Peter McGahan: There’s taxes and then there’s inheritance tax – it’s about as popular as a politician!
Inheritance tax is about as popular as a politician. After working your whole life and being smart and frugal, you rightly think you can now pass your money on to your children and make their lives a little easier than your own.
Along comes this wonderful idea called inheritance tax. A 40% tax on your assets over £325,000.
There are simple ways to protect yourself against this tax and the use of the zero housing rate bracket (RNRD) is one of them.
Before I explain that you have a zero rate band of £325,000 per person and that is transferable if not used. Thus, if a spouse dies and you do not use their allowance, on the second death, these two allowances can be added together to be deducted from your estate.
So on the second death, if the estate is less than £650,000, there is no tax to pay.
For many that will be enough, but with rising house prices, our homes are creating a problem that we had not bargained for.
In 2017, the RNRD was introduced. It simply acts as a top-up to the zero rate bracket above and is £175,000 each. Therefore, a couple can potentially pass on exactly £1million to their family.
The zero rate bracket and the zero rate residency bracket are now frozen until 2026, so this is the current total.
How it works? First, your estate at death must have an interest in a dwelling house in which you lived (or intended to live).
Buy to let properties do not count. If you live in more than one house, you can choose the one to which the RNRB applies, but it cannot be split between two houses.
The house should be left to direct descendants like children, grandchildren, adopted children and stepchildren, but not aside like nephews and nieces.
If your estate is worth more than £2million, the RNRB will reduce £1 for every £2 of your estate over £2million. Therefore, an estate over £2,350,000 will lose all RNRB.
Remember that the RNRB is only used against the value of the house, not other assets. If the value of the house share was less than the RNRB of £175,000, the difference could be transferred to the surviving spouse for use by them.
If you sell the house or reduce it to another house, you can still use the RNRB if you still hold those assets from the sale as long as they pass to the lineal descendants above. I imagine the reason this was put in place is so those receiving care can use the capital for care costs and not keep the property to keep the RNRB.
Remember that unmarried couples cannot transfer their RNRB between their estates or get RNRB on gifts to each other’s children.
There may be advantages to using an RNRB on the first death or leaving it until the second death by transferring it to the surviving spouse.
Think about it, but remember that you also have the option, within two years of death, of creating an amending deed to change the terms of the will.
Simply put, you look at what suits the survivor with today’s tax and estate value, and after agreeing with all of the estate’s beneficiaries, you modify that will to suit your needs. It must be carried out within two years of the death.
This can only be done by changing a will. If there is no will, the laws of the intestate apply. I won’t bore you with them as they are as acceptable as a politician’s party, so make a will ASAP.
In the meantime, during your lifetime, consider equalizing inheritances between spouses to allow easy use of wedding rings upon death, and also think about the gifts you can make during your lifetime. I still think it’s better to see the edge you’ve given, and if you live seven years, that’s completely out of the estate.
Peter McGahan is managing director of independent financial adviser Worldwide Financial Planning, which is authorized and regulated by the Financial Conduct Authority. For advice on your pension call Darren McKeever on 028 6863 2692, email [email protected] or visit wwfp.net.