Changes to Inheritance Tax

In his first budget as part of the Conservative party, Chancellor George Osborne implemented a new system that will raise the threshold for the inheritance tax.

What does this change mean? It means that once it goes through, someone will have the ability to leave up to £1million behind to their family and heirs without the sum accruing an inheritance tax. Currently, the cap is £650,000 before an inheritance tax is charged.

Before you get ready to start signing away £1million to your heirs, there are a few things that need to happen so that the full exemption will take place. One of these factors will be timing. The plan is set to be introduced and start taking places at the beginning of April 2017, but it will be implemented in stages.

In order to implement it, what the Chancellor has devised is a “main resident nil rate band” which allows for a £100,000 to be added on top of the current rate – £325,000 – which is actually a rate that will be frozen until 2020. And from there, the new band rate will increase to the tune of £25,000 per year until it caps off at the full £175,000 when the band rate becomes unfrozen in 2020.

To break it down, this means that within the first year of this new system being implemented, an individual, married or civil partnered couple will be able to leave their estate to the surviving partner without having to pay any inheritance tax. Currently, transfers of the estate to a living partner are already tax-free anyway. But the difference is that with the transfer to the second partner, that surviving partner will now be able to utilize their own individual £325,000 tax-free. And on top of this, they get £100,000 allowed for their home – totalling £425,000.

So if you add the £425,000 to the amount that the first partner left behind, then by 2020, the surviving partner will be able to hold £850,000 for the estate inheritance tax-free. And once the freeze is lifted in 2020, the current number will come up and £1million will be set aside for your relatives when the surviving partner passes away. But this obviously comes with the caveat that you and your partner need to both survive within this timeline and already have the correct sum locked and ready to go.

Along with this, the new band that the Chancellor put in place will apply to the deceased spouses’ residential assets, which must have been their primary home at some point. The deceased spouse must also will the property to one of their direct descendants in order for the full £1million to be tax-free. And in the instance that the dead spouse has multiple properties that could vie for the title of main residence, the executors of the will or the surviving spouse must then make the decision about which home will be able to qualify under this new inheritance tax system. And if you’re dealing with a property that is owned by the deceased but they’ve never lived in it – in the instance where it’s an investment property or rented out – then the property will not qualify for the tax relief. Or, if you’ve chosen to rent rather than purchase property with your money, then you will not have a property to attach the exemption to, and you cannot utilize the new band system.

In addition to these property restrictions, there are also some caveats on who you can leave the estate to, in order for it to qualify. Under this new system, the estate must be left to only direct descendants, which include adopted children, sons and daughters, adopted daughters, or step children. And if you don’t have a living or cooperative partner that can increase the band with their own £325,000 to add, then the most you would be able to leave behind is £500,000 before the inheritance tax would kick in. And if you do not have a direct descendant to leave your estate to, then you are unable to take advantage of the new system at all. Even if you have relatives like nieces and nephews you would like to leave the money to, under this new system – it does not count.

Another thing to note is that starting in 2017, if you have an estate that is worth more than £2million net, then every £2million after that first initial 2 will only have £1 deducted from the main residence threshold, which could be beneficial.

Say you are in the position where you would like to downsize your property, or you end up living in a care home in your elder years – you will still have the ability to take the new property, or property you own and formerly lived in, and use the balance made from the sale to give to your children free of tax within the same limits. This is because you will have the ability to still claim that main residence from 2017. This was part of the new legislation, and this lets anyone after this month to leave their smaller residences or assets to their descendants, but still under the main residence nil band. Some details of how exactly this piece will be implemented are still working out.

There are still some things that need to be worked out, but overall, this new system will save Inheritance tax and give you more flexibility to pass on your hard earned estate to your family tax-free.

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