TT105: Inheritance Tax Changes

November 22, 2007

The current position

Every person has a nil rate band (NRB) that they can pass on at death that is free of Inheritance Tax (IHT). The current NRB in 2007/08 is £300,000. With certain specific exceptions the amount of the deceased’s estate in excess of this NRB is subject to IHT at 40%. One key exemption is that assets passed from one spouse to the surviving spouse on death are exempt from IHT.

However, those assets passed to the second spouse remain to be taxed as part of the surviving spouse’s estate when they ultimately pass away. A problem used to be that if the first spouse did not make use of their NRB and passed all their assets to the survivor then, as a couple, their estate would only benefit from the one NRB on the death of the second spouse – this would cost an additional £120,000 IHT at current rates!

To mitigate or remove this problem, Will structures have been developed that allowed the first spouse to create a NRB Discretionary Trust on their death and pass to this Trust assets to the value of the NRB. The balance of the estate would be given to the surviving spouse. This allowed the NRB to be used up on first death and also the surviving spouse could be one of the potential beneficiaries of the Trust and could access the assets if they required them during their lifetime. Most usually the asset passed to the Trust would be a loan note to the value of the NRB, which would be secured on the house that the surviving spouse would inherit.

These Will structures did work, but as Topical Tips 99 described, they could go wrong if not set up correctly. Additionally, only those couples who took the steps of having correct Wills drawn up would benefit. For many whose combined estate exceeded the NRB the failure to do the Will planning correctly resulted in a large liability.

The new rule

In his Pre Budget Report the Chancellor, Alistair Darling, made a change to IHT to ensure that all married couples and registered civil partners will automatically benefit from both of the couple’s NRBs without Will planning. Under the new rule the unused proportion of the NRB on the first death is passed onto the surviving spouse to use on their death. Importantly, this new rule will be effective for couples where the first spouse has already passed away. This is a major benefit to all widows and widowers.

Action points

If you already have a Will with a Discretionary Trust structure in place then don’t panic! You may not need to change your Wills. If you do not want to use the NRB Trust on first death it can usually be broken within 2 years of death and the survivor can still benefit from the ‘double’ NRB. The NRB trust could still be useful, for example for assets that are going to increase in value faster than the NRB. The Trust may also exist for other valid purposes such as Double Dipping the value of business assets that benefit from Business Property Relief – see Topical Tips 6.

However you should not use the NRB Discretionary Trust in all circumstances – there may be a pitfall that could cost your family IHT. For example, if a spouse died today and used their old Wills to set up a NRB Discretionary Trust then this would shelter £300,000 from IHT. If the second spouse died, say after 2010, then the second spouse will use the current NRB value (which will have grown to £350,000 by that date under the government’s proposals) and therefore the IHT free part of the estate would total £650,000. However if the first spouse did nothing and let the new rules take effect then on the death of the second spouse the double NRB that would be effective would be 2 x £350,000 and hence an extra £50,000 would be passed on free of IHT. This £50,000 at 40% would otherwise cost £20,000 in IHT under the old Will structure.

Barnes Roffe Topical Tips:

  • Do not assume everything is fine – take this opportunity to review your Will planning.
  • Remember, you might still require a Discretionary Trust for other reasons.
  • Note that Wills that are not tax-efficient can be rewritten with the consent of all the relevant beneficiaries within two years of a death to correct this or other problems.
  • Take steps to understand your Will and the terms within it.

Consult your Barnes Roffe LLP contact Partner for guidance in this important area.

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