George Osborne fulfilled an election promise in the recent Budget to lift main family homes worth up to £1million out of inheritance tax if they are left to children or grandchildren.
However, the way it works is more complicated than it sounds so people are understandably thinking about where this leaves them in terms of inheritance planning.
In line with these changes, the Government is also still working out the details of an ‘inheritance tax credit’, so people who own an expensive home and want to sell it before they die can still benefit from the changes.
This is to avoid elderly people skewing the housing market by staying put rather than moving to a smaller property or into a care home.
The tax overhaul of last April produced the pension freedom reforms giving over-55s greater control over how they save, spend and invest their retirement pots.
People are stashing more into their pensions and trying hard to preserve what is already in there, according to recent research among over-50s by Investec Wealth & Investment.
How to make the best use of these changes
The good news is that you may not need to move house to benefit from the full inheritance allowance. The bad news is that the full allowance may not be £1million depending on your circumstances.
If we look at what we know so far about the new ‘Main Residence Nil Rate Band’, the Chancellor was eager to stress that £1million could now be passed onto your children tax free, but in practice a number of conditions must be met for that to happen.
Firstly, the £1million is made up of the £325,000 standard nil rate band for both husband and wife or civil partners, plus an additional Main Residence Nil Rate Band of £175,000 for both husband and wife.
The total of those allowances, assuming all are fully available, is £1million. However, the MRNRB will be introduced in April 2017 at only £100,000 and increase in stages to £175,000 by April 2020. It will also be means-tested, with estates above £2million losing £1 of their MRNRB for every £2 their estate exceeds £2million. In practice, this means that to pass down £1million to your children you must:
a) Be married or in a civil partnership
b) Own a house worth £350,000 or more
c) Have a total estate of less than £2million
d) Die after April 2020, or your spouse must die after that, because on first death any unused nil rate band is transferred to the surviving spouse.
The key point to all of this is that your property only needs to be worth £350,000 to fully utilise the MRNRB, so you may not need to move house after all. You could waste your MRNRB if the property is left to someone other than your children or spouse on death. With pensions as the alternative, it used to be the case that you had to die before age 75 having not touched your pension, in order to receive the fund tax free, any funds remaining on death were taxed at 55 per cent.
The new changes now mean that if you die before 75 any remaining pension funds, whether they have been used to provide benefits or not, can be passed tax free to nominated beneficiaries. If you die after 75, the pension fund will be exempt from inheritance tax, but your nominated beneficiaries will pay income tax at their own tax rate as they withdraw the funds. If you are a higher rate income tax payer and you believe your children to likely be basic rate when they take the funds, then living on other assets and leaving your pension to your children will probably be the most tax efficient way of passing on your estate. If you are a basic rate taxpayer and they are higher rate, then it will probably be better for you to take your pension at basic rate to fund your retirement and leave the other assets in your estate to your children. You can also take more than you need and gift the excess to your children over a number of years. Before making any life changing financial decisions, it is recommended that you should always consult your professional financial adviser.
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