26 February 2012

Transferable Nil Bands

Married couples naturally tend to leave their whole estates to each other. This always generated a tax disadvantage until the introduction in the 2008 Finance Act of the “transferable nil-band”. Under these new rules, if the first to die leaves everything to the survivor, the survivor’s executors can claim two nil-bands when the second death comes.

The way it works is best explained by example. In this scenario I have introduced a small complication, a legacy on the first death, to demonstrate what happens when part of the nil-band has been used.

Imagine a Mr and Mrs Smith. He died back in tax year 1996/97, and I chose that year because the nil-band at that time was a nice round number: £200,000. By his will he left a legacy of £50,000 to his children, and the rest of his estate to Mrs. Smith. Mr. Smith had “used” 25% (i.e. 50/200ths) of his nil-band. The rest of his nil-band was unused because he left his estate to Mrs. Smith, which was spouse-exempt.

Note that I was able to calculate that percentage without telling you how big Mr. Smith’s estate was. As long as there was enough money to cover the legacy, it does not matter whether Mrs. Smith’s inheritance was a hundred pounds or a hundred million pounds. The percentage comes out the same.

We do not need to worry about the fact that Mr. Smith died before the new rules were introduced. The first death can happen anytime, past or future, and can even have happened before the introduction of IHT in 1986.

Next, let us suppose that Mrs. Smith died in tax year 2007/8, after the introduction of transferable nil-bands. (I chose that year because the nil-band was a nice round number, also: £300,000.) This time we do need to know the size of her estate, so let’s assume she left £625,000, before inheritance tax, to her children.

Against that, her executors firstly claim her own nil-band of £300,000. Then, they can claim the unused proportion of Mr. Smith’s nil-band. They claim this not at the rate which applied on the first death, but at the higher rate which applies on the second death. So, they can claim 75% of £300,000, which is £225,000.

That makes a total second-death nil-band of £525,000, and if we subtract that from the total estate of £625,000 we get a taxable estate of £100,000, on which tax at 40% is £40,000.

So, to bring this example up-to-date: the nil-band is currently £325,000. So, at the moment, a married couple or civil partners with total wealth less than twice that figure (that is, less than £650,000), and who intend to leave everything to the survivor on the first death, can consider themselves out of the inheritance tax net.

19 February 2012

Inheritance Tax - Basic Principles

Inheritance tax (or “IHT”) is quite complicated, but the basic principle is very simple: Inheritance tax  is paid on the value of someone’s estate, when he or she dies.

There are a few other circumstances in which inheritance tax can be payable*, but really they are just there to stop people avoiding the tax.

At current rates, the first £325,000 is free of tax, and the rest of the estate is taxed at 40%.

Here’s a simple example. Imagine a Mr. Smith dies, a single man, worth £1million.


Value of Estate               £1,000,000
             
Less: Nil band**               325,000)
             
Total                           £675,000
             
Taxed at 40%                    £270,000


* The two most common such examples are:
(a) gifts made into settlements during your lifetime; and
(b) gifts made within seven years of your death.
Also, trusts have an inheritance tax regime of their own.

** This tax free £325,000 is known as the ‘nil rate band’, or sometimes just the ‘nil band’.  It is usually increased each April, and the new figure is announced in the Chancellor’s annual Budget speech.

18 February 2012

Introduction

In this blog, I will be writing about estate planning in England and Wales (the rest of the UK has different rules, in which I am not expert). By "estate planning", I mean mainly:
  • Wills
  • Intestacy
  • Inheritance tax (which will probably be the main thing I write about)
  • Probate
  • Powers of attorney
  • The Court of Protection
  • Lifetime gifts
  • Trusts
And I will be explaining what all of those things are about, in the coming months. This blog is not intended for experts: instead, my intention is to write about these subjects for the benefit of the people who might be affected by them.

I am a solicitor, and STEP member, who has worked in this field of law for around 20 years.