Lit­tle-known IHT trick could let you pass on £975,000 tax free

The Daily Telegraph - Your Money - - MONEY - Harry Brennan

Thou­sands could be need­lessly pay­ing large in­her­i­tance tax bills each year as a once widely used tax loop­hole has been all but for­got­ten.

Ev­ery­one has a per­sonal IHT al­lowance – the nil-rate band – of £325,000, above which their es­tate pays 40pc tax. There is also an ad­di­tional al­lowance for pass­ing a fam­ily home to di­rect de­scen­dants, now £125,000 and ris­ing to £175,000 by 2020.

In 2007 a new rule made it pos­si­ble to trans­fer un­used al­lowances be­tween spouses when one partner died. This gives a widow or wid­ower up to £650,000 in ba­sic IHT-free al­lowances and £250,000 in ad­di­tional al­lowances if el­i­gi­ble.

Be­fore this, to max­imise pro­tec­tion from the tax­man many peo­ple used IHT-ex­empt dis­cre­tionary trusts in­stead. Of­ten re­ferred to as nil-rate band trusts, they al­lowed peo­ple to ringfence up to £325,000 to pass on to their spouse free of tax on their death.

The trans­fer of al­lowances has meant this prac­tice has more or less died out. How­ever, wid­owed spouses who re­marry can still use it to give them­selves an ad­di­tional IHT al­lowance of £325,000, shield­ing even more from the tax­man. Faye Sil­ver of Ray­mond James, the wealth man­ager, said this would ben­e­fit peo­ple who had lost their partner but who could still re­marry.

Fig­ures from the Of­fice for Na­tional Statis­tics show that around 1,400 widows and 1,260 wid­ow­ers re­marry each year.

How it works

Margaret is mar­ried to Peter. Peter dies and some years later she mar­ries John.

There are no chil­dren in­volved, so the fam­ily home al­lowance doesn’t ap­ply. Peter’s death leaves Margaret with his full ba­sic al­lowance, giv­ing her £650,000 of IHT pro­tec­tion.

She puts the £650,000 into a dis­cre­tionary trust for John. On her death, John can add this to his own £325,000 al­lowance.

John also ringfences his own al­lowance through a trust, so Margaret can add his £325,000 to her al­lowance if he were to die first. Now the sur­viv­ing spouse will pass on £975,000 tax-free.

What’s more, ben­e­fi­cia­ries can use this tac­tic ret­ro­spec­tively.

By us­ing a le­gal doc­u­ment known as a deed of vari­a­tion up to two years af­ter death, fam­i­lies can al­ter a will to be more tax ef­fi­cient. Rachael Grif­fin of Quil­ter, an­other wealth man­ager, said such “lit­tle­known quirks in the tax sys­tem” were in­creas­ingly im­por­tant as the Gov­ern­ment was rak­ing in record sums from IHT – £5.2bn last year – and ex­pects re­ceipts to to­tal £7bn by 2023.

“Nav­i­gat­ing the tax sys­tem shouldn’t be akin to finding a nee­dle in a haystack. Peo­ple are en­ti­tled to use al­lowances, even if few peo­ple have heard of them,” she said. The Gov­ern­ment is con­sult­ing on how to make the tax and trust rules more trans­par­ent.

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