Parents and grandparents will be able to leave homes worth up to £850,000 to their children without them paying inheritance tax from 2017, rising to £1 million by 2020.
The move, first pledged as part of the Conservative Party pre-election manifesto, means that once fully in motion, each parent will be able to leave £500,000 in property up from the current £325,000 per person without paying the tax.
As allowances can be passed from one deceased partner to the other, when the first dies, their £500,000 allowance transfers to the other, giving the survivor a £1 million allowance.
For more help on how inheritance tax works and how to save £1,000s in other scenarios, see our Inheritance Tax guide.
How will the new allowance work in practice?
The current allowance whereby no inheritance tax is charged on the first £325,000 of someone's estate which is the value of their total assets they leave behind when they die remains unchanged. Above the threshold, the charge is 40%.
But a new tax-free band worth £175,000 per person on your main residence only will be introduced to add to the £325,000, making it £500,000 per person where there is a property involved.
When will this take affect?
The full £175,000 additional threshold will come into effect in 2020, but it will be introduced gradually, starting in 2017.
At that point, this new tax-free 'main residence' band will be set at £100,000, rising by £25,000 each year till it reaches £175,000 in 2020.
So in 2017 the amount that can be passed on tax-free is £850,000 as this is made up of the standard £325,000, plus the new £100,000 for the main residence, meaning a total of £425,000 per person. When the first partner dies and this is passed on to the survivor, this takes their allowance to £850,000.
Get Our Free Money Tips Email!
What about single parents?
Children or grandchildren where a single parent owns the property won't receive the full inheritance tax benefits as those who are married or in a civil partnership.
Here, only properties worth up to £500,000 can be passed on completely tax-free as there is only one allowance in play, not the two that couples have.
What about properties above £2 million?
For every £2 of value over £2 million, £1 will be deducted from the new 'main residence threshold' from 2017.
So those owning particularly expensive properties won't get the same level of tax break.
I want to downsize now, what happens?
Those who downsize now and therefore may have cash once their home is sold, where that money once formed part of the equity in a property, will still be able to pass on the same value of their estate tax-free to their dependents as had they kept a pricier property.
From today, anyone who downsizes their property and who dies after 2017 will still get the main residence threshold added to their allowance.
How does inheritance tax currently work?
See our Inheritance Tax guide for more help on how to save £100,000s on death duties. But in brief, here's how the system current works:
- Currently everyone is allowed to leave an estate, which includes property and savings valued at up to a £325,000 without their beneficiaries paying tax on it. This is called the nil-rate band.
- Anything you leave behind above £325,000 is subject to tax of 40% (or 36% if you leave at least 10% of your assets to a charity). So leave behind assets worth £500,000, for example, and your estate pays nothing on the first £325,000, and 40% on the remaining £175,000 a total of £70,000 in tax (if you're not leaving anything to charity).
- Officially, the £325,000 limit was frozen until at least 2017/18, when the Government was due to look at whether to increase it.
What is subject to inheritance tax?
When you die, the Government assesses how much your estate is worth, then deducts your debts from this to give the value of your estate. Your assets include:
- Cash in the bank
- Any property or business you own
- Payouts from life insurance policies