Inheritance Tax planning and your home: Planning through your Will

This is our final article in our series looking at your main residence and Inheritance Tax (IHT) planning. The purpose of this article is to bring to your attention some planning opportunities that exist on death via a Will as part of an overall IHT plan.

This article is for general information purposes only and does not constitute personal financial advice. Individual tax treatment depends on personal circumstances and may be subject to change. Appropriate professional advice should be sought before acting on any of the information contained here.

Most married couples/civil partners who jointly own property will own as joint tenants which means that on first death the deceased’s interest passes automatically to the survivor free of IHT (by virtue of the spouse/civil partner exemption). Until the introduction of the transferable nil rate band (from 9 October 2007) in many cases the IHT nil rate band of the first to die was lost if all assets passed to a surviving spouse/civil partner on first death. Now, any portion of the nil rate band not used on first death can be claimed when the surviving spouse or civil partner dies. This has taken away, for most married couples and civil partnerships, the need for (often complex) arrangements designed to make use of both nil rate bands, and this position has been enhanced by the introduction of the additional Resident Nil Rate Band (RNRB) from 6 April 2017.

There will, of course, still be some couples where perhaps for practical reasons, it will be desirable to gift the nil rate band on the first death. In addition, those whose spouse or civil partner has died and have remarried/entered a new civil partnership may be entitled to more than one nil rate band and, in such cases, a gift of the nil rate band on first death could still produce substantial IHT savings.

For these individuals, provided the property is owned on, or changed to, a tenancy in common basis, there are many options. It will, however, be important to remember that the RNRB will generally only be available where the deceased’s interest in a qualifying residence (i.e. one that has at some point been occupied as the main residence) is ‘closely inherited’ (where a property or asset has been passed on directly to direct lineal descendants, such as children, grandchildren, stepchildren, or their spouses). Consequently, if the deceased’s interest in the residence is left to some other type of Trust (e.g. a Discretionary Trust), the deceased’s RNRB will be lost.

Here each of the couple makes a provision in their Will to leave their share of the private residence to their adult children on the first death. After the first death, the home is then owned partly by the children and partly by the surviving spouse/civil partner.

Pros:

• Use of nil rate band of first to die (e.g. to take advantage of multiple nil rate bands in second/subsequent marriage situations) may be ancillary to asset protection benefits (for example where the survivor enters into residential care at a future date). The RNRB will be available.

Cons:

• The new joint owner could try to force a sale of the property against the wishes of the surviving spouse/civil partner; for example if there was a breakdown in relations or if a third party takes an interest in the property, on divorce, death or bankruptcy of one or more of the children.
• No Capital Gains Tax (CGT) main residence relief will be available in respect of a non-occupying owner’s share.

Wills are drafted so that on first death a cash legacy equivalent to the value of the nil rate band passes to a Discretionary Trust, while the deceased’s share of the property passes to the surviving spouse/civil partner. In practice, the gift to the Trust is satisfied by a charge placed on the property by the executors (or an IOU given by the surviving spouse/civil partner).

Pros:

• The spouse/civil partner owns the house outright (subject to the debt/IOU) which means security of tenure; continued availability of CGT main residence relief and the ability to claim the deceased’s additional RNRB on second death under the transferable nil rate band rules.
• The debt reduces the value of the house on second death thereby reducing the estate.
• No RNRB on the first death but RNRB can be claimed on 2nd death (value of property reduced by the debt/charge) under the transferable nil rate band rules.

Cons:

• Stamp duty land tax may arise unless the ‘charge’ route is used.
• Trustees must be seen to be active and exercising discretions to avoid the Trust being treated as a ‘sham’.
• Specialist legal advice is essential to ensure that all necessary formalities are complied with.

Given the ‘preventative’ power of the Gift with Reservation (GWR) and Pre Owned Asset Tax (POAT) legislation, (read our previous article, Inheritance Tax planning and your home, for more information) and the potential complications of planning via the Will, many clients, once they have had the planning position in connection with property explained to them, will choose the relatively simple and straightforward route of providing for the liability through joint lives last survivor life insurance held in trust for the benefit of the children/grandchildren.

There are a number of benefits in effecting life assurance in trust to meet any prospective IHT liability.

Pros:

• Tax-free sum assured payable on death once the first premium has been paid; the sum assured and/or premiums may be subject to review by the insurer under reviewable policies, so the guaranteed position will depend on the type of policy effected, ensuring there is no need to sell the home to meet the tax.
• Speed of payment provided there is a surviving trustee to make the claim.
• Premium payments are gifts and represent an excellent way of using the annual exemption and/or normal expenditure out of income exemption.
• Use of a Discretionary Trust means that changing circumstances can be catered for.
• Children can take over premium payments (after the first) if the premiums cause an unacceptable reduction in the net spendable income of the house owners.
• Generally immune from HMRC challenge.

Cons:

• The premiums for life insurance can be expensive, especially where larger sums insured are required.
• Life insurance is subject to underwriting, so cover may end up being more expensive than first thought and often medical exclusions and declinature where cover may not be obtained at all Even for those with relatively minor conditions.

Giving a property or share in it in a way that is acceptable (to the donor/donee) and effective for IHT, is likely to be difficult during the owner’s lifetime and largely unnecessary on the death of the first of the couple to die, following the introduction of the transferable nil rate band and the RNRB in April 2017, except where the value of the estate is in excess of £2 million above which the RNRB is tapered down.

Where IHT planning on death is deemed worthwhile for tax reasons (perhaps in a second or subsequent marriage scenario), care will need to be exercised to ensure that the surviving spouse/civil partner is not treated as acquiring an IPDI in the share of the property left by the deceased and that any RNRB is not wasted.

Given the difficulty in planning options, if IHT is still an issue for house owners who do not wish to complicate their lives, then:

• consider other assets for planning
• cover the provision for the liability through life assurance (joint lives last survivor for married couples/civil partners) in trust to those who will suffer because of the payment of the IHT.

It is worth noting that, from 6 April 2027, most unused pension funds and pension death benefits will be included in the value of the estate for IHT purposes. Certain benefits, including death-in-service lump sums from registered pension schemes and dependants' scheme pensions from defined benefit arrangements, are excluded from these changes. This is a significant development, and professional advice should be sought on how it may affect your individual position

As mentioned above, where the estate is worth more than £2 million, irrespective of including pension funds, the RNRB will taper away. The residence nil rate band tapers by £1 for every £2 that the estate value exceeds £2 million. Including the value of pension funds will of course mean that, from 6 April 2027, many more individuals will now lose part or all of the entitlement to the RNRB.