IHT shock as millions of couples face paying inheritance tax TWICE due to ‘harsh’ rule

Inheritance tax explained by Interactive Investor expert

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Inheritance tax is a bigger threat to family wealth than ever, with receipts hitting an all-time high of £6.1 billion during the 2021/22 financial year. They will steadily rise as the £325,000 nil-rate threshold at which IHT kicks in has been frozen until 2026.

Married couples and civil partners have some protection, as they can pass assets between each other free of IHT, and inherit each other’s allowances. Yet unmarried couples who cannot do this, even if they have lived together for years or decades.

More than six million Britons now cohabit with their partner, and they risk paying a lot more IHT when one of them dies.

In some cases, they could pay the hated death tax twice.

They often do not realise the danger until it is too late to do anything about it.

While many will be young, a growing number of cohabitees are older couples on second or third marriages, who did not wish to make their relationship official either because of past disappointment or because children disapprove.

The Government continues to insist that long-term live-in couples must formally be married or civil partners if the survivor is to inherit their partner’s assets free of IHT, said Paul Wilcox, founder of wealth planners WAY Group.

“This seems unnecessarily harsh in this day and age, when divorce and widowhood is so commonplace, and family pressures can often compromise those later life relationships.”

When a spouse or civil partner dies, their partner can inherit their £325,000 nil-rate threshold, plus the £175,000 main residence allowance, which applies where people are passing on their main home to direct descendants such as children and grandchildren.

This adds up to a potential £500,000 IHT allowance, allowing married couples and civil partners to pass on a potential £1 million of wealth to close family in total.

With unmarried couples, if one partner dies the value of their estate above £325,000 will immediately be taxed at 40 percent, as if they were single.

This applies even if they left their entire estate to their surviving partner. The tax must be paid before the estate passes on to the survivor.

If most of the couple’s wealth is in the name of the deceased partner, the bill could be huge.

“Denying long-term and devoted couples who failed to formalise their relationship IHT relief on their joint assets when one dies is unfair,” Wilcox said.

He has seen cases of older couples who have avoided the formality of marriage or civil partnership, to avoid upsetting complicated family structures or because their children were against it.

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Many then panicked and rushed to marry after one went into long-term care, but left it too late to cut what was often a “shocking IHT liability”.

In other cases, unmarried couples lose out because one dies unexpectedly, said Sam Ratnage, chartered financial adviser and wealth manager at Tideway Investment. “If above the threshold, IHT will be payable, and the nil-rate bands will not be inherited.”

Unmarried cohabiting couples could face IHT bills twice – both on the first and second death. “Unless they have planned for this, the surviving partner or children may have to sell assets such as a family home to pay the tax bill.”

Ratnage called on cohabiting couples to review and understand their inheritance tax exposure. “One option is to set up a savings plan to pay the estimated IHT tax, possibly with life insurance to meet a possible tax bill for your loved ones. Advice is essential.”

The earlier you start planning the better, Wilcox said. “Another option is to gift assets into flexible trusts managed which are removed entirely from IHT provided you live for another seven years after making them. It’s a safe and secure solution.”

Preparing a will is essential for everyone, to make sure your wealth goes to the right place.

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