Inheritance Tax - the small print

The biggest change to Inheritance Tax for nearly twenty years was announced on 9 October 2007 by the Chancellor of the Exchequer Alistair Darling. From that date a widow (including of course widowers and bereaved civil partners) who dies this year will usually pay no Inheritance Tax if they leave up £600,000. Next tax year that will rise to £624,000 and by 2010 it will be £700,000.

The new rule means that when a widow dies her heirs will be able to add the unused Inheritance Tax allowance of her late husband to her allowance. So if the late husband left everything to her and used none of his allowance then when she dies the allowance on the estate will be doubled.

Not every widowed person will get their late spouse’s allowance added in full. If they left money or property to someone else then that will have used up part of their allowance. The percentage left unused is applied to the new allowance at the time of death and added to the normal allowance. For example if the first to die used up a quarter of their allowance at the time of death, that leaves three quarters to be transferred. So the widow’s estate will benefit from one and three quarters of the current allowance when she dies.

This change should remove the fear of Inheritance Tax from almost all married couples and civil partners. Latest sales figures from the Land Registry show that in England and Wales only one home in 100 sold recently was worth more than £600,000. Even in London only 5% of homes sold exceeded the new limit.

The change will only affect married couples and civil partners. The basic IHT allowance is not rising so the tax still applies to other estates worth £300,000 or more this year.

Advice changes
This unexpected change in the rules means that advice given in the past to married couples to split their property is no longer necessary. Couples who have already taken that advice and changed the ownership of their home so that each can leave half to the children can now safely leave everything to each other. There is no need to change the way the home is owned. Both just change their wills to leave their half of the home to their spouse rather than their children.

Some couples have gone further and made arrangements so that each leaves property or money into what is called a ‘nil-rate band trust’ for the children and the rest to their spouse (nil rate band is the official phrase for the IHT allowance). These arrangements remain valid but are now generally unnecessary and can usually be undone quite safely. Even if the first spouse has already died it may not be too late. A will can be changed using a Deed of Variation as long as all the heirs agree and it is done within two years of the date of death. Couples who do split their estate will not benefit from the new rules as the first to die will use up all their allowance and there will be none to pass on.

In future the advice to married couples is to leave all their property to each other. That will ensure that when the second spouse dies their heirs will have two full allowances at the current rate to offset against the value of the estate. However, if their estate is worth at least double the IHT allowance and house prices rise more rapidly than the increase in the IHT allowance then their heirs will end up paying more tax. In all other cases they will pay the same or less. Over the last few years the Inheritance Tax threshold has not kept up with house prices. That is, of course, why so many more people now face paying the tax. But in his pre-budget statement the Chancellor promised "in future years we will take both house prices and inflation into account when setting inheritance tax thresholds."

Gifts
After the first spouse dies the survivor can make gifts to the heirs under the normal lifetime gifts rules. If she lives seven years after making the gift then it will not count as part of her estate when she eventually dies. She can also give away other amounts without them coming into the inheritance tax arithmetic even if she dies within seven years. She can give away a total of £3000 each year. In addition she can give £5000 to one of her own children on their wedding, £2500 to a grandchild or great-grand child, and £1000 to anyone who gets married. She can also give away surplus income she does not need without it counting when IHT is worked out.

One word of warning. If the person who died leaves instructions to make gifts out of their estate and the widowed person makes them within two years of the death then they can be considered part of the estate and Inheritance Tax will be charged on them.

Retrospective
The new rules also apply to widow, widowers and bereaved civil partners who were alive at midnight on 8/9 October 2007 as long as they were married (or in a civil partnership) when their spouse died. When the widowed person’s estate is worked out in the future her executors can look back to what happened when the first spouse died however long ago that was. They will have to look at the will and contemporary records to see if any of their IHT allowance was used up. Widows can carry forward allowances from more than one marriage. But the total percentage carried forward cannot exceed 100%. The only people excluded from the changed rules are couples who had both died before 9 October 2007. Their executors cannot use the new rules to revisit their Inheritance Tax bill.

The table shows a list of Inheritance Tax allowances in the recent past. One going further back is available from the Revenue website at www.hmrc.gov.uk/cto/customerguide/page15.htm. Earlier allowances and general advice can be obtained from the Inheritance Tax & Probate Helpline 0845 302 0900.

Example
Hester and Peter were married for 30 years. Peter got cancer and died in May 2005. Before his death Peter and Hester discussed inheritance tax and decided that he would leave the house to Hester and £55,000 in cash to their two children, Annie and Charles. That way they got the £55,000 free of IHT and Hester could manage without the income it brought.

Hester is now ill herself with just a few months to live. If she dies in August 2008 the IHT allowance then will be £312,000. Her home and contents are worth about £450,000. Hester lives on her pensions and has little else of value. Under the old rules Hester’s estate is £138,000 over the IHT threshold. So Annie and Charles would have paid tax on that amount at 40% costing them £55,200. Which is just about what they were left by Peter three years earlier!

Under the new rules Hester’s executors will look back to Peter’s death to see if Hester can add his allowance to hers. At the time he died the IHT threshold was £275,000. He left £55,000 which uses up 20% of that allowance. So Hester’s estate can claim 80% of the allowance current at her death — 80% of £312,000 is £249,600. That is added to the standard £312,000 to give a total allowance of £561,600. That is well above the value of the estate so no tax is due for Annie and Charles to pay, saving them more than £55,000.

Single people and unmarried couples
The new transferable allowance does not apply to unmarried couples or to relatives who share a home or, of course, to single people. For them the threshold is still £300,000 this year rising each year to £350,000 by 2010. The children of single parents will therefore be more likely to face an Inheritance Tax bill than children of a two parent family. Unmarried couples who jointly own a home which is already at or above the IHT allowance would cut their Inheritance Tax bill by marrying. Alternatively they can make wills so that each leaves half the home to their children. This process and the risks involved are described in earlier articles in Saga Magazine – see January 2006.

More details in my revised Inheritance Tax Guide at www.saga.co.uk/money

December 2007