Inheritance Tax (IHT), a daunting pair of words for most people and often accompanied by worries of it being complicated or a way for people to sneak tax-free under the radar… Well, today is the first part of how I can prove this is not the case and that this is how the government intends you to make the most of your tax-free allowance!
Although inheritance tax is the most reviled tax, the dreaded 40% that everyone has heard so much about may not actually come into effect at all on your assets, depending on how you plan for Inheritance Tax. You could even manage to completely avoid paying a penny of it, as intended; no sneaky schemes or shady money management, HMRC has thought about this!
Part 1/2: “Nil-Rate Band”
The “Nil-Rate Band” (NRB) for IHT very much does what it says on the tin! This is a financial band (amount) that has a Nil Tax Rate; everyone, even you, has this! So, when you leave your assets, which could be anything from your savings accounts, jewellery, cars, and properties*, the government allows you a tax-free allowance of £325,000 as of 2022 so far.
So, if you only have assets of £300,000 in total, everything below that £325,000 threshold can pass as you please, free of any IHT! Though anything over that threshold will likely be taxed at the dreaded 40%.
However, this is if you are a sole person. IHT has a strange preference to married couples/civil partners, these groups do get a special treatment when it comes to how NRBs interact. As we have just learned, each person gets £325,000 as their personal allowance; it is worth noting that if you are an unmarried couple, your personal allowance is used up by passing your assets to your partner.
If you’re married/civil partnered, when the first member of the couple passes away, their NRB (the £325k) doesn’t get used up or disappear… the amount of tax-free allowance that is left considered unused and could be transferred to the surviving spouse!
Let’s say for example, the husband dies, and he passes everything to his wife (my apologies for the nuclear family example) – firstly, there is the “spousal exemption” so all assets and monies passing to your spouse/partner are automatically free of tax! So, this means that the Husband’s NRB (£325k) of tax-free allowance was never used…
Instead, the surviving wife (or any spouse) combines their NRB with their deceased partner’s giving them a total of £650,000 of tax-free allowance to give to friends and family in their Will.
Please note: You can’t go around collecting partners and having them disappear in mysterious circumstances, followed by collecting their personal allowances like some Villain! An individual can only ever utilise their own NRB allowance (£325k) and one other NRB allowance from a deceased spouse +(£325k), for a combined total of £650,000 tax free.
(*Properties will form the second part of the explanation on how to make the most of your tax-free allowance. We will be discussing more on how your house can help you save more tax next week!)
Next week we will be finding the remaining £350,000 of tax-free allowance and completing this little explanation on how to pass up to £1,000,000 tax-free!
Part 2/2: “Residential Nil-Rate Band”
If you’ve made it this far, I haven’t scared you away with the first part of this Inheritance Tax explanation – or that you have yet to read it, which I would thoroughly recommend as it will help you understand this section better!
So far, we have explored how to potentially save up to £650,000 from being taxed, now I am going to explain where the remaining £350,000 comes from!
Most importantly the ‘residential’ property and who it passes to is the key to unlocking the final portion of the £1M tax free; the Residential Nil-Rate Band.
Each person can qualify for RNRB, currently at the rate of £175k each, naturally if you’re part of a married couple, the same rules apply as before and your share could pass to your spouse!
- As a reminder, this doesn’t happen for couples who aren’t married or in a civil partnership.
There are some limiting factors for RNRB that need to be considered, as the criteria to qualifying for this tax-free allowance is more restrictive:
- It can only be applied to a Qualifying Residential Interest; this is simply a house that you own or have an interest in, that you have at one point in your life used as your home (as a residential property).
- The house that you would like to qualify for RNRB can only strictly be Closely Inherited; this means that the property can only be passed to lineal descendants, which includes; children, step, adopted or fostered etc.
- They can pass to a trust, but only specific trusts! If you have concerns, you can always speak to a Will Writer, and they will be able to help you with this!
The key distinction between RNRB and NRB from last week is that this version will only qualify for the value of the property… So should your house be worth £150,000, unfortunately the excess £25,000 in your allowance if you were a single person, would be lost.
As previously mentioned, we know that these tax benefits always prefer those who are married or civil partners! So, the same will happen for the RNRB this time around; Should one spouse die, the remaining percentage (100% unless they’ve used it elsewhere) can pass to the surviving partner, currently £175,000 x2 = £350,000 tax free allowance that is specifically dedicated to being used for property that is passing to direct descendants.
I appreciate that previous section may have been a bit heavy on the process, but long story short: If you were to predecease your spouse, they could potentially get your share of Tax-Free Allowance, and vice versa!
For those of you currently without a property that you own that at one time you used as residence, or any lineal descendants such as children, stepchildren, fostered or adopted children, unfortunately this tax-free allowance is not available to you, but it might be to someone you know? Or someone you might be inheriting from?
So, in no uncertain terms, to qualify for your share of RNRB (£175k as of 2022) you will need the following:
- A Property that you use or have previously used as a place of residence
- Qualifying Lineal Descendants/ or a Relevant Qualifying Trust.
- For the Tax-Free amount to ONLY go to these descendants.
Now, I appreciate there was a lot to take in and not all of it is straight forward to wrap our heads around. But thankfully, you can speak to a Professional Will Writer to help you with the process of making sure you or your loved ones can make the most of their Tax-Free allowance!
These articles are by no means a comprehensive breakdown of Inheritance Tax, and the most effect form of tax planning is often bespoke to your assets! So, if you would like to find out more or see what you can save, you could contact us