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How downsizing can help with IHT

When comedian Ronnie Corbett died in 2016, it transpired that he had sold his house in 2003 for £1.27m. The intention seems to have been to raise cash for his children, which would avoid inheritance tax (IHT). After the sale, Corbett and his wife moved into a smaller home which was worth about £250,000. The case raises an interesting question: can downsizing be a legitimate option for mitigating a future IHT bill? In this post, our financial planning team at Vesta Wealth explores how this can be a valid option within certain estate plans.

 

Inheritance tax and downsizing relief

Downsizing relief is one of the most complex areas of IHT. This has led the Office of Tax Simplification (OTS) to recommend that those considering it as an option should seek professional advice. To qualify for downsizing relief, you need to meet three main conditions:
On or after 8th July 2015, you must have sold, gifted or downsized to a less valuable home.

  • Had you kept the home until death, it would have qualified for the Residence Nil Rate Band (RNRB) – i.e. up to £175,000.
  • At least some of your estate must be inherited by direct descendants (e.g. children).
  • You must not continue to live in a property after you have sold it. Doing so risks triggering the gift with reservation rules.

After you die, the representatives of your estate need to claim downsizing relief within two years from the end of the month in which you died (although HMRC does, sometimes, accept applications later than this).

In effect, downsizing relief allows an individual to claim the amount of RNRB that they would have been entitled to had they not downsized. The cash which has been released from the property sale, moreover, can now be put to other use – e.g. making gifts to children, or topping up a pension or paying for long term care.

 

Pros and cons of downsizing

Downsizing can be an attractive option for those in retirement. First of all, it can allow you to move into a home that is easier to manage and maintain in older age. Secondly, it can lower your monthly expenses and free up some much-needed cash to help fund your retirement lifestyle. It could also help reduce a future IHT bill. For instance, take the case of Mr & Mrs Corbett whose former property was valued at £1.27m – putting at least £270,000 of their estate above their combined IHT-free thresholds. By moving into a cheaper home and giving the remaining proceeds to their children, these could be exempted from IHT (provided they survive the gift by at least 7 years – which, in this case, it appears they did).

However, downsizing is often a highly emotional decision since it often means saying goodbye to a home full of cherished memories. Downsizing can also involve moving to a new area where you may be far away from familiar surroundings, friends and family. Also, there is not always an IHT saving to be made. Quite often, for instance, it is possible to almost entirely eliminate an IHT liability through other means, particularly if a family home is passed down by a married couple (or civil partnership) to direct descendants. Here, up to a £1m estate can be handed down to beneficiaries completely free of IHT.

 

Other potential avenues to explore

Downsizing is a big decision, and it may be that less drastic steps can be taken to mitigate an IHT bill. For instance, pensions are often a great tool for estate planning (as well as for retirement planning) since pension savings are usually exempt from IHT. By building up wealth in a pension, therefore, an estate owner could apply most/all of their IHT-free allowance towards their property upon death whilst also retaining a large IHT-free retirement fund. For those nearing their pension lifetime allowance, other IHT-efficient options may be available.

For instance, building up an ISA portfolio of well-selected AIM shares (alternative investment market) will typically qualify for Business Relief, which means exemption from IHT.

Gifts, of course, are also a great option for mitigating IHT. Each year, you can make up to £3,000 in gifts to one or more people (without these getting counted as part of your estate). You can also give up to £5,000 to a child for their wedding, IHT-free, or up to £2,500 for a grandchild or great grandchild (£1,000 for anyone else). Finally, there are also IHT-efficient investments such as EIS shares (enterprise investment scheme) which qualify for exemption if held for at least two years. Downsizing is not your only option for reducing a future IHT liability. There are many options you can explore with the help of an experienced financial planner.

 

Invitation

If you would like to discuss your IHT strategy, then we would love to hear from you. Get in touch with your Financial Planner here at Vesta Wealth in Cumbria, Teesside and across the North of England.

Reach us via:
t: 01228 210 137
e: [email protected]

This content is for information purposes only. It should not be taken as financial or investment advice. To receive personalised, regulated financial advice regarding your affairs please consult your Financial Planner here at Vesta Wealth in Cumbria, Teesside and across the North of England.

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April 12th, 2022