LONG-awaited changes were made to
inheritance tax (IHT) rules in Alistair Darling's first pre-Budget report (PBR) on 9 October and these should largely be welcomed by couples planning for the future and anyone who has been widowed.
The "death" tax is regarded by many as one of the most unpopular ways the government has of generating revenue. People resent having to hand over a chunk of their hard-earned money to the tax man rather than their family.
IHT no longer affects just the relatively wealthy - primarily due to house prices increasing much faster than the tax's nil-rate band (NRB) threshold.
Currently, only the first £300,000 of an estate is not subject to IHT and the value above that level is taxed at 40 per cent. There are now about 1.5 million houses in the UK valued over the threshold. In fact, the threshold would have to stand at £425,000 if it were linked to house price inflation in the past ten years.
However, the situation is now slightly more favourable for those currently carrying out IHT planning and for people who have already lost a partner following changes announced by the Labour party in its 2007 PBR this month.
In his PBR, Chancellor Darling announced new rules, which are already in force, to allow all spouses and civil partners to easily make full use of their combined NRBs for IHT.
Although the combined NRB for married couples and civil partners for 2007-8 still stands at £600,000 (the total they already had) Darling has made it more straightforward to take advantage of this threshold. What is new is the way the unused NRB from the first member of the couple to die can be transferred and used in the estate of the second person to pass away.
Previously, a "nil-rate band will trust" had to be in place to allow the second partner to make full use of the £600,000 threshold when they die and their estate is passed on. This is no longer necessary, although such a trust can still be helpful in planning for future generations.
More than 353,000 people in Scotland, who have already been widowed, are the big winners from these changes.
As Julie Hutchison, estate planning specialist with Standard Life Assurance, says: "This is positive for people who have already been widowed as they can take advantage of the new rules. It doesn't matter when the first spouse died - it could be as long ago as 1960 or 1970. While the retrospective nature of this is welcome, the difficulty will be where people have to go back and look at records from many years ago to try to piece together how someone's estate was wound up.
"I see a danger in people assuming they have a double NRB, when in fact they have forgotten to take into account lifetime gifts made by their partner seven years before death. Say, for example, a father gave £50,000 to his daughter, and he died within seven years and left the whole estate to his widow. That widow might think they've been left everything and no IHT is due. She is forgetting £50,000 of that nil-rate band was eaten up by the lifetime gift."
To assist financial advisers and their clients in tackling such issues, Standard Life Assurance is producing an information document in the format of a decision tree to help calculate someone's NRB on death.
There is also a guidance note on the changes and a detailed list of frequently asked questions on the NRB available from the government. See www.hmrc. gov.uk/cto/iht/whatsnew.htm for both resources.
Despite the recent changes, couples currently thinking about their IHT liabilities should not assume they can simply forget about tax planning.
Hutchison adds: "For example, people will still want to make use of a NRB will trust if they have children from a previous relationship and want to safeguard their interests. Some may not want to leave everything to a surviving spouse who may remarry, as there is no guarantee the money will go to their children. It may be an idea for people to re-visit their will, although there is no need to panic."
Going forward, the new NRB rules must be taken into account when considering what lifetime gifts someone wishes to make, as some of the finer details of the changes can be complicated.
For example, since the 2006 Budget a transfer to a flexible trust is treated as a chargeable transfer (CT). If the transfer is over the NRB, it attracts an up-front 20 per cent IHT charge.
The way the new IHT rules are written means the enhanced combined NRB for couples of £600,000 is only available to claim when the second person dies. It cannot be set against a lifetime CT at the time it is made, so it will not apply to transfers above £300,000 made to a flexible trust. For that, the client's "normal" single NRB still applies, above which the 20 per cent IHT is due.
According to Hutchison, this should be taken into account in estate planning. She explained: "A potentially exempt transfer (PET) could effectively benefit from these new IHT rules where a chargeable transfer would not. This is because IHT on a PET only arises on a death within seven years, at which point any enhanced NRB would apply. This makes PETs, such as an outright gift to an individual or a gift to an absolute or bare trust, particularly attractive."
Overall, the changes announced have been welcomed and should benefit people for years to come. A final piece of good news delivered by the Chancellor in the closing comments of his PBR was that future NRB increases will take account of house price inflation - an unprecedented move.
"That's the first positive indication there has been that house prices will have an impact on the IHT threshold," Hutchison says.
IHT thresholds
2003-4 £255,000
2004-5 £263,000
2005-6 £275,000
2006-7 £285,000
2007-8 £300,000
2008-9 £312,000
2009-10 £325,000
(Source: Standard Life Assurance)
