It is generally well known that IHT is levied at a rate of 40% where an individual’s estate exceeds any available nil rate bands, does not qualify for special reliefs or exemptions, and passes to non-exempt beneficiaries such as children or grandchildren.
What is less well known, however, is that Estates above £2m can suffer IHT on part of their value at an effective rate of 60%. This is explained below.
Residence nil rate band and Estates exceeding £2m
Following the introduction of the residence nil rate band last year, an individual can benefit from nil rate bands totalling £450,000 (2018/19 tax year). For a married couple or civil partners, the total can be as high as £900,000.
However, the residence nil rate band is subject to a tapering regime whereby £1 of the allowance is lost for every £2 of estate value above £2m. Significantly, the value of the estate is calculated before deducting special reliefs such as Business Property Relief and Agricultural Property Relief.
This means that the residence nil rate band is reduced to nil in cases where an individual’s estate is valued at £2.25m or greater, or £2.5m or greater in the case of a married couple or civil partners.
The tapering away of the residence nil rate between £2m and £2.25m (for an individual) and £2m and £2.5m (for a married couple or civil partners) results in that band of value being subject to an effective 60% IHT rate.
Example for an individual
An estate valued at £2m would mean total nil rate bands of £450,000 could apply. The IHT liability would be £620,000 i.e. (£2m - £450,000) @ 40%.
By contrast, an estate valued at £2.25m would mean only the standard nil rate band of £325,000 could apply. The IHT liability would be £770,000 i.e. (£2.25m - £325,000) @ 40%.
For an estate worth £250,000 more, the additional IHT liability is £150,000 or 60% of the extra £250,000!
How can this effective rate of 60% IHT be avoided?
It is the value of the estate on death that determines whether the residence nil rate band is tapered. Given this, lifetime giving – either absolute gifts or gifts into trust - is a valid means of bringing the value of your estate down to £2m and avoiding the effective 60% rate discussed above.
For further information on the planning possibilities in this area please contact Sheldon Cole or your usual Thomas Westcott contact.
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