Money
Retirement
Inheritance tax: the small print
The biggest change to inheritance tax for nearly 20 years was announced on October 9 by the Chancellor of the Exchequer, Alistair Darling, writes Paul Lewis
From that date widows (and, of course, widowers and bereaved civil partners) who die this year may be able to leave an estate of up to £600,000 without heirs having to pay inheritance tax. Next tax year that tax-free amount will rise to £624,000 and by 2010 it will be £700,000.
Under the new rule, when a widow dies her heirs will be able to add any of her late husband's unused inheritance tax (IHT) allowance to her own allowance. So if her late husband left everything to her and used none of his allowance, when she dies the allowance on the estate will be doubled. 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.
Not every widowed person will get their late spouse's IHT allowance added in full. If the late spouse left money, property, or other assets to someone else, then that will have used up part of their allowance. The percentage left unused is added to the normal allowance at the time of death. For example, if the first to die used up a quarter of their allowance when they died, that leaves three-quarters to be transferred. So the widow’s estate will benefit from one and three-quarters of the allowance current at the time of her death.
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.
NEW ADVICE FOR COUPLES
The change means advice given in the past to married couples to split their property is no longer necessary. Couples who have already changed the ownership of their home so that each can leave half to the children can now safely leave everything to each other. But there is no need to change the way the home is owned: both can just change their wills to leave their half of the home to their spouse rather than to their children.
Some couples have gone further and made arrangements so that each leaves property or other assets 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.
If married couples leave all their property to each other, this 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 the estate is worth at least double the IHT allowance and house prices rise more rapidly than the increase in the IHT allowance, the heirs will pay more tax. In all other cases they will pay the same or less. Over the past 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 the Chancellor promised "in future we will take both house prices and inflation into account when setting the thresholds".
MAKING GIFTS
After the first spouse dies the survivor can give away money, property, or other assets under the normal lifetime gift rules. If a widow lives seven years after making the gift it will not count as part of her estate when she dies. She can also give away other amounts even if she dies within seven years. She can give away a total of £3,000 each year under this rule. Also, she can give £5,000 to one of her own children on their wedding, £2,500 to a grandchild or great-grandchild, and £1,000 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 the gifts can be considered part of the estate and inheritance tax will be charged on them.
THE NEW RULES IN RETROSPECT
The new rules also apply to widows, widowers and bereaved civil partners who were alive at midnight on October 8/9, 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 check to see if any of their IHT allowance was used up.
Widows can carry forward allowances from more than one marriage but the total carried forward cannot exceed 100%. The only people excluded from the changes are couples who both died before October 9. Their executors cannot use the new rules to revise their tax bill.
IHT allowances dating back to 1988 are detailed on the HM Revenue and Customs website at hmrc.gov.uk/cto/customerguide/page15.htm. Earlier (and future) allowances and general advice can be obtained from the Inheritance Tax & Probate Helpline, 0845 302 0900.
THE NEW RULES IN ACTION
Hester and Peter were married for 30 years. Peter died in May 2005. Peter left the house to Hester and £55,000 in cash to their children, Annie and Charles. Hester could manage without it and the children got the £55,000 free of IHT.
Hester is now ill herself with just a few months to live. If she dies in August 2008 the IHT allowance will then 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!
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 which is £249,600. That is added to her allowance of £312,000 to give a total of £561,600. That is well above the value of the estate so no tax is due.
SINGLE AND UNMARRIED PEOPLE
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, rising each year to £350,000 by 2010. The children of single parents will therefore be more likely to face a tax bill than children of a two-parent family. Unmarried couples who jointly own a home which is at or above the IHT allowance can cut the tax bill by marrying, or each leave half the home to their children. This process and its risks have been described in earlier articles.
* The views expressed in this column are those of Paul Lewis. He regrets he cannot respond individually to readers' letters, but he will discuss some of the issues raised in his column. Write to him at Saga Magazine, Enbrook Park, Folkestone, Kent CT20 3SE, or email paul@paullewis.co.uk
