Inheritance Tax Planning

Planning using wills

The commonest Will arrangement for married couples is to leave everything to each other, when the first dies and to the children, when the second dies. This has the advantage of allowing the second spouse to retain access to all the marital assets. However, as the following example shows, until recently, this could have expensive repercussions, in terms of IHT. (Please refer to the last paragraph in this section for an update.)

Consider a married couple, with a house worth £400,000 and other assets worth £200,000, with the Will arrangement described above, there would be no IHT payable when the first died (due to the inter-spouse exemption).

Assuming no change in the estate value, or nil rate band, the situation when the second spouse died would be rather different. The remaining estate would be £600,000, which, after deducting the nil rate band, would leave £300,000 liable to 40% tax; - a tax bill of £120,000!

Many couples find themselves in this sort of situation and yet they probably do not consider themselves to be particularly wealthy. The real cause of the tax bill in this example was that, although each spouse had a nil rate band available, one of these allowances was completely wasted.

From a tax-efficiency viewpoint, it would have made sense for the first spouse to leave £300,000 to the children. In this example, the couple could then have avoided IHT altogether.

Using the full nil rate band of the first spouse to die is great in theory, but in practice, few couples have the financial resources to allow this; the surviving spouse needs access to most, or all, of the marital assets.

The ideal solution would need to allow both nil rate bands to be used, without the surviving spouse losing access to any assets. This has been achievable, using a 'Will Trust' . It is possible to include the value of the main residence in this form of planning, using a legal 'IOU' arrangement.

However, in the Autumn 2007 Pre-Budget Report, the Chancellor announced his intention to allow any unused nil rate band allowance of the first spouse to die to be available for the surviving spouse's estate to use. Assuming that this is confirmed, both spouses' allowances will be available, regardless of the way that the Wills are structured. This means that the classic will (‘Everything to each other when the first one dies and to the kids when the second one dies') will no longer end up costing up to £120,000 in unnecessary IHT.

Those clients who have already structured Wills tax-efficiently acted absolutely correctly with the information available to them at the time. Assuming the changes remain, they will still benefit because there will be no need to establish a trust when the first spouse dies, and this will make things simpler and cheaper for the survivor.

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