When it comes to writing your Will and planning division of your estate, it’s important to have a good understanding of UK inheritance tax laws. Making the right financial decisions now will not only ensure financial security for your spouse, but will also future proof your assets for children and other dependants. In this post, we’ll examine inheritance tax rules and exemptions for spouses and civil partners, and look at what happens when the surviving partner is non domiciled.
What is inheritance tax?
Inheritance tax is the means by which the Government taxes the transfer of assets and wealth when an individual passes away. The IHT threshold changes every year on 6 April; however, the main thresholds will remain in place until 2020/2021.
As it currently stands, estates valued below £325,000 are exempt from IHT, so if the estate is valued at less than this amount, no inheritance tax will be payable. This is known as the nil rate band (NRB). Those above the NRB are taxed at 40%; however, the amount of IHT payable can be mitigated by implementing a number of tax planning options, especially when it comes to spouses or registered civil partners.
IHT Spouse Exemption
For married couples and civil partners who both live in the UK, there is no limit on the value of the estate that can be passed on tax-free to their surviving spouse. This is known as IHT spouse exemption. This rule means that it is usually wise for couples to leave everything to each other.
Transferable Nil Rate Band
In addition to IHT exemption, married couples also benefit from being able to pass on unused individual tax-free allowance. This conveys tax relief to the estate of the surviving spouse, meaning that their estate can reach up to £650,000 and remain free of IHT. Known as the transferable nil rate band, this benefit is particularly important when estate planning for children and grandchildren.
Someone who has already been widowed can carry forward nil rate bands from more than one husband, up to 100% of the total nil rate band. However, if the person widowed has already reached the full allowance from a first spouse, it makes sense for the second spouse to pass their nil rate band on to any children, this way the children can combine nil rate bands from both parents and minimise inheritance tax that would otherwise have been due.
Residence Nil Rate Band
In April 2017, the residence nil rate band was introduced. This additional nil rate band applies to inheriting a home, and means that a direct descendant can inherit up to £150,000 of a property’s value (meaning a total allowance of £475,000) before becoming liable for inheritance tax.
Originally introduced at £125,000, the amount is increasing by £25,000 per year until it reaches £175,000 (or a total allowance of £500,000) in 2020/2021. The benefit tapers away for properties worth more than £2 million and for estates that include multiple properties, the exemption will only relate to one property. This allowance is also only valid on a main residence, so doesn’t include buy-to-let properties. While a spouse won’t have to pay inheritance tax on inherited assets, it’s worth noting that, just as individual tax-free allowance can be passed on to a surviving spouse, so can the residence nil rate band.
HMRC sets specific limits on the amounts that can be gifted tax free each tax year (which runs from 6 April to 5 April). This is known as ‘annual exemption’. However, as long as a spouse or civil partner lives in the UK permanently, no IHT will be payable on lifetime gifts. This means you can gift them as much as you like during your lifetime and is an effective way to remove value from an estate.
IHT Planning for Non-domiciled Spouses
When it comes to the issue of domiciliary, a person is deemed to be domiciled in the UK if they’ve been a UK resident for at least 15 of the previous 20 years. When a UK domiciliary passes away, their estate is subject to IHT on a worldwide basis, which can mean large property and income portfolios are involved.
However, if their surviving spouse is non-UK domiciled, they are only entitled to inherit up to £325,000 exempt of IHT. Additionally, any lifetime gifts made in the 7 years preceding the death of the UK domiciled spouse will affect this tax threshold.
In order to circumvent this, the non-domiciled spouse can elect to be treated as UK domiciled for IHT purposes. By doing so, they will be entitled to the tax-free status that UK residents enjoy. This has to be done within 2 years of the first spouse passing away, but does have repercussions for assets they already hold overseas, so this option needs to be carefully considered, depending on individual circumstances.
The election will lapse once the surviving spouse has been non-resident for 4 consecutive tax years, allowing their assets to once again be sheltered from UK tax jurisdiction. However, given that this loophole depends on the good health of the surviving spouse, there is another means by which assets can be ring fenced. Before becoming domiciled, a non-domiciled spouse can choose to place funds into an offshore trust. These assets will be deemed ‘excluded property’ and outside the remit of UK inheritance tax laws, protecting them from inheritance tax levies and allowing them to be passed down to future generations in their entirety.
When it comes to the transferable nil rate band, under current rules a non-domiciled spouse is entitled to the maximum of £650,000, so no planning is required to protect this benefit.
In order to take care of your loved ones, it’s vital to consider the many tax reliefs and exemptions that are available to you. While the situation for spouses is clear – and convey many benefits where IHT is concerned – if the surviving partner is non-domiciled then you should seek professional advice. Although you won’t be entitled to the same reliefs and exemptions, there are ways in which you and your spouse can protect your assets, sheltering them from UK inheritance and protecting them for generations to come.