The legal position of cohabiting couples varies to that of a married couple and they do not receive some of the benefits that married couples receive. Inheritance tax planning that is common place and simple for married couples may not therefore be the best option when it comes to unmarried couples.
A married couple can easily leave everything to each other IHT free and on the death of the second benefit from two Nil Rate Bands (NRB) (and potentially two Residential NRBs). Unmarried couples however do not benefit from either the spousal exemption for IHT or the transferable NRB. The estates of an unmarried couple leaving everything to each other would therefore be considered for IHT on both first death and second death and without the benefit of two NRBs on second death. This could lead to an unnecessarily high IHT charge on second death.
John and Jane are a married couple owning £300,000 each. They have no joint children, but John has children from a previous relationship.
John dies first, leaving a life interest in their home for Jane and residue to her outright. On his death no IHT is due thanks to the spousal exemption and his unused NRB (and RNRB) are available to transfer to Jane. On Jane’s death, she passes her estate of now £600,000 to John’s children. As her estate benefits from her own NRB, and John’s unused NRB, no IHT would be payable on her death. Whilst her estate does not need RNRB, stepchildren are classed as direct descendants for the purpose of RNRB.
Imagine this same scenario, but John and Jane were not married. On John’s death, no IHT would be payable as his estate is below the NRB. On Jane’s death however, her estate will only benefit from her own NRB. This would mean that £275,000 out of her £600,000 estate would be taxable at 40%. Her estate would also not qualify for RNRB, as her late partner’s children would not come under the definition of direct descendants for RNRB purposes.
Rather than leaving assets to the partner outright, or to a life interest trust where the partner will be seen as inheriting the assets for IHT purposes, they could consider using Nil Rate Band Discretionary Trusts.
The Wills would leave assets up to the value of the NRB to a discretionary trust, of which the partner and others are discretionary beneficiaries. The trust is its own legal entity and the trust therefore owns the assets rather than the partner.
If John and Jane had used NRB Discretionary Trusts, on John’s death no IHT would be payable as his estate is below the NRB. All assets would pass to the trust. On Jane’s death, she will only own £300,000 worth of assets. As this is below the NRB, it will pass IHT free to John’s children.
For the purpose of this article, all references to married couples also include civil partners.