Although it seems as if it has been with us forever, the residence nil rate band is only in its first year of operation. Every time I have to consider the provisions underpinning it, I am reminded of how amazingly complex they are.
This is especially so given the relatively simple objective set out by the Conservatives under David Cameron. Simply put, “No family with an estate of less than £1m should have to pay inheritance tax”. Or words to that effect. Not too difficult, one would think.
But then the legislation began to be put together and, because the additional relief was to be focused on the main residence rather than a simple increase to the nil rate band, complexity inevitably flowed… and flowed… and flowed.
We now have limitations, downsizing provisions, qualifying definitions and much more to consider. I am sure none of this was envisaged at the time of the initial aspiration.
One of the less expected provisions for the residence nil rate band is that it will be “cut back” by £1 for every £2 the estate of the deceased exceeds £2m. It is worth noting that, in arriving at the value of one’s estate for this purpose, you ignore business property relief and agricultural property relief and do not add in lifetime gifts made in the seven years immediately before death. In effect, a plain English meaning of estate is taken, unchanged by provisions affecting the inheritance tax liability introduced by legislation.
And let’s also not forget any unused residence nil rate band from the death of the first of a couple to die is transferable to the survivor in much the same way the “ordinary” nil rate band is.
Since the ordinary transferable nil rate band rules came into force in 2007, many married couples have chosen not to make use of the nil rate band on first death. Many believe this is because it is available for transfer so it can be used on second death, subject to a claim being made by the personal representatives within two years of that death.
Nevertheless, for those with more complicated family affairs, use of the ordinary nil rate band is still made on first death, often through the use of a discretionary nil rate trust.
With the introduction of a residence nil rate band, is there a further argument to make use of the nil rate band on the first death? As with all cases, client circumstances would need to be fully considered.
Here I provide an overview of where clients may wish to consider first death nil rate band planning.
1. To make use of a previously deceased spouse’s nil rate band
If a widow/er remarries having inherited everything from their first spouse, they may wish to draft their own will to make use of their nil rate band plus that of the previous spouse. If they die first leaving all assets to their new spouse, they will have lost the ability to claim their deceased spouse’s unused nil rate band and possibly unused RNRB.
Modern day relationships and families come in all shapes and sizes. Some may require the certainty assets are left to particular people; for example, children or grandchildren from a previous marriage.
2. To hold a high growth value asset
If assets have a high growth potential (for example, land with planning permission), it may be better placing them into trust on the first death to prevent increasing the estate of a surviving spouse for IHT purposes. In effect, this will be a bet that the asset(s) in question will increase in value at a greater rate than the nil rate band, which would be increased by the unused nil rate band.
3. To preserve business property/agricultural property relief
If all assets are left to a surviving spouse on the first death, the availability of business property relief and/or agricultural property relief could be wasted, as the assets will pass exempt to the surviving spouse in any event. In these cases, it may be worth executing the will to pass such assets into trust or in favour of a particular (non-exempt) beneficiary to prevent losing out on the relief.
4. To keep the estate of the survivor under the residence nil rate band taper threshold
This is the benefit most being talked about these days. Where the estate of the second of a couple to die would be in excess of the £2m taper threshold, the amount of the RNRB (possibly including that left from the first to die) available to the survivor will be restricted by £1 for every £2 exceeding it, even if the estate of the first to die was less than this amount.
So, for example, if on first death the estate is worth £2.2m, the residence nil rate band will be reduced by £100,000. If, however, the will of the first to die was drafted to leave the nil rate band of £325,000 into trust, the total estate on first death would be £1,875,000, which would not be affected by the taper threshold.
These are just a few points to be aware of when advising clients. Of course, it will all depend on overall objectives and circumstances. As always, wills should be reviewed regularly to ensure they reflect the wishes of the testator and take account of estate planning best practice.
Tony Wickenden is joint managing director of Technical Connection. You can find him Tweeting @tecconn