Avoid the pitfalls of inheritance tax

published 22 August 2008

New inheritance tax rules announced last October, allowing the transfer of unused allowances between spouses and civil partners on the first death, should not lull you into a "false sense of security", says Harriet Meyer in The Daily Telegraph. There are new pitfalls to watch when considering your will.

One is a common form of tax avoidance known as "nil-rate band discretionary trusts", which may need rewriting to make sure your heirs are not worse off than if you had not set up a trust at all. Under the new rules, if the first spouse dies now, when the nil-rate band is £312,000, but the second dies in a few years' time, when it rises to £400,000, the first spouse's use of a nil-rate band trust would result in a total tax-free allowance of £712,000.

Yet if the first spouse had not used a trust, heirs would get £800,000 tax-free on the second death. Nil-rate-band trusts can still be useful, says Dean McCarthy of Cobalt Financial Services, but only if you expect the asset placed in the trust to grow faster than the nil-rate band. In this example, had the first spouse's assets grown to £500,000 within the trust by the second death, beneficiaries would receive £900,000 tax-free.