QROPS Advice: Use your allowances to cut IHT

Following a change in the law in 2008, when a widow or a widower dies their estate can benefit from any unused inheritance tax (IHT) allowance their partner had - as well as their own. Estates up to the value of £325,000 do not incur IHT, but those above this will incur a 40 per cent tax.

Therefore if neither partner had used any of their allowance - and the first of the couple to pass away left everything to their spouse (assets passed between spouses do not incur IHT) the remaining partner would have a nil-rate band of £650,000. If the one partner had used some of their IHT allowance, their spouse would get however much of their £325,000 they had not used in addition to their own £325,000.

But the ability to transfer the nil-rate band between married couples does not apply to individuals whose spouse died before March 1972.

"Essentially, before March 1972, when a modest spouse exemption was brought in, someone who died and left their property entirely to their surviving spouse was always chargeable to estate duty, the forerunner of modern day IHT," says John Whiting, tax policy director at the Chartered Institute of Taxation. "They used up all of what we today call the nil-rate band, which means that under today's rules the surviving spouse has no additional nil-rate band available on their death."

Although this only affects a small number of elderly widows and widowers, the Low Incomes Tax Reform Group has been campaigning for the rule to be changed. It says those affected are mainly long-widowed elderly women who had to cope as single parents for many years and feel unfairly treated.

The Low Incomes Tax Reform Group drafted amendments to the Finance Bill 2008 which it discussed with HM Revenue & Customs (HMRC) and the responsible minister, Stephen Timms, but this was rejected at the end of 2009. HMRC's main objection is that opening up and sorting out old estates would be difficult and could create inconsistencies with estates on which tax was paid at the time.

The Low Incomes Tax Reform Group in turn argues that it does not want to reopen estates but to treat the cases as other deaths of spouses after March 1972. The group argues that the change would be very simple, and as so few people are affected the government would lose a negligible amount of money.

The campaign is backed by Rob Marris, Labour MP for Wolverhampton South West, one of whose constituents is affected. She is a widow whose husband died in 1969 whose only asset is her house. As this is worth more than £325,000 she cannot leave it IHT free to her children.

I HT mitigation strategies

Whatever your situation, you have a number of allowances that can lower your IHT bill.

Everyone can give away £3,000 a year IHT-free, and if you have not used your allowance in the previous year you can carry this forward and give £6,000 in that year. "Many people do not use this - there are low levels of awareness," says Julie Hutchison, head of estate planning at Standard Life. "Another hugely under-used allowance is gifts from surplus income."

If you have excess retirement income you can make gifts from it that are immediately tax exempt. This is in addition to your annual £3,000 gift allowance.

You can do this by looking at your income for the year and giving away what you don't need for your spending requirements. It can be declared via the IHT 403 form which you can download from the www.hmrc.gov.uk website. The website also provides advice on the detailed paperwork required to support this claim.

"You do not need to give away the same amount to the same person every year," says David Kilshaw, head of private client advisory at accountants, KPMG. "But it is advisable in the first year you do it to write a letter to the person you are giving it to saying you may not always give it to them and it may not be the same amount each year."

You can also make a potentially exempt transfer. This allows you to make a gift of any amount without incurring IHT, as long as you live for seven years after you make the gift.

Another alternative, is to put the assets you wish to pass on into a trust. This incurs a chargeable transfer of 20 per cent IHT on gifts to most types of trust over £325,000, rather than 40 per cent. Trusts can be beneficial in that they protect the assets for the person to whom they are being gifted to.

For example, if the person to whom the money in trust is being given is undergoing divorce proceedings, their divorcing spouse could not claim the money in a trust in a settlement. Or if the person to whom the trust is being gifted has a business that goes bankrupt, this cannot be clawed back by debtors as it is not counted as part of their estate.

If your only asset is your house it is more difficult to mitigate IHT, but you could sell the house, move to a smaller property, and pass on the cash you make using one of the above methods.
Written by:Leonora Walters