When you die, the vultures from HM Revenue and Customs begin to circle. Inheritance tax (“IHT”) is charged on the net value of your estate, after taking account of any debts at the time of your death. The first £285,000 is charged at 0% (this is known as the “Nil Rate Band”(“NRB”), and is scheduled to increase to £300,000 after 5 April 2007), and all the rest is taxed at 40%.
There are various reliefs from IHT for business property and for agricultural property, but any other assets you own when you die will be subject to IHT.
There is also an exemption for legacies left to your spouse (or civil partner). If you are married, and you leave all your estate to your spouse, there will be no IHT to pay when you die. When your spouse dies, however, IHT will be payable at 40% on their legacies to (for example) the children – except for their NRB of £285,000.
“Second death planning” is a basic IHT tax planning technique that effectively makes sure that the NRB of the first spouse to die is not wasted. Consider this:
Darby and Joan are comfortably off, with two children. In their Wills (drawn up by Darby on a form he bought at the local newsagent) they each leave their entire estate to the other, so they know there will be no IHT to pay when the first of them dies.
Their assets are:
If Darby dies first, leaving everything to Joan, there is no IHT to pay because of the “spouse exemption” described above, but when Joan goes, (assuming the values and the NRB are the same at the time), the NRB will be deducted from her estate of £890,000, and the balance of £605,000 will be liable to IHT at 40% - tax of £242,000 to pay, so the children will only get a legacy of £648,000.
If instead Darby and Joan had each left part of their estate equal to the NRB to a discretionary trust, then things would be different. When Darby died, there would be no IHT to pay (because the legacy to the discretionary trust was covered by the NRB, and the balance left to Joan was covered by the spouse exemption).
Joan’s estate is now worth £605,000, and there is also a discretionary trust (from which she and the children can benefit) worth £285,000. When Joan dies, the IHT payable is only £128,000 (£605,000 - £285,000 = £320,000 X 40% = £128,000), so the children’s legacy (including the value of the assets in the trust) is now £762,000 – they are £114,000 better off – which is, of course, due to Darby’s NRB having been used and not wasted (NRB = £285,000 X 40% = £114,000).
The key points to note about this type of planning are:
Darby | Joan | Total | |
House (jointly owned) | 200,000 | 200,000 | 400,000 |
Savings (Building Society joint account) | 150,000 | 150,000 | 300,000 |
Buy to let property | 125,000 | Nil | 125,000 |
Furniture, valuables, etc | 25,000 | 40,000 | 65,000 |
Total | 500,000 | 390,000 | 890,000 |
- It can save up to £114,000 in IHT on the “second death”
- It only works for married couples (or civil partners)
- The survivor need not be worse off, because he/she can benefit from the discretionary trust set up on the death of the first spouse
- The widow/widower would need access to all of the joint estate in order to maintain their standard of living, or
- The children are too young or too irresponsible to be trusted with a direct legacy
This article has been provided by Tax Insider, click here to visit the website.