How to ensure your heirs aren't stuck with the widow's mite. A husband or wife's unused inheritance tax allowance can be passed to the surviving partner. Stephen Ellis reports

The Daily Telegraph  -   24/11/2007

By Stephen Ellis
Hundreds of thousands of married couples have good reason to celebrate the Tories' recent rediscovery of the popularity of tax cuts which, perhaps by happy coincidence, came immediately before Labour's sudden decision to change the way inheritance tax (IHT) works. But, partly because of the hasty way the new rules have been introduced, many questions remain about how they will work in practice.

There are 2.86m widows and 800,000 widowers in England, Scotland and Wales who could all benefit from increased IHT allowances thanks to changes in the rules made by Chancellor Alistair Darling in his pre-budget statement. This year everyone has a £300,000 IHT allowance. Anything you leave over and above that value attracts a 40pc IHT bill. In the past husbands and wives or - more recently - civil partners have been able to inherit all their partner's assets without being liable to IHT. However, when the second partner died, the tax was liable on everything above the allowance or nil rate band, as it is known. What the changes mean is that, in addition to the free transfer, any unused allowances on the first death also pass to the other partner. So if the first partner dies and leaves everything to the other one, there will be a double allowance at the time of the second death. In addition the rule is enacted retrospectively and so can be claimed by all widows and widowers no matter when their partner died.

Importantly, the calculation is based on the percentage of the allowance used at the time of the first death and then applied to the allowance at the time of the second death.

Take, for instance, a woman whose husband died 30 years ago in 1977. At that time, the IHT allowance was £15,000. If he left everything to his wife, she would now be entitled to double the allowance when she died. So, if that happened in the current financial year the total allowance would be £600,000.

On the other hand, if he had died and left £7,500 to be split between other members of his family and the rest to his wife, it would mean he had used half of the original allowance. As a result, if his wife died this year the total allowance would be £450,000 because she is only entitled to half of the extra allowance.

Julie Hutchison, estate planning specialist with Standard Life Assurance, said: "It is all worked on percentages and, for once, the fact it is retrospective means people who have lost spouses in the past will also benefit. That even includes people whose husband or wife died in the Second World War."

Although Her Majesty's Revenue and Customs (HMRC) have said no one can benefit from more than one extra set of allowances from a previous partner, they have left it up to the individual to decide which partner's allowance to use. So, someone who has been married several times and lost each of their partners can select the one who used the least amount of their IHT allowance and have that applied to their estate.

Ms Hutchison explained: "This reinforces the need to keep paperwork. It will be up to executors to ensure everything is correct and, where necessary, carry out investigations into court papers to confirm the arrangements when the spouse died.

"It might cause extra delays in settling people's estates - especially where there was no original will. It is not a case of just assuming someone has a double allowance."

Nor does it mean that people can ignore IHT planning. Potentially exempt transfers - which are outside of your estate if you survive seven years - will still be a valuable tool.

Paul Wilcox is chairman of IHT planning specialist Way Group. "The message is that careful planning well in advance - at least seven years before death and longer for larger estates - remains the cornerstone of IHT planning.

"Making gifts within your nil rate band means you could put at least £1.2m from a joint estate beyond the IHT grasp of HMRC, provided you survive seven years and you will not have to bother about changes to your will."

But everyone agrees people with larger estates in particular need to get advice. Justine Littlemore, a probate partner at Cheshire solicitors SAS Daniels noted: "It is likely that each case will vary slightly. So without doubt the best course of action is to discuss the matter with a solicitor or other expert in wills and estate planning."

Additional information from HMRC is available at: www.hmrc.gov.uk/pbr2007/it-nil-rate-guide.pdf

© 2007 Associated Newspapers. All rights reserved
Date: 24/11/2007
Publication: The Daily Telegraph