Don’t let your clients miss out on IHT benefits

Andrew Gadd looks at how the transferable nil rate band can be used in estate planning.

I am confident you are aware of the quote from Lord Jenkins of Hillhead, the former Labour Home Secretary, who said that: “Inheritance Tax is, broadly speaking, a voluntary levy paid by those who distrust their heirs more than they dislike the Inland Revenue.”

I, of course, agree and in this ­article I want to concentrate on one particular area of IHT ­planning – the use of the ­transferable nil rate band (TNRB) for married couples and civil partners.

The TNRB was introduced in ­October 2007. Amid ­speculation the then Prime Minister ­Gordon Brown would call a snap ­General Election, the then Shadow ­Chancellor George Osborne said a ­Conservative government would introduce a Nil Rate Band of £1m. Of course, this is a promise the Conservatives have since had to shelve, but the TNRB remains.

Now the fact is that for many ­individuals, the simplest way to mitigate a potential IHT liability is to take out life cover for the ­liability written under a suitably flexible trust. The challenge is that under the current IHT rules, in ­order to assess the amount of cover required, you need to know how much of the TNRB will be ­available after the death of a ­surviving spouse. Where all of an individual’s assets are passed from one spouse to another on first death, this is a simple calculation. Unfortunately, tax planning is rarely simple.

Tangled web of litigation

A good example of a potential complication is where on the death of a UK-domiciled spouse, assets in excess of £55,000 are left to a non-UK-based spouse as the unlimited spouse exemption is not available.

Another scenario involves people who have the right to the income of pre-22 March 2006 interest in ­possession trusts. As the life tenant of the trust, the individual should appreciate that if they die first and a ­beneficiary then becomes entitled outright to the assets in the trust, the trust will utilise some or all of their NRB on death, thus reducing the TNRB.

It is also important to be aware that both gifts made ­during an individual’s lifetime that are not ­exempt transfers (made within seven years of death) and non-exempt gifts made in a will are set against the individual’s NRB, as are gifts with reservation of benefit.

Now perceived wisdom is that whenever possible, the maximum TNRB should be retained because this will ultimately be a ­percentage uplift of the NRB at the time of the second death. The expectation is that the NRB on second death will be of a higher ­monetary amount than the NRB on first death due to increases in the NRB over time.

But it must be noted that in his ­Emergency Budget last June, Mr. Osborne did not alter the ­previous decision made by his predecessor Alistair Darling that the NRB will be frozen at £325,000 until 2015.

Protecting your purse

Finally, from an IHT planning perspective, before the TNRB was introduced, it was good planning advice to use the NRB on the first to die or it would be lost.
As a result of this, wills made before October 2007 may specify various gifts from the deceased to children, grandchildren or various other beneficiaries to utilise all or part of the NRB. However, in order to preserve the TNRB, it will be better to route such gifts through the surviving spouse.

In addition, many pre-October 2007 wills will have been drafted on the basis of utilising the NRB on first death by ­transferring ­appropriate assets into a nil rate band discretionary trust. With the introduction of the TNRB, there may be an assumption that these are no longer required.

But ­depending on individual ­circumstances, an ­appropriate NRB ­discretionary will trust is, for ­example, an ­excellent means of protecting capital from ­being ­assessed as ­belonging to the ­surviving spouse if care fees ­become an issue. An ­appropriately worded trust can also ­guarantee the trust assets pass on to ­children rather than, say, a spouse’s new partner should they remarry.

All in all, my view is that when dealing with inheritance tax ­planning, it is best to plan for the worst while hoping for the best.