemptions and reliefs).
Where the family home passes on death to the deceased’s children, grandchildren and certain other family members such as step-children, as well as potentially benefitting from the main inheritance tax nil rate band (NRB) of up to £325,000 (or £650,000 in the case of a married couple), the estate may also benefit from an additional residence nil rate band (RNRB) of up to £175,000 from 6th April 2020 (or £350,000 in the case of a married couple).
However, if the value of the estate exceeds £2 million, the available RNRB is tapered down, and it is lost completely if the estate exceeds £2.35 million for an individual or £2.7 million for a married couple (from 6th April 2020).
Suppose a married couple have a joint estate of £3.15m so a potential IHT liability, at 40% after the £650,000 main nil rate bands, of £1m. If everything passes to the survivor on the first death, the RNRB will be unused then and taper away to zero on the second death.
Instead the value of the assets that each own could be equalised as far as possible to try to bring the total value of each estate to less than £2 million so that the RNRB is available on the first death (and it is important to remember that even when business assets are wholly relieved from inheritance tax, their value still comes into the calculation to determine the availability of the RNRB). If the residence were held as tenants in common so that a share of it could pass to children, or a trust for them, on the first to die, use could then be made of it at that point.
It may be appropriate for the estate of the first to die to pass wholly on to a discretionary trust in the first instance so that the trustees could take account of the family circumstances and what the legislation is like at the time of death. With a discretionary trust, the trustees would have the flexibility to appoint assets out to children or grandchildren to make use of the RNRB at whatever level it is at the relevant time and prevent IHT being due by appointing the remainder to the survivor to benefit from surviving spouse exemption. Appointments out of a discretionary trust arising from an estate within two years of death are treated for IHT purposes as if they were made directly from the estate at the outset so the allowances and exemptions that would be available if the will had set out what the final appointments were will apply.
So if the property were worth £1 million and the first death was in 2020/2021 when the RNRB was £175,000, 175/1000ths share of the property would be appointed to the children, or to a life interest trust for them to help provide the survivor with security of occupation, and everything else including the remaining 825/1000ths share of the property would be passed to the survivor. If the survivor died soon after her estate would be worth £2.975m (i.e. the total £3.15m less £175k worth of the property – although this might be further discounted as jointly owned property) with tax due after the main NRBs of £930,000 so a saving of £70,000.
The saving as a proportion of the total IHT liability and of the estate is not huge but many clients would want to take the opportunity for their family to pay less tax for little disadvantage.