Know the rules of inheritance tax - Gareth Shaw

QUESTION I am sitting down with my elderly parents to have a conversation about inheritance. I’m not looking forward to it. My father has a great civil service pension, but not much in savings. The main asset is their home, which is worth just under £1 million. Am I right in thinking that that this can be inherited without inheritance tax being payable? I’m trying to convince my father to avoid putting the property in complex trusts he really doesn’t understand. Any advice would be greatly appreciated.

ANSWER: I sympathise with your situation – it’s always tough to have matter-of-fact conversations about death and the administration that comes with it. But it is sensible for you to do it now, while your parents have the mental capacity and time to make decisions about the future and, critically, understand how the law, taxes and the processes in dealing with someone’s estate work.

Let’s start off with the fundamentals. Inheritance tax is charged at 40% on what you inherit. But each individual has an inheritance tax-free allowance – technically called their ‘nil-rate band’, that allows them to pass on assets tax free. This is currently £325,000 per person.

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I’m assuming that your parents are married. Assets can be inherited by married couples and civil partners tax free – so if your father dies first, for example, your mother can inherit his assets and won’t have to worry about a tax bill. But she will also inherit his nil-rate band, which can be added to her own £325,000 tax-free allowance, meaning that your parents can actually pass on £650,000 free of inheritance tax. You would then pay 40% on anything over this amount.

There is an additional benefit, however, when an estate includes a property. Since 2017, homeowners had had an additional tax-free allowance, called the ‘residence nil-rate band’. In the current tax year, this is £175,000 per person. Much like the standard tax-free allowance, this can be inherited by spouses and civil partners and means that with all tax-free allowances combined, your parents could give away £1m tax-free, provided their property is included in the estate.

There is a condition attached – the beneficiaries must be ‘direct descendants’ of the people who have died. The government describes this group as: Children and their spouses or civil partners; grandchildren and their spouses or civil partners; great-grandchildren and their spouses or civil partners; stepchildren; adopted children; foster children and children who were under the guardianship of the people passing on their estate.

Other relatives, such as siblings, nieces and nephews, do not benefit from this additional allowance.

This is not relevant in your case, but while the property allowance only applies to one home, it could be any property in an estate if there is more than one, and not necessarily the one that was considered to be the ‘main’ home. The owner would need to have lived in the property for a time, but there is no minimum period of dwelling or ownership. What is relevant, however, is that it needs to be included in as part of the estate, which means it is counted in the assets directly owned by your parents. If your father were to put the property in a trust, this may mean that he cannot claim the additional property allowance.

It sounds like your parents own a substantial property. If they decided to downsize, they can still claim the property allowance. The executors of your estate will need to work out what's technically known as your 'downsizing addition'. This is the amount of the main residence nil-rate band that you would have 'lost' by moving to a cheaper home.

Gareth Shaw is Head of Money at which.co.uk