The Recent UK Inheritance Tax Changes
|So What Changed in the Pre-Budget Report of 9 October 2007?|
In simple terms, the main change is that for married couples; (which of course includes Civil Partnerships) the Nil Rate Band can be transferred from one spouse to the other.
Everybody with a UK Domicile has a Nil Rate Band (NRB) for Inheritance Tax (IHT) purposes. For the current year, this is £300,000. On their death the amount of their taxable estate, up to the unused element of the NRB suffers no IHT (or technically IHT at 0%). The amount of the NRB available on an individual’s death can be reduced if they make any chargeable gifts in the seven years prior to their death.
So, let us take an example to help demonstrate the position:
Jack and Jill each have assets of £400,000. Jack dies and leaves all his estate to his wife Jill. Jill then later dies, when the NRB is £350,000 and the estate has increased to £950,000 and leaves it all to their children.
Prior to the changes of 9 October 2007, Jack’s NRB would have been wasted, as there is no IHT on gifts between spouses. Jill would have had her NRB of £350,000 and so would have paid IHT at 40% on £600,000, i.e. £240,000.
Now the position is that as none of Jack’s NRB was utilised on his death, the full NRB is available to Jill on her death. So as the NRB when Jill dies was £350,000 she would have a NRB of 200% of the normal figure, i.e. £700,000. This means that tax would only be due on £250,000 of the estate at 40%, i.e. £100,000.
Prior to the Pre-Budget Report of 9 October 2007, many people used a NRB Trust to mitigate IHT as this meant that the NRB was not “wasted” on the first death. Assets were passed into a trust which allowed the surviving spouse to benefit without the asset falling into their estate for IHT purposes.
Does the Pre-Budget Report mean that NRB Trusts are no longer needed?
The short answer is that it depends on a number of circumstances and how the assets grow over time.
It is certainly possible that the use of a Trust might mean less IHT is paid. However, there could be a Capital Gains Tax liability on the assets of the trust which would not be the case if a trust had not been used.
It can in some circumstances be more beneficial for the whole estate to be passed to the surviving spouse, but for them to then immediately make a gift into a trust of an amount equal to the then NRB. However whilst this might be much more IHT efficient, it is less flexible.
Clearly, in a significant number of circumstances there are a number of advantages in still utilising a NRB trust. Some of the reasons are:
• In many cases it will still mitigate IHT compared with not using a trust.
• The surviving spouse can benefit from the trust which is not the case if they set up the trust after the first death.
• There is much greater ability to protect assets from inclusion in any means testing of income or capital for the purposes of care fees.
• It provides for much greater control of assets in the event of the surviving spouse remarrying for example.
Whilst it is true that for many individuals whose combined estates are only slightly over the NRB the changes in the Pre-Budget Report means that no complicated planning is needed to mitigate IHT, this will not be the case where wider issues such as care home fees are concerned. Many people in this situation might well look back and regret any false sense of security they felt as a result of the Pre-Budget Report.
For couples whose combined assets exceed £500,000 then there are many reasons why including a NRB trust in one’s will is well worth considering.