Three inheritance tax saving tips for clients who can’t claim the residence nil rate band
Since 2017 an additional IHT allowance for those who leave a property interest to lineal descendants has been available: the residence nil rate band (RNRB). This allowance potentially exempts £350,000 from IHT for a married couple or couple in a registered civil partnership. However, the allowance tapers away by £1 for every £2 of an estate that exceeds £2 million and, if your clients do not have children, the allowance is of no benefit to them.
In this article we offer three tips on how your clients can reduce the IHT payable on their estates if they cannot claim the RNRB.
1. If your clients own a property they could consider fragmenting ownership of the property
This is achieved by your client either giving a small percentage (say 10%) of their property to a trust during their lifetime or, if they are married or in a civil partnership, leaving a similar percentage of their share in the property to a discretionary trust set up by their Will. If the Will trust route is taken, the share of the property then remaining in your client’s ownership, or in their partner’s ownership, should then be discounted in value by 10-15%. This discount reflects the difficulty of selling a part share in a property on the open market.
If your clients choose the lifetime trust route it will be necessary to pay a commensurate proportion of a full market rental to the trust.
Example: Sarah and Chris have a joint estate of £2.8 million including a jointly owned property valued at £1.5 million. They each make Wills leaving 10% of the property to a discretionary will trust on the death of the first of them. Chris dies first so Sarah now owns 90% of the property. Sarah’s share in the property is valued at £1,215,000 (assuming a 10% discount), £285,000 less than if they had taken no action.
2. Make sure your clients make full use of other available IHT reliefs
The RNRB is the relief introduced most recently but there are a number of other reliefs and exemptions, some of which are much more valuable.
Business relief, for example, can exempt the whole value of a business from IHT but there are traps for the wary which can limit its availability. If your client owns shares that might benefit from business relief, and they are married, then they should also ensure that their Will is drafted in a way that makes full use of the relief.
In many cases this could involve leaving their shares to a discretionary trust in their Will rather than to their spouse. No IHT is payable on the death of the first spouse, due to business relief and spouse relief, but the trust ensures that the business assets are outside of the surviving spouse’s estate while also enabling him or her to benefit from the trust assets.
Example:
Harry and Jessica’s £2.8 million estate includes Harry’s shares in the family company worth £300,000. Harry leaves the shares to a discretionary trust in his Will and the rest of his estate to Jessica. No IHT is payable on Harry’s death.
As planned, the company is sold after Harry’s death. When Jessica dies her estate amounts to £2.5 million as the £300,000 cash in the Will trust is outside of her estate. She leaves a property to her children and, because her estate has been reduced in value by the gift to the trust, her executors are able to claim part of the RNRB. In total the couple achieve a significant tax saving.
3. If your clients have children, and have owned a property at any time, they could consider reducing their assets by lifetime gifts to save IHT and to qualify for the RNRB
Example: Susan and Charlie have a joint estate of £2.8 million including a holiday home valued at £450,000. They do not qualify for the RNRB as their estate is too large. They use the holiday home for only a few weeks per year.
If the couple give the holiday home to their children, and pay a full market rental for the time that they use it, after seven years the value of the holiday home will fall out of their estate, reducing its value to £2,350,000. The couple’s entitlement to the RNRB is increased from nil to £175,000 and the total tax saving attributable to the gift and the increased claim to the RNRB is £250,000.
If Susan and Charlie wish to retain control over the holiday home then their gift could be made to a trust. A trust could also be used if capital gains tax on the gift is an issue.
So if the RNRB does not reduce your clients’ IHT liability, action can still be taken to minimize the tax on their estates, and it may be possible to take other measures depending on your clients’ particular circumstances.
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