Our two most recent articles considered unmarried couples. The first compared different property trust structures, unmarried couples and inheritance tax consequences. The second examined how a life interest trust could protect a surviving partner and affect a potential claim under the Inheritance (Provision for Family and Dependants) Act 1975.
Those articles prompted questions about a further scenario where one partner owns the whole property, and the non-owning partner has few assets but needs certainty that they can continue living there.
This highlights a recurring difficulty in estate planning for unmarried couples. There is often no perfect inheritance tax solution.
This article considers the main options available. These issues frequently arise when advising on unmarried couples and inheritance tax where one partner owns the family home outright.
Unmarried Couples and Inheritance Tax: Why Does Being Unmarried Matter?
Under the Inheritance Tax Act 1984, transfers between spouses and civil partners are exempt from inheritance tax (IHT). Unmarried partners do not benefit from this exemption, regardless of the length of their relationship.
Unmarried couples also cannot transfer unused IHT allowances between them. By comparison, when a spouse or civil partner dies, any unused percentage of their nil-rate band and residence nil-rate band may potentially be claimed on the survivor’s death.
The main allowances are:
- the nil rate band, which is currently £325,000; and
- the residence nil rate band, which is currently up to £175,000 and may apply where a qualifying home is inherited by direct descendants, such as children or grandchildren.
An unmarried partner is not a direct descendant. The residence nil rate band will therefore not ordinarily apply where the property passes outright to the partner or into a life interest trust for them.
Unmarried Couples and Inheritance Tax: The Potential IHT Liability on the First Death
Consider an unmarried couple, A and B. A owns their mortgage-free home in A’s sole name. The property is worth £600,000 and A has little other assets. B has limited savings and A wishes for them to remain living in the property.
A’s will could leave the property to B outright or on a life interest. However, no spouse or civil partner exemption would apply.
Assuming A has made no relevant lifetime gifts and has the full £325,000 nil-rate band available, the calculation would be:
- Property value: £600,000
- Nil-rate band: £325,000
- Taxable estate: £275,000
- IHT at 40%: £110,000
The residence nil-rate band would not apply because B is not A’s direct descendant.
If the property represents most or all of A’s estate, there may be insufficient cash available to pay the £110,000 liability. IHT attributable to land can generally be paid by annual instalments, although interest is payable.
If the liability cannot be funded from another source, the property may ultimately need to be sold.
The Planning Options
There are a few options that A could consider.
An Outright Gift to the Survivor
A could leave the property to B outright.
This would provide B with the greatest immediate certainty. B would own the property and could occupy, sell or mortgage it without requiring the consent of trustees.
The disadvantage is that A would lose control over who ultimately inherits the property. Once B owns it, the property would be exposed to B’s future decisions and circumstances. This could include:
- creditors;
- third party claims;
- a later relationship; and
- the terms of B’s own will.
The property would also form part of B’s estate for IHT purposes. If it remained worth £600,000 when B died, a further IHT liability could arise.
The exact position would depend on B’s other assets and whether the residence nil rate band applied to B’s estate.
A Life Interest Trust
A could instead leave the property on a life interest trust for B.
B could be given an enforceable right to occupy the property for life or until an event specified in the will, such as permanently leaving the property.
When B’s interest ended, the property could pass to A’s chosen beneficiaries. This would give B security while allowing A to control who ultimately inherits the property.
The will could also give the trustees power to sell the property and purchase a replacement home if B wished to move.
However, a life interest for B would be treated as an immediate post-death interest for IHT purposes. The property would be treated as passing to B on A’s death for IHT purposes.
As B is not A’s spouse or civil partner, no spouse or civil partner exemption would apply. The residence nil-rate band would also not be available.
The trust property would be tax as part of B’s own estate when B died. A life interest trust can therefore provide security and protect the property’s ultimate destination, but its value may be exposed to IHT on both deaths in the same way as an outright gift.
A Nil Rate Band Discretionary Trust
If reducing the potential IHT liability on B’s death is a priority, A could consider a nil rate band discretionary trust.
Assets up to the value of A’s available nil-rate band, currently £325,000, could pass into the trust. B, A’s children and any other chosen beneficiaries could be included within the class of potential beneficiaries.
The trustees could consider B as the primary beneficiary of the trust fund whilst they are alive but unlike a life interest B would not have an absolute right to remain in the property. B’s occupation would depend on the trustees’ exercise of their powers.
The trust fund would not form part of B’s estate merely because B was a discretionary beneficiary or had been permitted to occupy the property by the trustees. This would prevent that part of the property from being taxed again on B’s death.
The disadvantage is that B would have less certainty. A letter of wishes could explain that A wanted B to remain in the property, but the letter would guide the trustees rather than bind them.
A discretionary trust is also subject to the IHT relevant property regime. This can result in charges:
- on each ten-year anniversary of the trust; and
- when assets leave the trust.
What Happens to the Balance?
A nil-rate band discretionary trust would not deal with the whole of a property worth £600,000. The treatment of the remaining value would therefore need to be considered separately.
The balance could:
- pass outright to B, providing certainty but no protection over that part of the property;
- pass into a life interest trust for B, providing enforceable rights and control over the ultimate beneficiaries, but bringing that value into B’s estate for IHT purposes; or
- pass directly to A’s descendants, potentially securing the residence nil rate band on A’s death but affecting B’s ability to remain in the property.
A final option could also be to pass into a residence nil rate band life interest trust structured for A’s direct descendants. This can also preserve the residence nil rate band on A’s death whilst providing more protection and structure but the planning and subsequent administration of the trust would be significantly more complicated.
Conclusion
When considering unmarried couples and inheritance tax, particularly those with higher value estates, there is often no structure that perfectly balances occupation security, control and tax efficiency.
An outright gift to a surviving partner provides the highest degree of certainty but offers little long-term protection or IHT mitigation. A life interest trust can provide enforceable occupation rights and preserve control over who ultimately inherits, although it may expose the property to IHT on both deaths. A discretionary trust may reduce the inheritance tax exposure on the survivor’s death, but typically provides less certainty for the survivor.
The most appropriate solution will depend on the value of the property, the availability of funds to meet any tax liability, the identity of the intended beneficiaries and the level of security required by the surviving partner. Careful planning is therefore essential, particularly where the family home forms the majority of the estate.
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This article is provided for general information only and does not constitute legal advice. Any advice, wording or clauses referred to are illustrative and should not be relied upon as precedent without full consideration of the client’s circumstances, the will as a whole, and the law in force at the relevant time.
