Lifetime gifts, the residence nil rate band and a gift with reservation
Margaret, a widow aged 78, has an estate of £2,200,000, including her home worth £700,000. Her late husband died in 2018 and left his entire estate to her, so his nil rate band and residence nil rate band are unused. She wants to give £300,000 to her two children in 2024/25 and continue living in the home. She has made no lifetime gifts since 2018. She is considering transferring the home into a trust for the children while continuing to live there rent-free. Her solicitor has suggested she should 'use her annual exemptions'.
1. What IHT would arise on Margaret's death in 2024/25 if she makes no gifts and no trust arrangement?
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Margaret's estate is £2.2m. Her nil rate band is £325,000 and she can claim her husband's unused NRB, giving £650,000.
The residence nil rate band is £175,000, plus her husband's unused RNRB of £175,000, total £350,000. But the RNRB is tapered by £1 for every £2 by which the estate exceeds £2m. Excess = £200,000, so the reduction is £100,000. RNRB available = £250,000.
Total reliefs = £650,000 + £250,000 = £900,000. Taxable estate = £2,200,000 − £900,000 = £1,300,000. IHT at 40% = £520,000.
If the home were left to anyone other than direct descendants, the RNRB would be lost.
2. What is the IHT effect of the £300,000 gift if Margaret survives seven years, and if she dies within seven years?
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Survives seven years: the gift is a PET and falls out of the estate. It saves 40% of £300,000 = £120,000. It also reduces the estate to £1.9m, below £2m, so the RNRB taper disappears and the full £350,000 RNRB is available. That saves a further £100,000 × 40% = £40,000. Total saving about £160,000.
Dies within seven years: the PET fails and is added back. It uses the NRB first, so the £300,000 is taxed at 0% to the extent of the available NRB, and taper relief reduces the tax on any excess. The estate is still £2.2m for RNRB taper, so the RNRB reduction remains. The annual exemptions (£3,000 per year, with one year's carry-forward) should be claimed first, but they are small relative to the gift.
If Margaret needs the income or capital, a smaller gift may be better than risking the seven-year period.
3. Is transferring the home into trust while Margaret lives there rent-free effective for IHT?
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No. If Margaret continues to occupy the home rent-free, the transfer is a gift with reservation of benefit. The house remains in her estate for IHT purposes, so there is no saving, and the trust may also create CGT and administrative costs.
To be effective, she would need to pay a full market rent and genuinely give up the benefit, which is usually unattractive. Alternatives include downsizing, leaving the home to direct descendants to secure the RNRB, or making cash gifts and surviving seven years. The solicitor's suggestion to 'use annual exemptions' is good housekeeping but does not solve the GROB problem.