Trusts and Tax / Wills and Probate

Inheritance Tax – Changes to the Nil Rate Band

What is the nil rate band, and how has it changed?

Inheritance tax on death is currently at a rate of 40%. Each person, however, has an allowance which they may leave tax free. This allowance is called the nil rate band, and is currently £312,000 per person.

As anything left in a will to a spouse or civil partner is automatically tax free, many people use tax planning to reduce their IHT liability on death. One commonly used method is for the first partner to die to leave a legacy equal to the amount of the nil rate band on discretionary trust, for example for the benefit of their children. The rest of their estate would pass to their surviving spouse, tax free. The amount in the discretionary trust would therefore already be outside the estate of the second partner when they die, and would not be subject to IHT. Compare this to the situation where the first partner to die leaves their entire estate to their spouse; their nil rate band would be wasted.

In October 2007 the Chancellor announced changes to the rules governing IHT. Any unused proportion of a nil rate band is now automatically transferred to their surviving spouse or civil partner. This change will affect all surviving spouses and civil partners who die on or after 9th October 2007, regardless of when the first partner died.

Under the new rules, if the first partner to die were to leave everything to their spouse, 100% of their nil rate band remains unused. This is automatically transferred to the second partner, so when they die their nil rate band will be doubled to £624,000 based on the current nil rate band.

Does this mean I no longer need to consider tax planning?

These changes will be advantageous to many married couples and civil partners; in most cases, however, it is still important to consider how best to reduce IHT liability.

For example, if one partner owns assets that will significantly increase in value over time, it may be prudent to leave it them to someone other than their spouse on death. Although this may use up the first partner’s nil rate band, the overall IHT liability for the couple will be reduced if the assets grow in value more quickly than the nil rate band.

I have already drawn up a will with a nil rate band discretionary trust. What should I do?

Because of these changes, any wills with tax planning provisions, such as nil rate band discretionary trusts, should be reviewed. It is possible that wills drafted before the new legislation came in to effect could leave couples worse off than wills with no tax planning provisions at all.

An example of this is if the first partner to die leaves a nil rate band discretionary trust with a value of £312,000. When the second partner dies, the nil rate band has increased to £400,000, so the total left tax free by the couple is £712,000. If the couple had made no tax planning provisions, and the first partner to die left their whole estate to their spouse, the surviving spouses nil rate band would be doubled on death, in this case to £800,000. Assuming the rate of tax is still at 40%, the net effect of the nil rate band discretionary trust would be an increased IHT bill of £35,200.

Are there any ways to reduce IHT liability during my lifetime?

There are numerous ways to dispose of assets during your lifetime which will reduce the size of the death estate, and therefore reduce liability to IHT.

Individuals each have a £3,000 allowance per year to give away, tax free. Additional tax free gifts of between £1,000 and £5,000 may be given when someone gets married. The tax free amount available depends on what relationship the person giving the gift has to the newly-weds. Any number of small gifts up to £250 each may also be made, tax free.

Larger gifts are known as Potentially Exempt Transfers (PET). A PET will be tax free, as long as the person giving away the PET survives for seven years. If they do not, the value of the PET will be added back into the estate.

It is also possible to give tax free gifts out of surplus income, as long as the intention is to gift some or all of the surplus income annually. Any change in circumstances which means it is no longer possible to give away surplus income will not render previous gifts ineffective.

If you have any further queries, please contact Helen Freely, Lucie Sleeman, or Felix Appelbe on 0207 242 7000 or use the Contact Request Form.
 

© Ambrose Appelbe 2008
This web site contains general information only and does not constitute legal advice. You should take suitable advice as to your specific circumstances. Ambrose Appelbe accepts no responsibility and disclaims all liability in relation to such information.