Article

Inheritance tax-efficient wills - the new landscape

Introduction

It has become increasingly valuable for married couples to use the inheritance tax (IHT) nil-rate band on the first death, in addition to the amount which will anyway be available on the survivor’s death. The same is true for civil partners, who are covered by all references below to spouses or couples.

The nil-rate band is currently £300,000, but it is due to rise to £350,000 in 2010-11. The simplest way of making use of the available nil-rate band on the first death is to leave it directly to the children or other intended beneficiaries. The main drawback, however, is that the amount involved is not then available to the surviving spouse. The way round that has been to leave a legacy on the first death equivalent to the available nil-rate band to a discretionary trust, including the survivor, the children and others as possible beneficiaries.

Proposed new law

In the Pre-Budget Statement on 9 October the Chancellor announced that the unused nil-rate band on the first spouse’s death would be “transferable” to the survivor. Actually, the proposal is more generous, since the nil-rate band on the survivor’s death will be increased by the proportion of the nil-rate band which has not been used on the first death. Since the nil-rate band rises at least in line with inflation each year, it may be considerably higher by the time of the survivor’s death.

If on the first death the whole estate passes to the survivor, leaving the nil-rate band completely unused, the nil-rate band on the survivor’s death will be doubled. If, however, the first deceased has made gifts of £40,000 within seven years of their death and leaves non-exempt legacies in their Will totalling £20,000, they will have used£60,000 (20%) of the nil-rate band.

The unused balance will not be transferred to the survivor, and the survivor’s nil-rate band will be increased by only 80%.

Who will be affected?

This new approach will be available to all survivors of a marriage or civil partnership who die on or after 9 October 2007, no matter when the first spouse died or dies. If the surviving spouse has been married more than once before, the unused nil-rate band on each previous spouse’s death can be used, but not so as to more than double the nil-rate band on the survivor’s death.

Effect

If enacted, the proposed new law is likely to make nil-rate band discretionary trusts on the first death redundant. If there are legacies on the first death directly to children or other beneficiaries who will also inherit on the survivor’s death, they should be reviewed. It is almost certainly preferable for the survivor to inherit most, if not all, of the estate (either outright or in trust) and to make gifts by way of potentially exempt transfers (PETs) to the eventual heirs. In that way, if the survivor lives for at least seven years after the gifts, they will not count for IHT and in addition the survivor’s nil-rate band will be doubled. Even if the survivor fails to survive the PETs by seven years, the position will still generally be better than if the nil-rate band had been used on the first
death.

Any remaining advantages?

A nil-rate band discretionary trust may still be worthwhile if there is an asset the value of which can be expected to outstrip rises in the nil rate band during the survivor’s lifetime. Another advantage of a trust is that it should shelter the assets within it from means-testing or financial claims which the survivor may face. However, other considerations may still militate against using a trust.

Simplicity

The proposals, if enacted, should simplify the drafting of married couples’ wills and also the administration of the estate on the first death.

Business and agricultural property

It will still be desirable for there to be specific legacies on the first spouse’s death of business or agricultural property which is eligible for 100% relief from IHT, either outright to children or other beneficiaries, or preferably to a discretionary trust.

Existing wills

If couples already have nil-rate band discretionary trusts in their wills, they are not harmful. It will be possible within two years of the first death for the discretionary trust to be ended, by transferring the assets to the surviving spouse, and as a result leaving the nil-rate band unused on the first death. Wills leaving legacies on the first death to the eventual heirs should be reviewed. If they remain as they are, it will be possible for the children within two years of the first death to do a Deed of Variation in favour of the surviving spouse intended to liberate the nil-rate band on the first death. We do not recommend the removal of discretionary trusts from Wills at least until the Pre-Budget proposals are enacted in 2008.

New wills

We will not normally recommend including nil-rate band discretionary trusts in new Wills, but the position will need to be kept under review pending the enactment of new legislation.

For further enquiries please contact Simon Brown (view full profile) on 01892 510000 or email simon.brown@ts-p.co.uk.

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