Freezing of inheritance tax nil rate band

Married couples may wish to review their Wills for tax effectiveness following The Chancellor’s Budget.

Date: March 2010

Married couples may wish to review their Wills for tax effectiveness, following The Chancellor’s announcement yesterday that he will be freezing the inheritance tax nil rate band for the next four years will re-open the scope for some very effective tax planning when making Wills.

The introduction of transferable inheritance tax nil rate bands by the Chancellor in October 2007 was thought to render unnecessary a tax saving scheme that had, until then, been employed very effectively for many years. The scheme involved ensuring that on the death of the first spouse to die a trust arose under that spouse’s Will so as to make full use of that spouse’s inheritance tax nil rate band. The funds passing into the Trust immediately following the first death could be applied for the benefit of the surviving spouse but would not be taxed as part of the surviving spouse’s estate.

The introduction of the transferable nil rate band meant that the scheme was usually unnecessary and achieved little in saving inheritance tax (although there remain a number of side benefits). This is because on the death of the surviving spouse her executors will be able to claim not only her own nil rate band but an additional enhancement of her nil rate band. The enhancement will be the percentage of the nil rate band that was left unutilised when the first spouse died.

An example of how the transferable scheme works in practice will help to illustrate this:

CASE STUDY ONE

Suppose that H dies when the nil rate band is £325,000 and leaves 90% of his nil rate band unutilised (perhaps he gives £32,500 to his children and the residue of his estate to his wife).
Suppose also that then when W dies the nil rate band is £600,000.
In that case W’s executors will be able to claim not just the £600,000 but an additional enhancement of her nil rate band of £540,000 (i.e. 90% of £600,000).

It will be seen that the transferable inheritance tax relief is quite generous because it is calculated by reference to the nil rate band on the surviving spouse’s death and is not limited to the balance of the nil rate band at the time the first spouse died that was left unutilised at that time. The greater the increase in nil rate bands between the first death and the second death the more generous the relief.

By contrast, however, where there is little or no increase in the nil rate band between the spouses’ deaths then the transferable nil rate band relief looks anything but generous. And this is what the Chancellor has very cleverly done. He has frozen the nil rate band for at least four years.

It can be seen from this that if on the first death part of the estate (equivalent to the inheritance tax nil rate band at that time) is hived off into a trust (from which the survivor can benefit) then those trust funds can grow and be free from any inheritance tax that might otherwise be payable on the death of the surviving spouse.

Another example may illustrate the point.

CASE STUDY TWO

Suppose H had an estate of £400,000 and W had an estate of £400,000. Suppose, too, that at the time of each death the nil rate band was £325,000 and that funds are expected to double in value over the intervening period.
If H and W rely on the inheritance tax transferable nil rate band by leaving all of their respective estates to each other then on H’s death there is no inheritance tax to pay.
When W dies her estate (including that which she had inherited from H) will be worth £1,600,000 (because we are assuming that the £800,000 will have doubled in the intervening period) and the inheritance tax @ 40% of (£1,600,000 - £650,000) will be £380,000.
Now suppose that on H’s death £325,000 had been channelled into a trust for W’s benefit.
That will leave W inheriting outright £75,000; giving her an estate of £475,000.
On her death, the value of her taxable estate will have doubled to £950,000.
The inheritance tax payable on that @ 40% of (£950,000 - £325,000) will be £250,000. The trust fund will have doubled in value to £650,000 and will suffer no inheritance tax on W’s death.
This is a tax saving of £130,000.

In light of the Chancellor’s announcement reviewing your Will is essential if proper consideration is to be given to the tax saving opportunities the careful Will drafting can offer.

For further information about Inheritance Tax, Wills and the Chancellor’s Budget, contact Harvey Barrett on 01227 763939.

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