With Inheritance Tax, there are some crucial factors to consider for a comprehensive understanding of the subject. In this blog, we shall cover everything you need to know about inheritance tax and how to make the most of your hard-earned wealth for generations to come. Starting with the amount of money you intend to leave your loved ones.
When the Inheritance Tax bill was introduced to replace the Capital Transfer Tax, the goal was to boost the government’s revenue. Inheritance planning is a key aspect of financial management, especially when considering the state of your financial affairs for your loved ones after you’re gone. If you want to save your family from a potential inheritance tax bill that could cost a significant amount of your wealth, you should effectively plan your estate in due time.
How Rights Function Under Inheritance
Another crucial aspect to consider is the way rights operate in terms of inheritance. When a person dies, certain automatic rights fall on some individuals. For instance, when a person dies, the part of their estate left to a spouse or registered civil partner doesn’t get taxed. However, unmarried partners do not enjoy the same right, as parts of the estate left to such a person fall under the Inheritance Tax rules.
Nevertheless, certain steps can be followed to reduce a person’s costs during inheritance. Notably, where a beneficiary is now a spouse, such a person will incur tax on any amount exceeding £325,000.
What if the Spouse is Dead?
The nil rate band (NRB) refers to the threshold amount every person can leave in inheritance to a non-exempt beneficiary without incurring inheritance tax. Notably, where a widow or widower is yet to use up their NRB, the percentage can be increased based on the amount unused. However, the executors must make the necessary elections within two years of the death.
Certain things must be considered when determining the payable inheritance tax before getting the final amount. This includes non-exempt gifts made to the person. Where the total of such gifts within seven years alongside the estate value of the property left for non-exempt beneficiaries is higher than the NRB, then the inheritance tax will be charged at 40%.
This is to do with the reduction in the payable tax. For instance, the payable tax on an estate that qualifies for charity or bequest is 36%. Furthermore, although we earlier mentioned that gifts are non-exempt, sometimes these gifts might be subject to inheritance tax. However, in such cases, they shouldn’t have been made within three to seven years before the death — as gifts made during this period will be entitled to taper relief. Notably, an Inheritance Tax Residence bill was introduced in 2017 to complement the existing RNRB. For the 2020/21 tax year, this is worth about £175,000, and taper relief becomes operative if the taxable estate exceeds £2 million.
The Case with Residential Property
There’s an inherited tax charged when someone leaves a residential property they previously occupied to their descendants. Also, any house sold or downsized from 8 July 2015 will also be subject to this tax. It should be noted that this doesn’t operate in the same manner as standard NRB. Instead, its applicability is limited to transfers on death.
Duties of Personal Representatives
One of the most important things here is the payment of the inheritance tax due on the estate left by the dead. If this has not been done, many other activities, such as paying beneficiaries, cannot be done. The only exception is about the property where the tax can be paid in instalments. It’s essential for beneficiaries to pay the due taxes on time, as this can be problematic when interest has accumulated.
There’s a vast difference between the taxable value and the actual value. As such, when an estate is to be taxed, this will be determined based on the taxable value. For instance, any such item that doesn’t fall under taxable value will be excluded. Furthermore, it’s also noteworthy that where the surviving spouse of the dead needs the unused RNRB, such a person can elect to use it.
The RNRB will also gradually reduce by £1 for every £2, adding to the £2 million threshold. Different provisions are applicable in cases where the person downsized the house.
When there has been a breach of the threshold, careful consideration must be taken to ensure that the right exemptions are considered. Some reliefs ignored when doing this calculation include business and agricultural reliefs. This means that while the £2 million is based on the value of the assets owned when the person died, lifetime gifts made by the deceased do not count, even if they were made within seven years of death.
What’s Available to Direct Descendants?
Concerning direct descendants, the inheritance tax will be set against an estate with a lower value than the inherited property. The 2020/21 tax year will see estates with a value of £2.35 million and above not benefit from an RNRB.
Where the Spouse is Deceased
The deceased spouse will be entitled to the unused allowance when the property’s value falls below the maximum RNRB. In this case, either the deceased allowance or a registered partner will have the right to receive the transfer of such allowance. The surviving spouse can claim this once the person elects to receive the unused allowance.
In instances where the deceased has passed on residential interest, close family members must have inherited such property, such as direct descendants, for the property to utilize the Inheritance Tax RNRB. To take effect, however, the death must have occurred on or after the 6th of April 2017. Also, regarding the residential interest in the question, no requirement exists whether the deceased inherited or owned the property.
Evaluating the Role of Guardians
For clarity, it’s important to state that direct descendants are the people who share direct lineages with the deceased, such as children and grandchildren. This also includes their spouses, registered partners, widows or widowers where applicable.
This term, however, also covers adopted children, stepchildren, and even those whom the deceased played as guardians while alive and when the child was yet to be 18. You should, however, note that relatives such as nephews and nieces do not fall under the category of direct descendants.
Residence Plays a Crucial Role
Irrespective of where the death occurred, the importance of the facility to claim the RNRB cannot be overemphasized. Before introducing the Inherited Tax rules, those entitled to the deceased property can claim 100% of a deemed RNRB of £175,000. The only exception to this rule is if the estate in question is more than £2 million.
Deed of Variation
It’s possible to claim the unused RNRB from more than a registered civil partner. This, however, cannot exceed 100% of the amount existing. The deed of variation states all the relevant details that pertain to inheritance. For instance, when direct descendants inherit a property left to them by the deceased, it becomes part of their estate.
Does the Main Residence Have an Implication?
It’s immaterial whether a property’s location is the deceased’s principal residence. Since it can be established that the deceased owns a home at a certain place, the personal representatives can make moves to determine which of the properties should enjoy RNRB. For all calculations necessary, the property’s market value — after considering any liability that might lie against the property — will be the relevant value to use for assessing RNRB.
RNRB and Trust
In some cases, a property may have become the subject of a Trust, or the deceased might have entered an agreement to transfer their home into a Trust once they die. An example of this nature might make it a bit challenging to determine whether RNRB will be available. One crucial consideration here is to assess whether the home belongs to the estate of the deceased and whether direct descendants have a right to inherit the property.
Where an Estate Doesn’t Qualify for Full RNRB
You might be faced with the challenge of not qualifying for the full amount of RNRB, either because the property’s value was earlier downsized or due to other factors. In an instance such as this, the property might be entitled to a downsizing addition. However, some conditions must be present here: the deceased must have ceased to own a property as of the 8th of July 2015. The former home of the deceased would have qualified for RNRB if it wasn’t downsized. Some parts of the home were subject to being inherited by direct descendants.
Essentially, what the downsizing addition seeks to cover is the part of the RNRB that appears lost. Nevertheless, personal representatives won’t be able to access this downsizing addition, where the new home carries a higher value than the available RNRB.
Furthermore, where the deceased had not replaced the downsized home before they died, the representatives can elect to get the downsizing addition. However, an action for this must be brought no later than two years after the person’s death. Notably, different techniques can be leveraged to address the potential tax liability on an inheritance. The crucial thing to do is ensure that planning techniques are considered when drawing up the financial arrangements for an individual’s estate.
If you would like to learn more about how our Wealth Partners can help you put an all-encompassing plan in place to manage your estate, please contact us today.
Ross Whatnall is CEO and co-founder of GSB and a highly experienced private client director. Ross holds many insurance and investment management qualifications, including CISI, CII, LIBF and CFA. He started his career in private banking with HSBC in the UK before moving to the UAE in 2013 to focus on serving his private clients.