New transferable nil-rate band for inheritance tax

The nil rate band is the amount of value in their estate that a person may give away before becoming liable to inheritance tax.  The Finance Act 2008 introduced the transferable nil-rate band which makes it possible for spouses and civil partners to transfer their nil-rate band allowances, so that any part of the nil-rate band that was not used when the first person died can be transferred to the surviving spouse for use on their death.

Naturally we all wish to minimise the amount of inheritance tax payable, by maximising the use of reliefs such as the nil rate band and usually a husband and wife make wills giving each other all (or most) of their property on the death of the first to die to ensure that the survivor has enough to live on. The family home may be the main item of value in the joint estates and if this is excluded what is left may be fairly small in value.

If this course of action is followed, the transfer from husband to wife (or vice versa) is completely exempt for IHT purposes and there will be no tax payable on the death of the first spouse.

Considered in isolation, this is most welcome at a very difficult time.  However, the whole value of the joint assets become concentrated in the hands of the survivor, upon whose death it becomes liable to IHT at 40%, over and above the nil rate band. In effect, the nil rate band of the first to die has been lost resulting in an IHT liability of up to £40.000.

Before October 2007, the only way of avoiding this tax charge was to draft the wills of husbands and wives to include a nil rate band discretionary trust. On the death of the first to die, a legacy of an amount equivalent to the then nil rate band would be given to trustees to hold on discretionary trust for the benefit of family members, including the surviving spouse. The legacy did not have to be paid until such time as the trustees considered it ‘appropriate’, usually on the death of the surviving spouse.

Now, the Government has introduced the so-called ‘transferrable’ nil rate band. Actually, this is misleading, because it is not possible to give it all or in part to a beneficiary.  In fact, the new arrangement is simply a relief that must be claimed by the executors of the surviving spouse on their death, for the beneficiaries of his or her will or intestacy.

This may be sufficient for many couples, who will make mirror wills leaving everything to the surviving spouse and trust that the new relief will, when applied to the provisions of the survivor's will, do everything they had wished to achieve.

However, there are many circumstances where this will not be sufficient, particularly in cases of re-marriage, and clients should take professional advice on their particular situation.

• For example, if you remarry then any will made previously is no longer valid and if you forget to make another will, your estate will go partly to your new spouse, and partly to your children.  Suppose that you and your new spouse do make another will giving each other all your property, then there is no guarantee that your children will benefit at all, because after your death the survivor could change any arrangements by making another will.  This is easily overcome by leaving property to the surviving spouse on trust.
• In an alternativescenario, even if you do not remarry, you may need full or part-time care later in life.  This is very costly and the initial source of funds must, under current rules, be the patient's own assets.  If your capital is used until it is exhausted, the standard of care may well fall.  By use of trusts a substantial sum may be preserved, which may be invested and used to provide an income to “top up” the standard of care.  This has the advantage of saving the capital sum for the benefit of your children, which is a concern for many.
• In a third situation what happens where a spouse dies and the survivor remarries? When both the surviving spouse and his or her new husband dies, the estate of the survivor will of course be able to use the nil-rate band of that individual, and will also be able to claim a further nil-rate band, under the new rules. But what of the nil-rate band of the first spouse to die? Only one further nil-rate band may be claimed, and so the nil-rate band of the first has been lost.  This problem is expanded if two people marry, both of whom have previously been married. Then, there is the potential for obtaining up to four nil-rate bands, but only if there has been careful planning in the lifetimes of the spouses concerned.

To conclude, we can say that the new rules may well be of considerable assistance in many cases, particularly as a safety-net where there has been inadequate or no lifetime planning.

However, in many cases, the problems have simply changed. It will now be, more than ever, necessary to think about the destination of property, and how best to achieve the aims of the person making the will. In many instances, the use of trusts in wills is likely to afford the best solution.  The particular form of trust depends on the circumstances of the case, however, and care must be taken to ensure that whatever trust is included in the will is appropriate to those circumstances.

It is vitally important to seek professional advice in all aspects of inheritance planning.  For further information, please contact Peter Harris, Associate of the Chartered Institute of Taxation (CTA) and a Registered Trust and Estate Practitioner.

13 January 2009

Disclaimer

The contents of this article are for the purposes of general awareness only.  They do not purport to constitute legal or professional advice.  The law may have changed since this article was published.  Readers should not act on the basis of the information included and should take appropriate professional advice upon their own particular circumstances.