The changes announced on 9th October 2007 only affect married couples (and civil partnerships), and those who were widows or widowers on 9th October 2007. If you have never been married, you might as well stop reading – except that you may feel that getting married might not be a bad idea once you have read this article!
In order to understand where we are now, we need to look at where we were before 9 October 2007.
IHT is charged on the value of your estate when you die, plus the value of any gifts made in the seven years preceding your death. Everyone has a “nil rate band” of £300,000. That is the current figure but it is increased each 6th April. The first £300,000 of your estate is charged at 0% and the balance is charged at 40%.
A legacy to your spouse or civil partner is exempt from IHT. Before 9 October 2007, much IHT planning focussed on how to make sure the nil rate band of the first spouse to die was not wasted. If you simply left everything to your spouse, there was no IHT payable on your death, but when it was their turn to die, they would only be able to set their own nil rate band against the value of their estate, so yours would have been wasted.
The planning strategy to get round this problem was known as “second death planning” and it generally took the form of a “nil rate band discretionary trust”. The first spouse to die left £300,000 (or whatever the nil rate band was when they died) to a discretionary trust, with the surviving spouse and (typically) the children as beneficiaries. The rest of the estate was left to the spouse absolutely. There was no IHT to pay because the legacy to the spouse was exempt from IHT, and the legacy to the trust was within the nil rate band so IHT was payable on it at 0%.
When the second spouse died, their nil rate band could be set against their estate and the assets in the discretionary trust did not form part of their estate, so their heirs benefited from both the couple’s nil rate bands.
There were problems with nil rate band discretionary trusts, particularly where, as in so many cases, the major asset was the family home. It was still possible to use a trust but there were complications for capital gains tax, and if the trust was not set up by an expert, there could also be IHT problems.
As from 9 October 2007, the rules have changed. From now on, if the first spouse to die does not use their nil rate band – because, for example, they leave everything to the surviving spouse – then the survivor “inherits” the nil rate band and can use it against their estate when they die.
For example, if Mr Brown (to pick a name at random) dies today and leaves everything to his wife, there will be no IHT to pay because of the exemption for legacies to spouses. If his wife dies in January 2008, her executors can use her nil rate band of £300,000 AND Mr Brown’s unused nil rate band of £300,000, so there is no IHT to pay on the first £600,000 of her estate.
The change in the rules is also retrospective. If Mr Brown had died in, say, 2002/03 (when the nil rate band was £250,000), and he had left £125,000 to his brother and the rest to his wife, he would have used up 50% of his nil rate band on the legacy to his brother. His wife’s executors can therefore use the other 50% of the current nil rate band (£150,000) together with Mrs Brown’s own £300,000, so the first £450,000 of her estate is free of IHT. Notice that the amount of the unused nil rate band is expressed as a percentage, so that Mr Brown’s unused 50% gets more valuable each year as the nil rate band is increased for the new tax year.
Even if Mr Brown died 20 years ago, if his wife was alive on 9th October of this year (2007), then when she dies, any unused percentage of Mr Brown’s nil rate band can be added to her nil rate band.
This of course produces administrative nightmares – already in my firm we are desperately rooting through old files to find out how much of the nil rate band was used up when the spouses of our client widows or widowers died some years ago.
There are three vital planning points for anyone who is married or whose spouse has died:
Check your will – if it includes a “nil rate band discretionary trust” take advice on whether this is still the best choice for you. In many cases, the best strategy will be to leave everything to your spouse, even if they then immediately make gifts to other people you wish to benefit.
If your spouse has died, check how much, if any, of the nil rate band was unused on their death and keep a record of it – as time goes by, it will become harder and harder to find the correct figures as the documents get lost or eaten by mice.
If your spouse died less than two years ago and left a “nil rate band discretionary trust”, you must urgently consider whether you need to use a “Deed of Variation” to redirect their entire estate to you and thus take advantage of the new rules.
There are still some circumstances where a nil rate band trust will still be the best choice, but in the majority of cases, a simple will leaving everything to the spouse is likely to be the new strategy.
I am seriously considering giving up tax consultancy and opening a marriage bureau. I will specialise in very poor, very old people. I will introduce them to widowed millionaires whose dead spouses (possibly because of my advice under the old rules!) used up their nil rate bands on a discretionary trust when they died. If the millionaire marries my elderly client (and thus acquires their nil rate band when they die) I will charge a fee of 10% of the current nil rate band. I will soon be a millionaire myself!