Sarah Sarwar, a Senior Associate Solicitor in our Private Client team at our Wimbledon office discusses maximising the inheritance tax allowances on a second marriage in the below article, discussing the nil rate band (‘NRB’) available on death in a fictional case study.
Inheritance tax (‘IHT’) is a tax on an individual’s estate on death and on certain gifts made during their lifetime. When an individual dies, IHT is charged at 40% on the value of an individual’s estate which exceeds their available nil rate band (£325,000 in the tax year 2015/16 and frozen until at least April 2021) (‘NRB’). Any gifts made within seven years of death will reduce the nil rate band available on death.
Since 8 October 2007, the estate of a spouse/civil partner is able to benefit from the deceased spouse/civil partner’s unused IHT nil rate band, regardless of when the first death occurred. The amount of the nil rate band available for transfer is based on the proportion of the nil rate band that was unused when the first spouse/civil partner died. This means that a maximum of two nil rate bands (currently £650,000) can be claimed.
In addition the residence nil rate band allowance will, when fully in force in 2020/21 exempt £175,000 of an individual’s assets from IHT provided on death they leave an interest in a home worth at least this amount, or assets of equivalent value if they have disposed of their home, to ‘lineal descendants’ (broadly children, grandchildren and their spouses and civil partners). This allowance is also transferable between spouses and registered civil partners.
If one of the couple has been married previously, but has been widowed, he or she will potentially have an unused nil rate from their first spouse. If all of their estate is left to their second partner, the first partner’s unused nil rate band is lost because on the second partner’ death only two nil rate bands can be claimed.
Accordingly where one party to a marriage or civil partnership has survived a partner, the aim should be to benefit from three NRBs in total. Each spouse should arrange to leave at least the value of the amount transferred from the previous marriage to chargeable beneficiaries or a nil rate band trust, on the first death of the second marriage. Accordingly one nil rate band will be used up on the first death (whoever dies first), leaving double nil rate band for the last survivor.
Where both parties to a marriage or civil partnership have lost a spouse previously, it should be possible to make use of four NRBs in total, ie one for each person. One approach would be for each spouse to leave the value of one nil rate band plus any amount transferred from the first marriage to chargeable beneficiaries. Then no NRB is transferred in the second marriage, but each party benefits from the transferred amount from the first marriage.
Fictional case study
Sally is married to Greg and they have a child, Rory. Greg dies leaving all of his assets to Sally. Sally marries again to Callum who has children from his previous marriage which ended on divorce.
Sally and Callum’s combined estate amounts to £750,000 which they wish to leave equally between all of their children. If Sally leaves all of her assets to Callum, then on Callum’s death after Sally, his Executors can claim Sally’s unused nil rate band of £325,000 and his own nil rate band of the same amount. Inheritance tax of £40,000 is paid as Greg’s allowance cannot be used. There is no control over how Callum deals with the assets he has inherited from Sally and so he could potentially exclude Sally’s son, Rory, from any benefit.
However if Sally had left assets to the value of the nil rate band to the discretionary trust on her death, with the remainder to her current husband Callum, Greg’s unused nil rate band will be used in this instance. Callum can have the benefit from the trust at the trustee’s discretion. On Callum’s death there are assets of £425,000 in his estate (£750,000 less the £325,000 left by Sally to the discretionary trust). Accordingly there will be no inheritance tax to pay as the value of these assets are within the total of his and Sally’s unused combined nil rate band allowance of £650,000. In addition, the assets in the trust can now be distributed by the trustees to Sally’s surviving son Rory, and cannot be given to Callum’s children.
Finally if Callum’s first marriage had also ended on death, then he too could use a nil rate band discretionary trust in his Will, and potentially four nil rate bands could be claimed in total.
If you have any questions or would like to discuss any of the issues raised in this blog, please feel free to contact Sarah Sarwar, in our Private Client team. Sarah is contactable by telephone on 020 8971 1089 or by email on [email protected].