Wills And Inheritance Tax Planning

The will is now a significant inheritance tax (IHT) planning tool for families, although perhaps less so for co-habitees (due to the lack of the inter-spouse exemption which applies only to married couples and civil partnerships).

On death, capital gains tax (CGT) presents no adverse tax consequences, as all assets owned at the date of death are re-valued to their then market values without precipitating any CGT charges. The IHT charge, however, may be significant due to the 40% rate (on the excess of the estate over the £325,000 nil rate band, assuming its availability).

Every individual is entitled to a nil rate band of £325,000, and if no lifetime gifts are made then, on death, the first £325,000 of the estate is taxed at 0% and the excess at 40%.

For a married couple, typically the issue is whether the first spouse to die should leave their whole estate to the surviving spouse, or part to that spouse and part to others (e.g. children, relations etc). Under the former, no IHT charge generally arises due to the unlimited inter-spouse exemption. Under the latter, if the amount left to the non-spouses exceeds £325,000, then the excess is liable at 40%.

Of the two options, the decision rests on a number of factors, including the size of the combined estates; the needs of any surviving spouse, children or relations; protection against care home fees; availability of reliefs (e.g. for business property and agricultural property); and whether there are children from earlier marriages.

£325,000 to children and rest to surviving spouse

Where the combined estate of both spouses is significant, it may be more appropriate for the first spouse to die to leave part of their estate to the children absolutely, or on trust for them (and the surviving spouse). The maximum that can be left to the children without precipitating any IHT charge on death is £325,000 (with the balance going to the surviving spouse).

Where an estate includes property that will attract 100% relief from IHT, it does not usually make sense to leave such property to the surviving spouse (which would generally be exempt anyway). 

Relief at 100% applies to relevant business property including a sole trader business (but typically excluding a property letting business) or a shareholding interest in an unquoted company; 100% relief also applies to the agricultural value of agricultural property including agricultural land, farm buildings and farmhouses. In some cases, the relief is 50%, not 100%. This can be a complex area where relief may be uncertain (due to the need to satisfy various conditions), in which case leaving the property on discretionary trust is often advisable pending resolving whether the reliefs apply or not.

For those spouses who are in second marriages and who want to protect children from first marriages (possibly from a spendthrift second spouse!), it may be sensible to leave an appropriate amount on trust, allowing the second spouse to enjoy the income on the trust assets during lifetime and on death for the children to then take the trust assets absolutely.

Where co-habitees have no children, the IHT position is clear. On each death, IHT is payable at 40% subject to any nil rate band (the inter-spouse exemption not applying).

If children are involved and some part of the estates is left to them (absolutely or on trust), this does not alter the IHT charges arising.

Unfortunately, the effective use of pilot trusts (trusts set up initially with a small sum, e.g. £10) to mitigate IHT on death may be coming to an end following announcements by HMRC to include legislation in a future Finance Act designed to quash their advantages (although some relief may be available for a short period where wills were executed before the changes).

Ensure any will is modified/rewritten should family circumstances change, and/or tax laws impact thereon (e.g. pilot trusts).