You may perhaps be aware that you can leave part of your estate free of inheritance tax – as matters currently stand the amount concerned is £325,000.00.
There are also exemptions for gifts to charities, and subject to certain restrictions, farmland, forestry land, business assets and unquoted shares. The most important exemption, however, is for a gift to a spouse.
This means that if you leave your whole estate worth £1,000,000.00 to your wife on your death, there will be no tax payable.
Before October 2007 we used to advise testators to give as much as was possible up to the tax free limit to their children or to a discretionary trust since otherwise by leaving the estate of the first to die to the spouse, it serves to swell the spouse’s estate with a potential tax bill on their death of an additional £120,000.00.
Matters were stood on their head in October 2007 when as part of the bidding war between Gordon Brown and David Cameron by way of preparation for the election which never happened, David Cameron announced that he was planning to lift the inheritance tax threshold to £1,000,000.00 to which Gordon Brown came up with the rival offer of a carry forward of the allowance for the first to die provided that this had not otherwise been used.
Following this very significant change in the law, we cannot now recommend discretionary trusts as a tax avoidance measure though they can be useful in other circumstances, such as for an ESN child.
Our recommendation now is that on the death of the first, they should leave the whole of their estate to the survivor and if it was intended that there should be gifts to the children on the death of the first, these should be made by the survivor as lifetime gifts. The reason for this is rather complicated, and is best illustrated by an example.
Let us imagine that by a fluke a husband and wife are both each worth £500,000.00.
On the death of the husband, he leaves £200,000.00 to the children and the remaining £300,000.00 to his wife.
On the death of the wife she leaves £800,000.00 being her £500,000.00 plus £300,000.00 from her husband – most unlikely in fact that it would be this exact but let’s imagine! There is an exemption for the first £325,000.00 and the balance pays tax at 40% – 40% of £475,000.00 is £190,000.00.
The Executors realise, however, that they can claim the carry forward allowance, but this is not a full second allowance because £200,000.00 of this was used up on the gifts to the children and therefore the carry forward allowance is only £125,000.00.
You might think at first sight that there is in reality no difference in the figures and it is just a matter of timing when the children will receive that £200,000, but tax saving on leaving everything to the survivor comes about because the tax exempt allowance tends to be increased from time to time. It is currently frozen, but there have been increases in the past and if by the time the second dies the tax free allowance were to be £500,000.00, then the figures are up rated proportionately and the carry forward allowance after the gift to the children becomes £192,000.00 whereas if everything had been left to the spouse the carry forward allowance would have been £500,000.00, i.e. tax will be payable on an additional £107,000.00 and that gift to the children on the death of the first parent to die will cost on the death of the second £43,000.00 in extra inheritance tax.
Food for thought!
A possible way of avoiding this problem might be for the husband and wife to agree between themselves that on the death of the first, the second will make a gift of £200,000.00 to the children. This is inside the tax free limit for gifts (£325,000.00) and will only be taxable if the second were to die within seven years.
There would be no problems over loss of any part of the carry forward allowance.
If you wish to discuss matters with us in more detail, please do not hesitate to contact our Mr. Tim Napier.