Inheritance Tax Efficient Wills

The Government’s Pre-Budget Report outlined proposals for reforming the Inheritance Tax (IHT) regime.

Below are some details these proposed changes and how they will interact with Nil Rate Band (NRB) Discretionary Will Trusts.

The Government have not increased the IHT threshold but the Pre-Budget Statement does introduce the concept of transferable NRB’s between spouses and civil partners.

The December 2009 Pre-Budget Report included provisions that the yearly automatic inflation rise in the Nil Rate Band allowance would not take effect in April 2010 and the present exemption of £325,000 would be maintained. This restriction means a review of Inheritance Tax planning might be in order.

The situation before 9 October 2007

Married couples and civil partners did not pay IHT at the time of the first death, if the first spouse to die left everything to the surviving spouse. The spouse exemption applied and property passing between spouses qualified for 100% spousal exemption.

The IHT problem arose on the second death, when the surviving spouse had a then increased estate to pass on; those assets they had always owned and those they had inherited.  The IHT bill would be calculated by taking the whole value of the surviving spouse’s estate, deducting the NRB (£312,000 for the tax year 2008/09) and any other available reliefs and then applying a 40% charge on the remaining balance above £312,000.

The allowance of the first spouse to die had not been used and was therefore wasted and £124,800 of extra IHT could arise (£312,000 at 40%). So many couples took advantage of a NRB Discretionary Trust in their Wills, to make use of the allowance of the first spouse to die (the creation of a NRB Trust is classed as using the allowance) and the couple would obtain the benefit of two IHT allowances.

The situation after 9 October 2007

The estate of the second spouse can now use the NRB allowance of the first spouse (if it has not already been used) to offset against the second spouse’s IHT bill. The concept of a transferable NRB has therefore now been introduced.

Example

Mr X died in April 2007 and left everything to his wife. His estate was valued at £300,000. Spousal exemption operated and she received his estate free of IHT and his NRB was not used. Mrs X dies in April 2009 leaving an estate worth £600,000 (her assets and those she had received from her husband). Her Will leaves everything to her two children. By April 2009, the NRB allowance is due to increase to £325,000.

Pre October 2007

Her estate could deduct her NRB allowance of £325,000 from the value of her estate leaving:

£600,000 - £325,000 = £275,000.

This figure would then be subject to IHT and produce an IHT liability of:

£275,000 @ 40% = £110,000

Post October 2007

Her estate can claim to use any unused portion of her husband’s NRB, he had not used any of his allowance on his death so another 100% allowance would be available. This unused NRB allowance is based on the value of the allowance at Mrs X’s date of death (£325,000).

Mrs X’s IHT bill is:
£600,000 - £325,000 - £325,000 = £0 @ 40% = £0

No IHT being payable on Mrs X’s estate

Inheritance tax planning pre 9 October 2007

If a couple did not want to gift outright on the first death of the two of them, to try and ensure they used the first spouse’s NRB, we would have recommended:

• On the death of the first spouse, the Will was constructed so that a legacy of the NRB exemption was left to a Discretionary Trust and
• The remainder of the estate was left to the surviving spouse. This meant the NRB had been utilised (monies left to a Trust are classed as using the NRB) and it was not wasted.

Following the changes in the legislation and the concept of being able to utilise both NRB exemptions for a married couple on the death of the second spouse, does this mean this type of Will is no longer now required?

How does the new legislation affect Nil Rate Band Discretionary Trust Wills?

The ability to make a claim on the second death of a couple for the unused NRB allowance of the first deceased spouse will not necessarily solve the IHT liability.  There are still many advantages in setting up a NRB Discretionary Trust Will:

• Assets are ‘ring fenced’ and protected in situations such as divorce or bankruptcy.
• Assets can be protected from means tested calculations for nursing home fees. IHT can take up to 40% of an estate, nursing home fees can take nearly the whole, so this is an important planning tool.
• Growth in assets can be split between the trust and the surviving spouses’ estate. This is important if house prices rise. With a trust the growth of surviving spouses’ estate (and IHT liability) can be restricted.
• The surviving spouse may re-marry. Without a trust owning part of the estate, the surviving spouse might leave everything to the new spouse and the deceased spouse’s children miss out or receive nothing.
• Trusts can protect the interests of children with disabilities or those in receipt of means tested state benefits. It might not be wise to pass capital to these children as they may not be able to manage the money sensibly and/or they may lose their entitlement to state benefits.
• Unmarried couples cannot claim the transferable NRB, so they would benefit from the IHT saving NRB trust arrangements in their Wills.
• The NRB threshold might increase at a slower pace than inflation and house price increases.
• The Transferable NRB will not be automatically deducted on the second death, the onus of claiming the unused allowance will be on the personal representatives dealing with the second spouses’ estate and this must be done within two years of death or it is lost.
• If the surviving spouse remarries, then, by effective use of the NRB on the first death through a trust, there is potential for the combined estates to benefit from three NRB’s before IHT would become payable!

Conclusion

The Pre-Budget Report on IHT appears generous but there is still no substitute for forward planning.

Clients who have already have IHT effective Wills using the NRB route do not need to make any changes now, they can always review the position after the first death. If required, the NRB trust can be altered or even wound up within the first two years of the first spouse’s death, so the NRB trust route is not used if it is not appropriate to use it.

For more information on any of the issues discussed above please contact Frances Davies on 0113 227 0100 or email frances.davies@gordonsllp.com

Published: 28th April 2011

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