RESIDENCE NIL-RATE BAND: TAPERING, TRANSFERABILITY AND TRUSTS

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1 TECHTALK This article originally appeared in OCT 17 edition of techtalk. Please visit for the latest issue. RESIDENCE NIL-RATE BAND: TAPERING, TRANSFERABILITY AND TRUSTS Bernadette Lewis This article focusses on three aspects of the residence nil-rate band (RNRB): valuing the estate for tapering and a surprising opportunity for lifetime gifting the transferrable RNRB including the interaction with tapering will trust planning less restrictive than you might think. If you re new to the topic, or just want a refresher on the rules, you ll probably find it helpful to read Jeremy Branton s article An introduction to the residence nil-rate band first. RNRB TAPERING The RNRB is tapered by 1 for every 2 the deceased s inheritance tax (IHT) estate exceeds the taper threshold. This is 2 million up to 2020/2021 and then increases in line with the consumer prices index (CPI). RNRB tapering is based on the value of the death estate including any trust funds that fall into the estate and after deducting allowable liabilities. Importantly, this valuation ignores any exemptions and reliefs, and also any lifetime gifts made in the seven years before death. So calculating a client s potential IHT liability may now require two steps first establishing if their RNRB is likely to be tapered, then estimating their IHT liability on death.

2 Example Nick was divorced when he died in 2017/2018 and his estate didn t benefit from any transferrable RNRB or NRB. He left 100,000 to charity and everything else to his son including AIM shares qualifying for 100% business property relief. He d made no lifetime gifts in the previous seven years. Nick s death estate exceeded the 2 million RNRB taper threshold by 290, ,000 / 2 = 145,000. This exceeded the 100,000 RNRB for 2017/2018, tapering his RNRB to nil. Estate valuation for RNRB taper House Nick occupied as his home 950,000 AIM shares 300,000 Other investments 500,000 Cash ISA 400,000 Chattels 140,000 Estate on death 2,290,000 When it came to calculating the IHT due on Nick s estate, the exempt charity bequest and business property relief were taken into account, along with the full standard NRB. The IHT liability was 626,000. IHT due on Nick s estate Estate on death 2,290,000 Exempt transfer to charity ( 100,000) Business property relief on AIM shares ( 300,000) Taxable estate on death 1,890,000 Nil rate band ( 325,000) 40% IHT due on: 1,565,000 IHT 626,000

3 RNRB TAPER AND LIFETIME GIFTING Surprisingly, the RNRB tapering provisions mean that lifetime gifting can lead to IHT savings even when there s no likelihood of the donor surviving seven years. Outright gifts or transfers into trusts can both be considered. Of course, the anticipated IHT savings might be offset by legal fees, disposal costs or capital gains tax (CGT) liabilities. Example Let s change Nick s situation, so his death followed a terminal illness diagnosis giving him time to review his IHT planning. Four months before he died, he gifted 300,000 from his cash ISA to his son. His 3,000 annual IHT exemptions for 2017/2018 and also 2016/2017 were available, making his failed potentially exempt transfer (PET) 294,000. Gifting cash outright meant no legal fees, disposal costs or CGT implications. The lifetime gift kept Nick s death estate within the 2 million taper threshold. His estate benefitted from the full RNRB for 2017/2018 because he left a home worth more than 100,000 to a direct descendant. Estate valuation for RNRB taper House Nick occupied as his home 950,000 AIM shares 300,000 Other investments 500,000 Cash ISA 100,000 Chattels 140,000 Estate on death 1,990,000 The failed PET reduced the standard NRB available to set against Nick s death estate. Nil rate band 325,000 Failed PET ( 294,000) Nil rate band available to estate 31,000 However, regaining the full RNRB resulted in an overall IHT saving of 42,400 his estate was liable to 583,600 IHT rather than 626,000. IHT due on Nick s estate Estate on death 1,990,000 Exempt transfer to charity ( 100,000) TRANSFERRABLE RNRB AND TAPERING The transferrable RNRB allows the second spouse to die s legal personal representatives to claim any unused percentage of the RNRB from the first spouse to die s estate. This also applies to civil partners. If someone s been widowed more than once, their estate can benefit from multiple unused RNRBs up to an additional 100%. It doesn t matter when the first spouse died, although the second spouse has to die after 5th April It also doesn t matter whether or not the first spouse to die s estate included a qualifying property. However, the tapering rules certainly complicate matters compared with the transferrable standard NRB rules. FIRST SPOUSE DIED BEFORE 6TH APRIL 2017 the remaining available percentage of the first spouse to die s RNRB is based on a deemed 100,000 RNRB tapering applies if the first spouse s death estate exceeded 2 million as tapering won t apply in most cases, the second spouse to die s estate will normally benefit from 100% transferrable RNRB. FIRST SPOUSE DIES FROM 6TH APRIL 2017 the remaining available percentage of the first spouse to die s RNRB is based on the amount of the RNRB in the tax year they die tapering applies if the first spouse s death estate exceeds the threshold in the tax year they die the first spouse s transferrable RNRB is reduced if they leave a qualifying property (or a share in one) to direct descendants. SECOND SPOUSE TO DIE S RNRB IS CALCULATED AS FOLLOWS the second spouse to die s RNRB is based on (RNRB for tax year they die) + (available percentage of first spouse s RNRB x RNRB for second spouse to die) tapering applies next, if the second spouse s estate exceeds the threshold the second spouse s RNRB is restricted if the qualifying property left to their direct descendants is worth less than their available RNRB (subject to downsizing provisions). Business property relief on AIM shares ( 300,000) Taxable estate on death 1,590,000 Residence nil rate band ( 100,000) Nil rate band ( 31,000) 40% IHT due on: 1,459,000 IHT 583,600

4 Example June and Luke were married when Luke died in 2015/2016. He left his entire 1.1 million estate to June. He hadn t made any lifetime transfers in the previous seven years. Therefore, his estate is now treated as making no use of his deemed 100,000 RNRB as well as no use of his 325,000 NRB. June dies in 2018/2019 with a 2.2 million estate. Her will hasn t been reviewed since the introduction of the RNRB and leaves her home worth 420,000 to their child and her two nephews in equal shares. She hasn t downsized. The RNRB will be 125,000 in 2018/2019 June s RNRB including the transferred percentage from Luke s estate will be 125,000 + (100% x 125,000) = 250,000 her tapered RNRB will be 250,000 - ( 2,200,000-2,000,000 / 2) = 150,000 however, she s leaving just one third of her 420,000 home to a direct descendant so her RNRB will be restricted to 140,000. The nil rate band available to June s estate including the unused 100% from Luke s estate will be 325,000 + (100% x 325,000) = 650,000. So the total nil rate band available on June s death will be 790,000. It s more complex where tapering applies on the first death, or on both the first and second deaths: Example Moira and Lydia are civil partners. Moira dies in 2018/2019 leaving her 2.2 million estate to Lydia, so Moira makes no use of her RNRB or her NRB. the RNRB at the date of Moira s death will be 125,000 her RNRB after tapering will be 125,000 - ( 2,200,000-2,000,000 / 2) = 25,000 Moira s unused percentage of the RNRB will be 25,000 / 125,000 = 20%. Lydia dies in 2019/2020 when her estate is worth 2.3 million and she leaves her 1.6 million home to their children. the RNRB will be 150,000 in 2019/2020 Lydia s RNRB including the transferred element will be 150,000 + (20% x 150,000) = 180,000 Lydia s tapered RNRB will be 180,000 ( 2,300,000-2,000,000 / 2) = 30,000. The nil rate band available to Lydia s estate will be 325, % x 325,000 = 650,000. So the total nil rate band available on Lydia s death will be 680,000. RNRB AND WILL TRUSTS At first sight, the RNRB will trust legislation appears restrictive. However, it s actually possible to use flexible interest in possession trusts, and even fully discretionary trusts. Clients will normally need specialist legal advice taking account of the complex legislation and their personal circumstances. However, financial advisers can offer professional legal connections their own expertise when it comes to the financial fact finding element the RNRB taper and downsizing provisions introduce into will trust planning. Where this section refers to trusts created in wills, this also includes trusts created by deeds of variation validly using section 142 IHTA TRUSTS SPECIFICALLY COVERED IN THE RNRB LEGISLATION A direct descendant of the deceased is treated as if they d directly inherited the deceased s home if they do so as the beneficiary of four specific types of settlement : immediate post death interest (IPDI) trusts disabled persons trusts section 71A bereaved minors trusts section 71D trusts. IMMEDIATE POST DEATH INTEREST TRUSTS The RNRB is available if a direct descendant of the deceased acquires a qualifying interest in possession in the deceased s home via an IPDI trust. So what s an IPDI trust? IPDI trusts can only be created upon death either by a will, or if a statutory trust is created as a result of dying intestate. IPDI trusts fall into a special IHT category which means these trusts can be flexible, but always fall into at least one beneficiary s IHT estate and are not subject to IHT periodic and exit charges. IPDI trusts include life tenant trusts created by wills. There are lots of variations, but at their simplest, one beneficiary the life tenant has a qualifying interest in possession. This is because they have the right to live in the trust property or receive the trust income for life. The trust fund falls into their IHT estate. Other beneficiaries the remaindermen become absolutely entitled to the trust property when the life tenant dies. In Scotland, the equivalent beneficiary classes are the liferent and fiars. It s also possible to create very flexible IPDI trusts in wills. Again, there are many variations but there must be at least one beneficiary with a qualifying interest in possession. This can be created by giving them the immediate but revocable right to the trust income, or to live in the trust property, so that the trust fund falls into their IHT estate. These trusts also have potential beneficiaries. The trustees have discretionary powers to appoint trust property to any of the beneficiaries. The RNRB should be available provided the trust property is a qualifying residence and the original qualifying interest in possession beneficiary is the deceased s direct descendant.

5 If an IPDI trust is created to use the RNRB and this affects your clients, the next issue for their legal advisers to confirm is whether any RNRB will be available when the life tenant or other qualifying interest in possession beneficiary dies. It s an important consideration as the value of the trust fund will be in their IHT estate. DISABLED PERSON S, SECTION 71A AND SECTION 71D TRUSTS These trusts are relatively uncommon but in summary: disabled person s trusts not only have to be for a disabled person, but also meet specific criteria in IHT Act 1984 section 71A bereaved minor s trusts must be established by a deceased parent s will, intestacy or the criminal injuries compensation scheme for their minor child, who must become absolutely entitled by age 18 other conditions also apply section 71D trusts must be created by a parent s will or the criminal injuries compensation scheme and their child must become absolutely entitled by age 25 other conditions also apply. A client s legal advisers should be able to confirm whether their will trust falls into any of these categories. DISCRETIONARY WILL TRUSTS AND OUTRIGHT APPOINTMENTS USING SECTION 144 IHTA 1984 RNRB AND PROPERTY ALREADY IN TRUST Clients occupying a home owned by a trust should check their RNRB position with their own legal advisers, as this will always depend on the specific trust provisions. If someone s home is a trust asset when they die and they have a qualifying interest in possession in that trust, the value of their home is in their IHT estate. Whether the RNRB is available depends on the trust provisions. A direct descendant of the deceased beneficiary must become entitled to the property as a result of their death in a way that meets the legislative conditions. Where the RNRB is available on a beneficiary s death, so is downsizing relief. If someone s home when they die is a property held in a discretionary trust, the value of their home isn t in their IHT estate. The RNRB won t be available even if the trustees make an outright appointment of the property out of the trust to the deceased s direct descendants. FURTHER INFORMATION HMRC provides a good summary of the rules at There are also useful linked case studies. For more detailed information, see also HMRC s Inheritance Tax Manual starting at IHTM The RNRB legislation certainly appears restrictive in terms of will trust planning options. However, section 144 IHT Act 1984 means the RNRB can be available even when using a discretionary will trust. This is confirmed in HMRC s Inheritance Tax Manual at IHTM As just one example, the trustees can meet the RNRB requirements by making an outright appointment within two years of death of the deceased s home out of a discretionary will trust to a beneficiary who s the deceased s direct descendant. Provided the appointment is made within two years of death, section 144 applies effectively treating the beneficiary as if they d been left the property directly by the deceased under the original will provisions. The discretionary will trust approach offers maximum flexibility at least for those willing to give their trustees control over their estate. The client can indicate who they want to inherit and how much importance to put on IHT efficiency through their choice of potential beneficiaries and a non-binding letter of wishes. The executors/ trustees can then take account of the family s circumstances and the IHT rules in place when the client dies. BARE TRUSTS While settlement and trust are often treated as meaning the same, there are subtle differences. It should be possible to use bare will trusts for RNRB purposes, as they aren t treated as settlements in the IHT legislation. The beneficiary should be treated as if they d directly inherited the property. Every care has been taken to ensure that this information is correct and in accordance with our understanding of the law and HM Revenue & Customs practice, which may change. However, independent confirmation should be obtained before acting or refraining from acting in reliance upon the information given. Scottish Widows Limited. Registered in England and Wales No Registered office in the United Kingdom at 25 Gresham Street, London EC2V 7HN. Authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. Financial Services Register number