Following recent tax law changes it is now possible to "claw forward" unused Inheritance Tax allowances from the estate of a deceased former husband or wife or civil partner (NB not in the estate of a last-surviving cohabitee - the new law is strictly applied and only benefits the survivor of a legally married couple or registered civil partnership).
The changes were made by the Government in response to a Conservative Party promise to raise the individual Inheritance Tax allowance to one million pounds. The response did not increase IHT allowances at all but, for married couples and civil partners, simply permitted the aggregation of unused allowances, following the first death, in the estate of the last deceased.
This was a significant benefit to married couples and civil partners since, ordinarily, transfers on death between husbands and wives or civil partners are exempt from IHT but, until the latest changes, this created a problem in that, if one partner left their entire estate to the survivor, the aggregate estate wound up in the hands of the last survivor and only that last survivor's individual tax allowance was then left available to be offset against the total of the former joint estate. At the time of review the personal allowances currently allow each party to a marriage or civil partnership, (and assuming no lifetime transfers have to be taken into account), to dispose of up to £325,000.00 without IHT becoming payable. This meant that, before the tax changes and assuming for the sake of this example that each party had separate assets conveniently totalling £325,000.00, if one partner left everything to the survivor, then on the death of the second partner only that second partner's tax allowance would have remained available so the joint estate would have been charged to tax at the rate of 40% thus the tax bill would have been, on the first £325,000.00 covered by the nil rate allowance nothing, but on the second £325,000, IHT at 40% would have been payable giving a tax bill of £130,000.00.
After the tax changes, and given the same circumstances, all of the deceased partner's allowance can be claimed in the estate of the survivor so all £650,000.00 of the joint estate can be disposed of in the survivor's estate without any IHT becoming payable.
Furthermore the wording of the new law allows the unused percentage of the first deceased's allowance to be offset against the joint estate at the IHT rates applicable on the second death so, if IHT allowances have increased between the dates of the first and second deaths, a greater allowance may be available on behalf of the first deceased than would have been available at their own date of death.
Following the changes many couples have seized the opportunity to simplify their Wills as the former somewhat artificial means of being able to use both parties tax allowances involved the creation of nil rate band discretionary trusts and added considerably to the complexity of the documents and also frequently to the costs of administering the estate.
Practical considerations
- Nursing Home Fees
Tax efficiency is one thing but it is also important not to lose sight of practicalities. Whilst the "new" allowance affords a very welcome relief for couples from a tax which, whilst created as a tax for the very wealthy, has become one applicable to most home-owners there are circumstances where leaving the entire estate of the first deceased to be dealt with on the second death may not work to best advantage. Consider the situation where a husband dies, making an immediate gift of all his property and estate to his wife, who then falls ill and spend the last five years of her life in a state nursing home. In these circumstances the entire joint estate is vulnerable to claims from the local authority for recouping the costs of care of the wife. At current nursing home rates this can quickly use all, or at least make a very substantial inroad upon, the estate available on the second death to be distributed to beneficiaries. If Wills had been made setting aside the IHT nil rate band on the first death, whether by means of a discretionary trust or by a straight disposal, although only one tax allowance would be available on the second death, the beneficiaries of the first deceased would still be entitled to those funds which were set aside, tax free and without them being subject to any claim whether from a local authority or any other creditor claiming in the estate of the second deceased.
- Agricultural or Business Property reliefs
The availability of a relief for tax purposes may not be clear until after death. Where only one of a couple may have an entitlement to a relief it may be important to keep assets in their hands so as to allow value against which the relief can operate. If the estate has passed on to a survivor who does not have the qualification for the relief this may be lost. A typical example would be where one of a married couple has an entitlement to Agricultural Property Relief as the qualifying farmer or land owner. By making disposals which are conditional upon the relief being available, with alternative provisions for the spouse in the event that the relief is not claimable, no relief should be unnecessarily lost.
- Planned disposals on a first death
The other common consideration to be borne in mind is that if couples have substantial assets they may well be able to afford to make a provision for the next generation on the first death which, whilst losing the ability to claw forward some or all of their personal IHT allowance (depending on the amount of the first death provision), may in practice benefit their offspring more than the relative value of preserving their IHT allowance for use on the second death.
As an example a couple who are financially secure themselves and whose individual assets are sufficient for either of them to be able to continue their former lifestyle, from their own individual resources, without having the need to use assets from the estate of the first deceased, might well choose to leave the first partner's IHT allowance, (or such lesser sum as they decide), to their children, tax free, on the first death. This could enable the children to pay off mortgages or deal with student loans or other financial matters much earlier than they would have been able to do from their own resources and will therefore potentially save the children many thousands of pounds of interest payments etc which would otherwise have fallen due before their entitlements under the estate of the second deceased crystallise.
- Making Provisions for issue of a former relationship
Another increasingly common purpose for disposals on a first death is to enable the first deceased to make provisions which the second deceased might not do. A typical example is where one of a married couple has children by a former partner and wishes to make provision for them. If they rely upon their new partner to make provision in their will then they lose control over the process and it is possible that by error or design no provision may be made, on their behalf, by the second partner on their subsequent death. This can arise by accident, where for example, the survivor dies without having made a will ("intestate") or the will made is invalidated by operation of law (for example where the surviving partner remarries, which has the effect of revoking or cancelling former wills) and in each such case the state then dictates who gets what, (and children of a deceased former partner in another relationship are not entitled to a share) or on purpose where the survivor chooses to favour their own offspring or beneficiaries at the expense of the children of the former spouse.
- A final warning
Tax law changes constantly. Wills which, when made, were competent, tax efficient and effective to implement the wishes of the deceased may need to be reviewed at least annually to make sure that the personal circumstances of the testator (the person making the will) haven't changed and the tax provisions which dictated the content of the will remain relevant. We strongly recommend that you review your Will at least once a year (we suggest you do this after each budget or pre-budget announcement) to make sure that no changes need to be made to keep your will effective and again on any significant personal or family event. Arrival of a(nother) (grand)child, loss of a partner, sale of a formerly tax efficient or relief qualifying asset should all be matters prompting a review. We are always happy to review your Will and if no changes need to be made we can usually do this both quickly and cheaply.
We cannot stress too strongly the importance of making and maintaining a good Will. Remember it is the last best thing you can do for your nearest and dearest - and that applies even if your nearest and dearest is a favoured charity!
For advice in making or updating a Will contact Brian Haite via our contacts page or, in the case of situations where specific tax planning advice and more complex considerations occur contact Mr Fluck.
