Despite being in place for many years now, the residence nil-rate band (RNRB) still has an aura of “newness” about it.
This likely stems from the fact that, compared to the nil-rate band, it feels complicated. While being a very welcome incremental inheritance tax (IHT) allowance available to most estates, there are some details, complexities and pitfalls to be mindful of.
It’s an area where advice feels especially valuable to most families.
In the very early days of the RNRB, most commentary was focused on either the perceived unfairness of the allowance for those without children or the mechanics of the rules where the family home had been downsized or sold prior to death. More recently, focus has shifted to the operation of the £2m taper threshold.
I thought I’d share a client planning scenario I recently talked through with one adviser.
The scenario combines tax-efficient investment and trust planning, illustrating how a client might restore the full value of the RNRB where their estate exceeds £2m.
Deborah is 82. She is widowed, with two children and four grandchildren. When her husband died, his share of their estate was worth less than £2m and, as he left everything to her, her estate will benefit from both of their NRBs and their RNRBs.
Her estate is worth a total of £2.7m. Deborah’s estate will lose entitlement to £1 of the RNRB for every £2 by which it exceeds the taper threshold of £2m.
If she were below the taper threshold, her total RNRB would be £350,000 (her own £175,000 allowance plus her late husband’s allowance). But, as things stand, because of the value of her estate, there would be no RNRB available to Deborah’s estate at all.
Deborah meets with her adviser to look at her estate planning options. As part of the discussion, they consider gifting in order to reduce the value of the estate below the £2m threshold.
Deborah could make a lifetime gift of £700,000, which would immediately restore the RNRB, saving £140,000 of IHT when she dies. However, she is uncomfortable with the idea of giving away further assets immediately, as she wants to retain control of her wealth until she is older or until death.
Additionally, Deborah is concerned that as IHT would be payable on that gift if she died within seven years, the benefit is not sufficient to take this course of action.
As Deborah is keen to start planning for her estate while retaining access and control over her wealth, her adviser thinks a business relief (BR) qualifying investment could be an attractive option.
A BR-qualifying investment can be left free from IHT when Deborah dies as long as the investment has been held for at least two years. Because it’s an investment that stays in her name, she could request to sell some or all of it later, should her needs change.
Of course, there’s no free lunch here. BR-qualifying investments put capital at risk and the value of the investment, and any income from it, can fall as well as rise. Deborah might not get back the full amount she invests. For the purpose of our illustration below, we have assumed no loss or gain on the BR-qualifying investment over the holding period.
Being able to make withdrawals is subject to liquidity and can never be guaranteed. Qualifying shares may be harder to sell than shares listed on the main market of the London Stock Exchange. Their value can also be more volatile.
There are tax risks Deborah must consider, too. Tax treatment depends on individual circumstances, and tax rules could change in the future. And the companies invested in need to maintain their BR-qualifying status.
Based on her objectives and attitude to risk, Deborah’s adviser recommends she makes a £1m BR-qualifying investment. This should save her estate £400,000 of IHT when she passes away.
However, while BR-qualifying investments that have been held for two years are zero-rated for IHT, they still count as part of the estate when working out whether the RNRB taper threshold applies.
Four years later, Deborah’s health has deteriorated, and she agrees with her adviser that she is now comfortable to give up ownership of some of her assets.
She can choose to gift £700,000 of any assets from her estate to her family, or to settle some or all the BR-qualifying investment into a discretionary trust. The latter option would avoid her incurring a chargeable lifetime transfer charge of 20% above her NRB of £650,000.
Either action would immediately bring the value of her estate below £2m, allowing it to claim the full RNRB allowance in addition to the benefit of IHT relief on the BR-qualifying investment.
By this point, Deborah already thinks of those assets as being for her children and grandchildren – so she’s happy to settle the investment into trust in order to free up her full RNRB allowance. Though it’s important to remember the trust or direct beneficiary of a gift must continue to hold the BR-qualifying investment for the either seven years, or until Deborah dies, in order for the benefit of BR to be retained by Deborah’s estate.
In summary, the BR-qualifying investment has provided Deborah with flexibility and the ability to start to plan for IHT earlier than she otherwise might have felt comfortable with.
In planning ahead, her estate has been able to benefit from both BR and reinstating the RNRB, saving £540,000 in total.
Jess Franks is head of investment products at Octopus Investments
