Making inheritance tax work for you

Another major change in the Pre-Budget Report from the new Chancellor represented a significant reform to inheritance tax (IHT). However, what happened to IHT is not quite as generous as he made it sound.

If you are married or in a civil partnership, the estate of the second person to die will benefit from any unused nil rate band from the first person to die. So, for example, if you leave everything to your spouse/partner, their estate will benefit from two nil rate bands (£600,000 at current rates and £624,000 from 6 April 2008).

This is good news if your estate planning is not designed to use the full nil rate band on first death – at current rates there could be IHT savings of up to £120,000 (£300,000 @ 40%). However, if your wills are structured to use the nil rate band on the first death perhaps by creating a discretionary trust – then the Chancellor has not saved you any IHT. Similarly, if you are not married, the Chancellor’s reform has made no difference to you – unless you are widowed.

This new transferability of the nil rate band applied on the death of a surviving spouse or civil partner after 8 October 2007, regardless of when the first spouse/partner died. Thus if you (or a parent) are widowed, the IHT liability on your (their) estate might be considerably less now than it was a few months ago (see box below).

Inherit the difference

Jenny’s husband died in June 1994. In his will, he left a £50,000 legacy (one-third of the then nil rate band) to his son and everything else to his widow. That inherited nil rate band is now worth two-thirds of £300,000.

  • If Jenny had died on 8 October 2007, she would have had only one nil rate band of £300,000.
  • Were Jenny to die now, £500,000 of her estate (£300,000 of her own nil rate band plus £200,000 of the nil rate band she inherited) would be free of IHT.

Until this change to IHT, couples were often advised to use the nil rate band by passing down assets at the death of the first spouse or partner. This is now probably no longer appropriate for most families, and a review of estate planning might be highly desirable. The Financial Services Authority does not regulate tax advice.