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This month’s free tip - Inheritance Tax Planning for Married Couples and Civil Partners (or survivor)
A recent change in the law has simplified and improved the Inheritance Tax position of married couples and civil partners with regard to the nil rate band (ie. that part of a deceased person’s estate that is not subject to inheritance tax at 40%). Under the new rules, when one spouse or partner dies the unused part of their nil rate band allowance is effectively taken over by the surviving spouse or partner. On the subsequent death of the survivor, their estate would then have the benefit of an additional nil rate allowance (equivalent to the unused proportion of the first deceased’s nil rate band) on top of the survivor’s own nil rate allowance at that time.
If the first deceased leaves all their estate to the survivor, as this is covered by the usual “spouse exemption” it is not subject to inheritance tax, so none of the deceased’s nil rate band allowance has been used. Thus, on the death of the survivor, their estate will have the benefit of two whole nil rate band allowances (ie. double the nil rate band in force at that time).
If the first deceased makes gifts by their Will that are not exempt, the total value of those gifts will use up the appropriate proportion of the nil rate band and only the unused proportion will be transferred to the survivor. Thus if (for instance) the first deceased uses up 20% of their nil rate band by gifts that are not exempt, the survivor will have the use of an additional 80% nil rate band on their own death.
The only gifts that are exempt from inheritance tax are gifts to a surviving spouse or civil partner and gifts to charities. (Thus gifts to children or grandchildren, for instance, are not exempt and would come out of the nil rate band allowance.)
The effect of the change is retrospective, which means that if you are the survivor of a couple it does not matter how long ago your late spouse or civil partner passed away – it is simply a matter of establishing how much, if any, of their nil rate band allowance was used up on their death. (It will therefore be important to make sure that the relevant records are kept for as long as necessary.)
In the past, for many years it was usual for most couples to make Wills leaving the whole (or greater part) of their estate to the survivor, on the basis that children would only inherit on the second death, and although there was only one nil rate band allowance available this was high enough to ensure that, in the majority of cases, there would be little or no tax. However, in recent years the sharp increase in property values (and smaller increase in nil rate band levels) led to more and more couples being faced with tax liability on the second death because their combined estates would be over the single nil rate band. To avoid this, many couples made Wills incorporating special trust provisions (nil rate band discretionary trusts) enabling them to take advantage of both their nil rate band allowances, without adversely affecting the financial position of the survivor. Assuming they are properly drawn, such Wills still operate effectively to protect the interests of the survivor, whilst affording a great deal of flexibility, so if you have made Wills on this basis there is no need to change them at all.
However, the change in the law means that if you are considering making a Will for the first time (or changing an existing one) and your combined estates do not exceed twice the nil rate band, you no longer need to use discretionary trusts to avoid inheritance tax on the second death. If you are only concerned about tax, you can therefore safely leave everything to your surviving spouse or civil partner.
It should be borne in mind, however, that this will leave all the assets in the hands of the survivor of you and this might not be advisable if there is any likelihood that the survivor may have to go into long-term residential care, in which event they would be required to use their assets to pay for the cost of that care (excluding nursing care which is supposed to be paid for by the NHS). In some cases this could mean that the majority of the assets may have to be used up in paying for care (save for the small amount that the survivor would be allowed to keep whilst still claiming benefits).
If you feel there is a risk of this happening, and you wish to shelter some or all of your estate for the benefit of your children or other heirs, this can readily be achieved by giving the survivor a life-interest in your estate (or a substantial part of it – for instance your half-share of a jointly owned home) instead of giving it to them outright. Although they would not own the assets, they would have the use of them (or the income from them, if any) for their lifetime, after which the assets would pass to your heirs.
The gift of a life-interest to a spouse or civil partner would still be exempt and would therefore not affect your own nil rate band allowance. However, on the death of the survivor their estate would be valued as if it included the assets in which they had a life interest, so if the total exceeds the combined nil rate bands there might be some inheritance tax on the surplus. (This would normally have to be reimbursed by the heirs who receive those assets after the death of your surviving spouse or partner.)
Alternatively, you can still make use of nil rate band discretionary trusts, which will have a similar sheltering effect whilst providing greater flexibility, as the trustees would have power to release income and/or capital to the survivor (at their discretion). See separate information sheet: “Nil Rate Band Discretionary Trusts (for married couples or civil partners)”.
To take full advantage of the tax-saving effect of the above provisions it may be advisable for you and your spouse or partner to equalise your respective assets, so far as reasonably possible, for which purpose we recommend that you consult an independent financial adviser for guidance. Also, if your home (or any other property you own) is held by you and your spouse or partner in joint names this should be held as “beneficial tenants in common”, not “joint tenants”. (See separate information sheet regarding “Joint Ownership of Property”). Any existing joint tenancy should therefore be converted into a tenancy in common (in equal shares) by a Notice of Severance.
If you would like to discuss the above, or need further advice about your own requirements, please let us know (and feel free to make use of our Free Advice Service, if you have not already done so).
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