Beyond the IHT spouse exemption – utilising available reliefs to minimise your estate’s tax liability
Through Inheritance tax (IHT), the government seeks to tax the transfer of assets and wealth from one individual to another person, trust or company.
IHT becomes payable on estates above the standard nil rate band (NRB). The NRB is currently £325,000 per person. This has been set until April 2021.
Estates above the NRB are taxed at 40% – meaning IHT has the potential to substantially diminish the amount you are able to pass on.
Exposure to IHT can however be mitigated through effective use of reliefs and exemptions.
For married couples and civil partners in particular, a number of tax planning options may be available that can help to keep wealth and assets safely in the family, and beyond the clutches of HMRC.
IHT Spouse Exemption & Transferable Nil Rate Band
Under the IHT spouse exemption, married couples and civil partners domiciled in the UK are able to pass on the entirety of their estate to their spouse, inheritance tax-free.
There is no limit to the value of the estate that can be passed on tax-free to a spouse.
In addition to the IHT spouse exemption, married couples and civil partners are also able to pass on their ‘unused’ individual tax-free allowance (i.e. NRB) to their spouse. This provides greater relief on the estate of the surviving spouse. This known as the ‘transferrable nil rate band’.
For example, Tom dies and leaves his entire estate to his wife, Sarah. His full NRB remains unused. On Sarah’s death, her estate benefits from her personal NRB of £325,000 as well as Tom’s transferable NRB, which is transferred to Sarah’s estate on her death. Sarah’s estate benefits from a combined IHT exemption of £650,000.
In another scenario, had Tom left £100,000 of assets to beneficiaries other than Sarah, (or perhaps gifted £100,000 to donees other than Sarah within seven years of his death), on Sarah’s death, the transferrable NRB would be £225,000. The combined NRB on Sarah’s estate would therefore be £550,000.
Other IHT exemptions & reliefs for spouses
Beyond the IHT spouse exemption and transferrable NRB, there are other tax planning opportunities for married couples and civil partners to consider.
Residence nil rate band
Under the residence nil rate band (RNRB), where a home is passed on to a direct descendant of the deceased property owner – such as the spouse – the first £125,000 (as at April 2018) of the property’s value will also be exempt from inheritance tax.
The RNRB was introduced in April 2017 and will increase by £25,000 each year until it reaches £175,000 in 2020/21:
- 2018/2019: £125,000
- 2019/2020: £150,000
- 2020/2021: £175,000
RNRB applies only on the death of a surviving spouse after 5 April 2017, irrespective of the date of death of the first spouse to die.
The amount of the RNRB available for an estate will be the lower of:
- the value of the home, or the share that is passed to the spouse (or other direct descendants), or
- the maximum additional threshold available for the estate when the person died.
The additional band can only be used for one residential property. If the deceased had more than one residence, only one of the properties can qualify for the relief. The property does not have to be the main family home, but it must at some point have been a residence of the deceased. This means buy-to-let properties, for example, will not qualify.
Looking specifically at spouses, similar to the NRB, it is possible to transfer unused RNRB to a surviving spouse or civil partner to be applied to their estate on their death. This means spouses can pass their share in the property to their surviving spouse without utilising the RNRB.
This is in addition to the main NRB – effectively raising the IHT-free allowance to £500,000 per person under the 2018/19 RNRB rate.
So where a married couple jointly owns a family home and wish to leave this to their children, the total IHT exemption for the couple will be £1million.
Note that the value of the transferred allowance will be determined by the prevailing rate on the date of the surviving partner’s death – not that of the first spouse. Should the first spouse die in May 2018, and the second in May 2020, £175,000 could be transferred to the estate of the second spouse.
For estates over £2million – that is, the residence plus all other assets less any liabilities but before exemptions and reliefs applied – the RNRB is reduced by £1 for every £2 above the threshold. Lifetime gifts are excluded.
Lifetime transfers & gifts
A further estate planning consideration for spouses is the use of lifetime transfers and gifts to others. These will generally fall into one of three categories:
- Exempt transfers: No IHT is payable. Lifetime transfers between spouses and civil partners are generally classed as exempt transfers, and are unlimited, provided the receiving spouse is domiciled in the UK. As such, transferring assets in lifetime can offer tax-efficient planning, by enabling nil rate bands to be maximised on death. If the spouse receiving the transfer is not domiciled in the UK, the limit is £325,000 and anything above this it would be treated as a PET.
- Potentially Exempt Transfers (PETs): Lifetime transfers to individuals other than your spouse or civil partner will be treated as PETs. This means they are IHT exempt where donor survives transfer by at least seven years. No tax is due when the transfer is made. If the donor dies within seven years of the transfer, IHT will be due at a tapered rate. If the donor dies after seven years of making the transfer, there will be no IHT due.
- Chargeable Lifetime Transfers (CLT): Lifetime transfers into most trusts are treated as CLTs. IHT may be payable at the time of transfer at the lifetime rate of 20% to the extent that the loss to the estate of the donor exceeds the available nil rate band. The value of the transfer is aggregated with the rest of the donor’s estate in calculating the liability on death and therefore additional tax may be due should the donor die within seven years of making the gift. No further IHT arises if the donor survives seven years.
IHT spouse exemption & non domiciled spouses
Since April 2013, non domiciled surviving spouses are permitted to receive a spouse exemption of up to £325,000, where certain conditions are met. This rate – equivalent of course to the current NRB for UK domiciled individuals – is a marked improvement on the previous rate of £55,000.
Under the current rules therefore, non dom spouses are able to benefit from the £650,000 transferable nil rate band.
There is however almost always a ‘but’ when considering non dom tax rules. Significant limitations may apply on the amount a UK domiciled spouse can transfer to their non-UK domiciled spouse both during lifetime and on death since any lifetime gifts made in the seven years preceding the UK domiciled spouse’s death will affect the tax threshold.
One tax planning option potentially available where the first spouse’s estate is above the NRB, is for the surviving, non dom spouse to elect to be treated as UK domiciled for IHT purposes.
The impact of such an election requires a full assessment, not least as it is irrevocable. For example, following election, the worldwide assets of the surviving spouse would on death then fall under the UK IHT regime. This may be a deal-breaker where non-UK held assets are substantial.
If this option is concluded as advantageous, the election would have to be made within two years of the first spouse’s death for the full IHT-free spouse exemption to apply to the estate.
IHT planning options
Making best use of the many reliefs and exemptions available requires effective planning. Without estate planning or a valid will, your estate becomes subject to the prevailing tax and/or intestacy rules at the time of your death.
There is no silver bullet or single, winning formula.
Your approach to estate planning should always be determined by your specific individual circumstances, assets and wishes. Wider tax liabilities beyond IHT also have to be considered, such as capital gains.
Considerations should include your surviving spouse’s needs, and what happens to the surviving spouse’s estate on their death. Can lifetime transfers and gifts be maximised to preserve nil rate bands? Should the NRB be left untouched in the expectation of a future increase in the allowance?
Do you have a question about the IHT spouse exemption? ETC can help!
With effective tax planning, there are ways to manage IHT liability and maximise financial benefit to your loved ones, including your spouse or civil partner.
To mitigate any resulting IHT liability, it becomes a matter of ensuring you make effective use of tax planning through exemptions and reliefs.
The IHT spouse exemption is one of many tools available. Taking advice on your specific circumstances and reviewing your planning regularly will ensure your wealth and assets pass on as you wish.
Enterprise Tax Consultants are a team of tax specialists helping individuals with all aspects of tax planning – business and personal. If you are concerned about IHT and estate planning, we can help. Speak to one of our chartered tax advisers today.