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Wills ServicesOur Wills Services What Happens if you die without making a will Fees Wills FAQ New Inheritance Tax Rules
Inheritance Tax or IHT Rules
In his Pre-Budget Report, the Chancellor of the Exchequer announced that from 9th October 2007, it will be possible for spouses and civil partners to transfer their nil-rate band allowances so that any part of the nil-rate band that was not used when the first spouse or civil partner died can be transferred to the individual's surviving spouse or civil partner for use on their death.
This means where a surviving spouse or civil partner dies on or after 9 October 2007, a proportion of the unused nil rate band from the death of the first spouse or civil partner can be used on the second death. The amount that can be transferred will be based on the proportion of the nil rate band unused at the date of first death and applied in the same proportion to the current nil rate band.
The transferable allowance will be available to all survivors of a marriage or civil partnership who die on or after 9th October 2007, no matter when the first partner died / dies .
What has NOT changed?
The Government has not increased the nil rate band tax free amount, as Mr Darling claimed in his Pre-Budget Statement speech. This has remained at £312,000 for the 2008/2009 tax year and will increase to £325,000 per person from April 2010.
What has changed?
What has changed is the rules on how the tax free allowance can be used when a husband, wife or civil partner dies. Transfers of property between spouses and civil partners are generally exempt from inheritance tax. This means that if an individual dies and leaves some or all of their estate to the surviving spouse or civil partner, they may not have fully used their tax free allowance.
Prior to 9 October 2007, the effect of this was that the surviving spouse or civil partner would pay more inheritance tax on their death, as they would only have the use of one nil rate band allowance.
Under the new rules since 9 October 2007, the unused allowance of the first spouse or civil partner to die can now be transferred to the surviving widow, widower or civil partner. This helps inheritance tax planning for married couples and civil partners. Under the old rules the usual way to ensure both spouses' tax allowances were used was by setting up nil rate bankd distretionary trust in their respective Wills.
The amount of the transferable nil rate band will be a proportion of the allowance which is not used on the first death. So, for example, if Mr Brown died in March 2000 and left all of his estate to Mrs Brown, then 100% of his nil rate band is therefore available on Mrs Brown's death.
So if Mrs Brown was to die in March 2008, her executors could use not only her £300,000 (the IHT threshold 2007/2008) of allowance but also 100% of Mr Brown's allowance, which would be a further £300,000. For this all to work and be effective, Mrs Brown's death has to fall after 9th October 2007 and that Mr Brown's transferred allowance is calculated as that at the time of Mrs Brown's death (March 2008), and not his own death (March 2000).
So if you are a surviving spouse and you have inherited all the assets from your spouse or civil partner, your executors upon your death could add your spouses (first death) nil rate band to the nil rate band that applies when you die. The executors will need to look at what proportion of the nil rate band that was unused when your spouse or civil partner died and uprating the nil rate band available when you die by that same proportion.
Uprating the nil rate band by the same proportion
The key concept here is uprating the nil rate band available by the same proportion. This involves the amount to be transferred is worked out by taking the proportion of the nil rate band that was unused on the first death and applying that to the nil rate band available when you die.
So if your spouse left assets worth £150,000 to your children with everything else to you and the nil rate band on their death was £300,000; one-half of their nil rate band is unused and is available for transfer. If, when you die, the nil rate band had increased to £325,000, the amount available for transfer would be 50% of £325,000 or £162,500 giving your estate a nil rate band of £325,000 + £162,500, or £487,500 in total.
Another way to interpret the new rules is regardless of the size of first estate was, whatever proportion of the nil rate band is unused may be transferred to the surviving spouse. If your spouse or civil partner's estate was worth only £200,000 and they left everything to you, they will not have used any part of their nil rate band. So 100% of the nil rate band is available for transfer when you die.
Examples of how the new rules will work according to HMRC
A dies on 14 April 2007 with an estate of £400,000, which he leaves entirely to his spouse, B. B dies on 17 June 2009 leaving an estate of £600,000 equally between her two children. When B dies the nil-rate band is £325,000. As 100% of A's nil-rate band was unused, the nil-rate band on B's death is doubled to £650,000. As B's estate is £600,000 there is no IHT to pay on B's death.
J dies on 27 May 2007, with an estate of £300,000. She leaves legacies of £40,000 to each of her three children with the remainder to her spouse K. The nil-rate band when J dies is £300,000. K dies on 15 September 2009 leaving his estate of £500,000 equally to his three children; the nil-rate band when K dies is £325,000. J used up 40% of her nil-rate band when she died, which means 60% is available to transfer to K on his death. So K's nil-rate band of £325,000 is increased by 60% to £520,000. As K's estate is only £500,000 there is no IHT to pay on K's death.
R dies on 14 April 2007 with an estate of £450,000, which he leaves entirely to his spouse, S. S dies on 17 June 2009 leaving an estate of £675,000 which she leaves equally between her two children. When S dies the nil-rate band is £325,000. As 100% of R's nil-rate band was unused, the nil-rate band on S's death is doubled to £650,000. This leaves £25,000 chargeable to IHT on S's death.
The trustees have to act in the best interests of the beneficiaries so they have to think carefully about the terms of the debt or charge, for example, they may index link it or provide for the payment of interest.
What does it all mean?
If you have an existing text planning Will which includes inheritance tax planning measures, you may be assured that these remain perfectly effective for saving inheritance tax. Most of these Wills will save the tax by setting up a trust on the death of the first spouse or civil partner to die. Where this is the case, you may wish to change your Wills if you feel that the downsides of keeping the trust (e.g. costs of setting up and running the trust) outweigh the benefits of retaining the trust structure (e.g. the protection of family assets).DISCLAIMER: This Article has been written for general information purposes only and should not be relied upon as legal advice. We accept no liability for your use of this Article. Legal advice should be obtained on any specific issues.