Techzone

Statistics show the traditional nuclear family is in decline, with around one in three marriages in England and Wales ending in divorce. More complex family dynamics often require more complicated wealth transfer planning to ensure that the needs of different family members can be met. But when it comes to the family home those plans could be further complicated when trying to make sure that residence nil rate band (RNRB) remains available.

A reminder of the basics

The IHT residence nil rate band rules are notoriously complex. The basic premise is that additional nil rate band of up to £175,000 is available when the family home passes to direct descendants. Like the standard nil rate band any unused residence nil rate band from the earlier death of a spouse or civil partner can be claimed on the death of the second partner. But the residence nil rate band will begin to be tapered away for estates in excess of £2 million. The RNRB will be lost completely if the estate exceeds £2.35 million, increasing to £2.7 million where an unused RNRB can be claimed.

Direct descendants

For the RNRB to be claimed the family home has to be 'closely inherited'. This means it has to pass on death to direct descendants which includes stepchildren and adopted children.

Co-habiting couples will only able to claiming RNRB if the property passes to their own children not their partners children. Unless a couple are married one partner's child from a previous relationship is not considered the stepchild of the other partner.

For example, Paul and Emma are co-habiting. Emma has a daughter Olivia from an earlier relationship. Their family home is owned as joint tenants and this will pass to the survivor automatically on death meaning no RNRB can be claimed by the executors of the first to die.

If Emma were to die first, on Paul's subsequent death his executors would be unable to claim any RNRB if the property passes to Olivia. This is because Olivia is not Paul's step daughter.

Should Paul and Emma get married this would no longer be an issue as Olivia would become Paul's stepchild on marriage, and on his death his executors could potentially claim Paul's RNRB plus Emma's unused RNRB.

Trusts involving the family home

It is not uncommon for the family home to pass into trust on death rather than passing directly to children. The RNRB can still be claimed where the trust immediately forms part of a direct descendant's estate. This would be the case where a share of the family home passes into one of the following trusts;

• Absolute (bare) trust
• Disabled trust
• Bereaved minors trust or 18-25 trust
• Immediate post death interest (IPDI)

Leaving a life interest

Where a couple each have children from a previous relationship they may consider owning their home equally as tenants in common. On first death, half of the property is transferred into a trust created by the will, giving the surviving partner a right to live in the deceased's share of property for life and on their subsequent death the property share passes to first partner's own children. This referred to as a life interest trust (or life rent trust in Scotland), with the children known as 'remaindermen'.

If the couple are married, there will be no IHT payable on the first death as the interest inherited by the survivor will be an 'immediate post death interest' (IPDI) and included in their estate for IHT. The transfer will therefore be covered by the spousal exemption. The estate on second death will include both the 50% share of the property they own outright plus the other 50% held in the life interest trust. The executors will be able to claim the first spouse's unused RNRB. This can be used against their own share should it pass to direct descendants and also the 50% in the life interest trust as this will pass to the life tenants stepchildren.

Unmarried couples will not enjoy the same IHT benefits. There's no spousal exemption on creation of a life interest for the surviving partner and the first RNRB would be lost. And only half the property value will be available to claim RNRB against. The property share inside the trust will not pass to direct descendants as the deceased partner's children are not deemed to be the survivor's stepchildren.

Discretionary will trusts

Creating a discretionary will trust up to the value of the available nil rate band (NRB) has been a popular planning tool. Prior to the introduction of transferable nil rate bands in 2007 it ensured the NRB was not lost on the first death.

They can still play a part in estate planning today, providing some control over who ultimately benefits from the trust assets and when. Choosing the right trustees can alleviate concerns that the settlor's own children may not be taken care of should the surviving spouse have their own children or remarry in the future.

No RNRB will be available on any share in the family home passing into a discretionary trust even if the intention is to ultimately benefit children or grandchildren. Of course, a surviving spouse or civil partner may still be able to claim the unused RNRB against their own share of the property.

This could be an issue if the value of the surviving spouse's share of the family home is less than the combined residence nil bands.

For example, Carl and Dawn are married and own their property as tenants in common. Carl died in May 2020 and his will left assets to the value of the nil rate band (£325,000) into a discretionary trust with the balance of the estate passing to Dawn absolutely. At the time of Carl's death, the family home was valued at £500,000 and his executors transferred his half share of the property (£250,000) into the discretionary trust along with savings of £75,000 to satisfy the £325,000.

Dawn sadly passed away the following year. She leaves her entire estate of £1M to their son Robert. At Dawn's death the property was valued at £550,000 meaning her half share is £275,000. Dawn's estate will not benefit from any transferable nil rate band as Carl's used his NRB. Her executor's can still claim Carl's unused RBRB giving a maximum RNRB of £350,000 in addition to her own standard NRB of £325,000. However, as the value of property passing to direct descendants is only £275,000 it means £75,000 of potential RNRB is lost.

This could have been avoided if on first death Carl's executors had satisfied the NRB legacy with other assets rather than the property share. Dawn would then own the entire property rather just half of it – more than enough to satisfy the full £350,000 RNRB saving £30,000 in IHT. If there had been insufficient other assets in Carl's estate, this may not be possible.

However, some will trusts may allow the trustees of the discretionary trust to accept an IOU or place a charge against the property repayable on Dawn's death. Again, this would have given Dawn outright ownership of the property and allow her to fully utilise all the available NRBs.

Summary

The residence nil rate band can mean on up to £140,000 can currently be saved in IHT for a couple. It therefore makes sense, where ever possible, to ensure that additional nil rate band isn't going to waste. Understanding how family dynamics interreact with how the home is inherited can help to get the most from this valuable but complex allowance.