Inheritance tax

Do you have double the nil-rate band?

Inheritance tax (IHT) worries a lot of people because the IHT threshold, known as the nil-rate band, has not been increased in line with house prices over recent years. On death, all your wealth, including the value of your house, is taxed at 40% on all amounts above the nil-rate band, which is currently £325,000 (2009-10).

If your house is jointly owned the actual wealth in your name may be less than the £325,000 threshold. When the first spouse or civil partner dies and leaves everything to the surviving spouse or civil partner there is no IHT to pay, as the bequest is exempt from IHT for transfers between spouses and civil partners. However, when the surviving spouse or civil partner dies there may be a large IHT bill as all the wealth previously owned by the couple is now in the hands of one person, with only one nil-rate band to use.

The Chancellor has tried to solve this problem by allowing any unused nil-rate band on the death of the first spouse or civil partner to be transferred to the surviving partner who dies on or after 9 October 2007. That may give a total IHT exemption for a surviving spouse or civil partner of £600,000 (for 2007/08) rising to £700,000 for the tax year 2010/11.

Say Fred, a widower, died on 1 October 2007 with an estate worth £500,000. His executors will be required to pay IHT at 40% on £200,000 (£500,000 – £300,000) amounting to £80,000. If Fred dies on 1 November 2007, and his wife did not use her nil-rate band when she died, his estate has the benefit of two nil-rate bands totalling £600,000. Now Fred’s executors will pay no IHT at all on his estate of £500,000.

The effect of transferring the nil-rate band could be achieved before this IHT change with the use of a discretionary Will trust. If your Will contains such a trust the Will does not necessarily have to be rewritten. If the only reason for the trust was to use each spouse’s or civil partner's nil-rate band there may be little point in creating such a trust. However, there can still be advantages in creating a trust:

a person may want to direct who the ultimate beneficiaries of the assets will be rather than leaving that decision to the surviving spouse or civil partner
assets put into the trust on the first death may grow at a faster rate than the increase in the nil-rate band. That growth is not included in the surviving spouse’s or civil partner's estate.

The inheritance tax change does not help couples who are not married or not in a registered civil partnership.

Please contact us on +44 (0)20 8363 5502 if you would like more advice specific to your circumstances.