MARRIED COUPLES AND TAX PLANNING

Every individual taxpayer in the UK pays IHT on their estate at death. However, no tax is due on the first £255,000 of the estate’s value (the “nil rate band” – the figure relates to the year ending 5 April 2004, and rises each year with inflation). In addition, there is no IHT to pay if assets are left to the surviving spouse – this is called the inter-spousal exemption.

Yet many married couples waste a nil rate band when the first spouse dies, by leaving all that spouse’s assets to the surviving spouse. The entire joint estate will therefore be taxed on second death, with the benefit of only one nil rate band. This normally occurs out of fear or ignorance. Ignorance, because they didn’t understand the tax rules; or fear, because they thought that the only way assets could be removed from their estate was to give them away.

This example shows the cost of wasting the first nil rate band.

Example 1

Jack and Vera each have wills which state that all assets on first death will pass to the surviving spouse, and on second death everything goes to their son Terry. They each have assets worth £255,000.

Jack is first to die, and since all of his estate is inherited by his widow, no IHT is due. Vera now owns assets worth £510,000.

On her death, Terry inherits his mother’s estate. The IHT bill is 40% of the excess over the nil rate band: 40% x (510,000 – 255,000) = £102,000.

If Terry could have benefited from both Jack and Vera’s nil rate bands, he would have been able to inherit the entire estate with no tax. The cost of not planning is £102,000.

It is certainly true that giving away assets to someone other than the spouse will ensure that the nil rate band is not wasted. This, however, has problems of its own – if £255,000 is given away on first death, will the surviving spouse have sufficient assets to preserve their lifestyle? Can the surviving spouse get access to those funds in case of need or hardship?

UK Inheritance Tax

Discretionary Will Trusts