Rather unexpectedly, in the Pre-Budget Report of 9th October 2007, the Government announced an effective doubling of the Inheritance Tax threshold for married couples or civil partners with immediate effect and, in some cases, with retrospective effect. The legislation to achieve this finally received Royal Assent on 21st July 2008. HMRC had been proceeding on the basis that the legislation would be enacted but were not, until now, able to finalise any estates which benefited from the new provisions.

In straightforward terms, if one spouse or partner has died and his executors do not use the whole of or part of the inheritance tax threshold (commonly referred to as the “nil rate band”), then the survivor of the couple can carry forward the unused part of the threshold and add it to his or her own threshold on their subsequent death. The rules apply where the second spouse dies on or after 9th October 2007, regardless of the date of death of the first spouse to die. The transfer does, however, have to be claimed on the death of the survivor and the claim must be supported by documentation.

Savings To Be Made

The technical rules calculate how much of the threshold was not utilised on the death of the first of the couple to die, change it into a percentage and then allow the survivor to increase the threshold available on their death by the same percentage.

For example, if the threshold was £275,000 on the first death, and that person had given legacies of £68,750 to his children and the remainder to his wife, then £206,250 of the threshold has not been used as the bequest of residue to the wife is exempt from Inheritance Tax.

In percentage terms, 75% of the threshold has not been used on the first death. On the death of the survivor, if the threshold is £312,000, then it will be increased by 75% to £546,000. This means that tax will be charged on the survivor’s death on the value of the estate in excess of £546,000. Under the old rules, tax would have been charged on the excess over £312,000. In many cases, with an effective doubling-up of the nil rate band on the second death (where the first estate passed in its entirety to the surviving spouse) both estates will escape IHT.

The tax saving could previously have been achieved by active tax-planning. Instead of leaving their entire estates to each other on the first death, a married couple or civil partners could make Wills which included what is known as a “nil rate band discretionary trust” provision. The surviving spouse or partner was normally a trustee and he/she and the children or other relatives were all potential beneficiaries.

Both income and capital were available to the survivor throughout his/her lifetime at the discretion of the trustees. On the survivor’s death, the trust would normally be wound up and the assets made over to the children/beneficiaries free of tax (assuming the growth in the value of the trust estate was not greater than the uplift in the ‘nil rate band’ in the interim).

As the trust was a separate taxpayer in its own right, with its own nil rate band, the effect of this arrangement was to ensure that both nil rate bands were used rather than just the nil rate band of the surviving spouse. This doubled the assets which could pass free of tax to the children/other beneficiaries from £312,000 to £624,000, at present rates.

All married couples and civil partners with combined assets of more than £300,000 at the present time will benefit from the new “doubling-up” of thresholds. They could alternatively benefit from investing in a tax effective Will; in either case, the saving at current rates could be as much as £124,800!

Non Tax Benefits

While some commentators consider that nil rate band trust Wills have had their day, there are non-tax reasons why a married couple or civil partners may still want to include a trust in their Wills. For example the survivor may wish to shelter assets against the potential cost of nursing home fees. Trusts can also shelter assets which are likely to increase greatly in value in the short term. If a nil rate band trust is wound up within 10 years of the death of the first of the couple to die, the assets can pass to the beneficiaries free of IHT, regardless of their value when they leave the trust. Trusts can also be a useful way to provide for children of a first marriage or partnership, or to protect assets from the consequences of a child’s divorce. A trust can also help with IHT planning for future generations.