We recently wrote about the misconception of the “common law spouse” and the importance of putting a will in place to ensure your assets are passed on as you wish. In this article, we consider how couples who do not wish to get married can mitigate their inheritance tax (IHT) exposure upon death.
Recent estimates by the Office for National Statistics show there is a rise in unmarried couples cohabiting, representing 13.1% of the population in 2020 compared to 11.3% in 2010. It is important that this growing group is aware of the IHT and estate planning tools that can be used to plan for their future.
Married vs unmarried couples
IHT is charged on an individual’s estate upon death at the rate of 40%. Each individual enjoys a nil-rate band amount which is taxed at 0%. The nil-rate band is currently £325,000 (less any gifts made in the seven years before death), so if you die leaving a £400,000 estate and have a full unused nil-rate band, IHT is charged at 40% on the £75,000 excess.
The principal IHT benefit available to married couples is spouse exemption. This allows one spouse to leave their entire estate to the other spouse free of IHT. In addition, the surviving spouse will inherit any unused nil-rate band from the first spouse to die which can be claimed when the second spouse dies. Therefore, a surviving spouse can inherit tax-free upon the first death, and then enjoy a nil-rate band of up to £650,000 to pass their estate on as they wish when they die.
Unmarried couples do not benefit from the spousal exemption and cannot inherit each other’s nil-rate bands. Therefore, if you leave your estate to your partner upon death, they will have to pay IHT on any assets in excess of the nil-rate band.
If you own a house, you may be able to benefit from the residence nil rate band (currently £175,000) (RNRB) when your property (or the net sale proceeds) are inherited by your lineal descendants i.e. children or grandchildren. However, whereas married couples can inherit each other’s RNRBs, unmarried couples cannot. It is therefore important that unmarried couples structure their affairs in a tax efficient manner.
Option 1: Will trusts
Finally, you may wish to consider using a trust created by your will in order to ensure your chosen ultimate beneficiaries inherit your assets as you intend. For instance, you may have children, but would want your partner to be able to live in the house you own together. A trust structure would allow your partner to be able to continue living at the property whilst protecting the underlying capital for the benefit of your children. It would also stop the value of the assets you would like your partner to benefit from potentially aggregating with their estate and IHT being paid twice i.e. on your death and then on your partner’s death.
Option 2: Purchase life assurance
In consultation with your financial adviser, if you do not want to enter into a marriage or civil partnership, purchasing life assurance and placing it in trust for the benefit of your partner (and/or children) can be a useful tax planning method. By placing the benefit of the policy in trust, the policy would not pay into your estate on death and would therefore not be subject to IHT. Upon your death, the trustees of the trust would pay the proceeds to your nominated beneficiaries.
Option 3: Tax efficient investments
Your financial adviser will be able to advise you on tax efficient investments designed to mitigate your IHT exposure by investing in assets that are taxed at 0% on death, therefore reducing the IHT payable on your death.
Option 4: Consider a civil partnership
The above options do not constitute legal or financial advice and, as each individual’s circumstances vary, we would encourage you to take advice on the options available to you. If you require advice about your estate planning matters, please contact email@example.com