For richer, for poorer, inheritance tax remains
A Recent sculpture by Shirley How entitled ‘Restricted Freedom’ is described by the sculptor as her personal testimony.
However, the restricted freedom that I am about to address does not refer to either civil liberties or personal freedom, but is concerned with an inter-spousal exemption for Inheritance Tax (IHT) purposes. This may sound a little esoteric and something best left to those who deal with tax for a living, rather than the average citizen. But read on as I think you will find that it is of more relevance than may be apparent at the outset.
As a nation we are more widely travelled since World War II, than any previous generation. We also have many more overseas students attending our universities, colleges and schools. One of the results of this has been the celebration of many more international marriages. While we tend to assume that transfers between spouses are free from IHT without limit whether they are made during a lifetime or on death, in certain circumstances this does not happen and the consequences can be unpleasant.
In marriages taking place before 1974 a wife automatically acquired the domicile of her spouse. But after this date the wife’s domicile will remain as it was before unless the couple take steps to change it. In other words anyone who married someone domiciled outside the UK after 1974 (and this includes those cross-border marriages) needs to pay attention.
As I can only offer a brief synopsis of how this works, a simple case study must serve to illustrate the key points. Take, for example, a woman coming into Northern Ireland from Donegal perhaps, who met and married a man from Enniskillen in 1997. In due course they had children but, unfortunately, the husband died on December 1 2002. He left an estate of £205,000 and his will was conventional, leaving everything to his wife. If the nil rate band was, say, £250,000 then there was no IHT for his wife to pay.
Move on then to July 1 2010 when the wife dies leaving an estate of £700,000. The nil rate band for that year is £350,000 so under present rules the children can claim their father’s Nil rate band as well as their mother’s. So, on the face of it, there is no IHT payable. However, since the wife was not domiciled in the UK, the inter-spousal exemption is only £55,000.
Despite the fact that all of the husband’s estate was left to his wife on his death, part of this included a chargeable lifetime transfer of £150,000. Without going into detailed mathematics the result is that the children will pay £84,000 in IHT. So could anything have been done to limit this? Let us assume, for a minute, that the husband had set up a discretionary will trust and put £150,000 into it on his death and that the trustees of that trust put the cash into a life assurance bond.
This would change nothing on the husband’s death, but on the wife’s death, because the trust is outside her estate, the effect is reduced and only £24,000 is paid as IHT. Sounds good? But we can do even better. What would happen if the trustees granted loans, of say £60,000, to the wife during her lifetime? In this case, when the wife dies, the loan would be a debt on her estate and thus no IHT would be payable.
This is a huge subject and I have merely highlighted here some of the problems in the hope that those in this position will seek out the appropriate advice. Alternatively, the wife in my example could also have taken steps to change her domiciliary status. But that’s another story entirely.
Nicholas Watts is an independent financial adviser with Positive Solutions Financial Services which is regulated by the Financial Services Authority. To contact him, use the website www.realwealthmanagers.co.uk