Inheritance tax (IHT) is a tax on the estate of a deceased person. It is levied at 40% on estates valued over the nil-rate band threshold, which is currently £325,000. Any unused nil-rate band can be transferred to a surviving spouse or civil partner on death, doubling the threshold for married couples and civil partners to £650,000.

IHT is only charged on the value of the estate above this threshold. The ‘estate’ includes property, money, investments and certain gifts made within seven years of death. IHT is payable by the executor or personal representative of the deceased before probate can be granted.

Ways for Spouses to Minimise IHT

There are several ways spouses can arrange their assets to minimise IHT liability:

Outright Gift: Assets can be gifted outright from one spouse to another. These immediately become the property of the recipient spouse and are no longer part of the estate of the donor spouse for IHT purposes. Gifts between UK-domiciled spouses are exempt from IHT, provided the donor survives seven years from the gift date.

Will Trust: A will can establish a discretionary trust so that one spouse leaves their nil-rate band to trust on their death to benefit the survivor. Assets left to the trust up to the nil-rate band amount are exempt from IHT. The surviving spouse can benefit from assets in the trust. When they die, assets distributed from the trust to beneficiaries are outside the survivor’s estate.

Pension Nominations: Pensions usually fall outside one’s estate for IHT if death benefits are paid to a chosen beneficiary (other than the estate). Nominating a spouse as a beneficiary ensures the funds pass IHT-free on the first death. The surviving spouse’s future drawings are taxed as income rather than being liable to IHT on the second death.

Lifetime Gifts: Gifts made more than seven years before death are generally exempt from IHT. So it can be tax efficient for spouses to gift assets well in advance. Small gifts under £250 per recipient per tax year are immediately IHT-free. Larger gifts are potentially exempt if the donor survives seven years.

Alter Property Ownership: Spouses can own property as ‘joint tenants’, which automatically passes to the survivor on the first death or as ‘tenants in common’, where each spouse’s share is dealt with under their will. Joint tenancies remove an asset from the estate of the first to die.

Use IHT Reliefs – Certain business and agricultural assets and heritage assets like woodlands qualify for IHT reliefs if held for the requisite periods. Married couples can combine their nil-rate bands and reliefs for greater benefit.

Use IHT Allowances: An additional nil-rate residence allowance of £175,000 currently applies if leaving home to direct descendants. For married couples and civil partners, this could add up to £500,000 of allowance for property. Annual gifts of up to £3,000 are exempt too.

Critical Factors for Couples

• Trusts and gifting assets must be genuine and outright to be effective for IHT. Retaining benefits or control could invalidate tax planning.
• Using reliefs and allowances fully ensures that the taxable estate is minimised. Allowances cannot be transferred between spouses if unused on the first death.
• Lifetime gifts must be a genuine loss of access to assets to work for IHT. Gift recipients may have to pay IHT if the donor dies within seven years.
• Pensions and life insurance payable to chosen beneficiaries should be kept under review after marriage or divorce to ensure tax efficiency.
• Wills should be updated after marriage. Trusts in a will and life interest clauses might not achieve tax savings for spouses as intended.

Proper IHT planning can save couples hundreds of thousands of pounds. However, the rules are complex. Taking professional advice is essential to implement arrangements correctly. Contact our tax advisors for Inheritance Tax and related tax planning.