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Inheritance Tax for Unmarried Couples: Understanding Your Financial Position

Published on 
28 Feb 2024

Inheritance tax is a levy on the estate of someone who has passed away, and its impact on unmarried couples can be significantly different from that on married couples or those in a civil partnership. Unlike those in a legally recognised partnership, unmarried couples do not benefit from the same inheritance tax exemptions. This means that assets passed from one partner to the other could potentially be taxed if the value of the estate exceeds the tax-free threshold, currently set at £325,000.

The concept of 'transferring' any unused nil rate band (NRB) between spouses or civil partners, which can effectively double the threshold before tax is due, does not apply to cohabiting partners. This inability to share allowances can result in higher inheritance tax liabilities for the surviving partner upon death. Furthermore, the residence nil rate band (RNRB), an additional threshold allowance when passing on a home to direct descendants, also cannot be transferred between unmarried partners, which may lead to additional tax burdens.

For unmarried couples looking to manage their inheritance tax implications effectively, understanding the various exemptions, thresholds, and potential tax charges is crucial. Without the automatic exemptions available to spouses and civil partners, cohabiting couples must plan meticulously to ensure their assets are distributed according to their wishes and that their inheritance tax exposure is minimised.

Understanding Inheritance Tax

Inheritance Tax (IHT) is a key financial consideration for individuals planning their estates, especially for unmarried couples who may face different rules compared to their married counterparts.

Inheritance Tax Overview

In the UK, Inheritance Tax is a tax on the estate of someone who has died. The threshold for this tax is commonly known as the Nil Rate Band (NRB), and it stands at £325,000. Estates valued below this threshold are not liable for IHT. However, anything above this amount is subject to tax. It is important to note that the threshold can change based on government policy, and thus it requires regular review.

Rates and Reliefs

Inheritance Tax is levied at varying rates. Typically, assets passed on death are taxed at 40%, while lifetime gifts are taxed at 20%, provided they exceed the threshold and do not fall within any exemptions. There are various forms of reliefs and allowances that can reduce the IHT liability:

  • Spousal Exemption: Transfers between UK-domiciled spouses are exempt from IHT.
  • Charity Exemption: Any gifts left to charity are exempt from IHT.
  • Business Relief: Some assets related to businesses can be passed on with up to 100% relief from IHT.
  • Annual Exemption: Individuals can give away up to £3,000 each year without it adding to the value of their estate.

Please note: Unmarried couples do not benefit from the Spousal Exemption, making it crucial for them to plan their estate carefully to minimise potential IHT liabilities.

Legal Status of Unmarried Couples

The legal recognition and rights afforded to unmarried couples are distinct from those of married counterparts or formalised civil partnerships. In the UK, unmarried partners may be in long-term relationships but are not granted the same legal status as spouses or civil partners.

Rights and Recognition

Unmarried couples in the UK do not have the same legal rights as married couples or those in a civil partnership. The term 'common-law spouse' is a widespread misconception and carries no legal weight. Without marriage or a civil partnership, individuals do not have automatic rights to their partner's property or assets upon separation or death.

Civil Partnerships vs Unmarried Partnerships

Civil partnerships provide a legal union between partners that is separate from marriage but offers similar legal rights and responsibilities. Civil partners benefit from inheritance tax exemptions much like a married spouse would. On the other hand, unmarried partnerships do not automatically receive these exemptions, potentially leading to significant inheritance tax implications upon the death of a partner.

Wills and Estate Planning

In the context of inheritance tax considerations for unmarried couples, it is vital that they engage in effective wills and estate planning to ensure their wishes are fulfilled and to utilise potential tax-saving opportunities.

Importance of Having a Will

It is essential for unmarried couples to have a will in place. Without a will, an individual’s estate is subject to the rules of intestacy, which may not reflect their personal wishes. Unmarried partners do not automatically inherit from each other unless there is a will. A well-drafted will ensures that one’s estate is left to chosen beneficiaries, and may help in mitigating potential inheritance tax liabilities.

Estate Planning Strategies

Estate planning for unmarried couples requires careful consideration of applicable laws and available planning strategies. This includes taking advantage of available reliefs and exemptions unique to their situation. Additionally, couples can look into setting up trusts as a means of estate planning to ensure that assets are allocated and used according to their wishes, potentially providing both protection for the beneficiaries and tax-efficiency.

Nil Rate Band and Transfers

When considering inheritance tax, unmarried couples need to be aware that they do not have the same transferring allowances as married couples or civil partners. A clear understanding of the Nil Rate Band and the ability to transfer unused allowances can offer significant tax benefits.

Understanding the Nil Rate Band

The Nil Rate Band (NRB) is the threshold up to which an estate has no Inheritance Tax (IHT) to pay. Each individual has a NRB of £325,000, which is the maximum amount that can be passed on tax-free at death. Anything above this threshold is typically taxed at 40%. However, the introduction of the Residence Nil Rate Band (RNRB) further allows an individual to pass on their home to direct descendants with an additional tax-free allowance, which can significantly increase the amount that can be left to loved ones without incurring IHT.

Transferable Allowances

Unlike married couples and civil partners, unmarried couples cannot transfer their unused Nil Rate Bands to one another. This means that if one partner dies, any portion of their £325,000 allowance that isn't used cannot be added to the survivor's allowance. Similarly, the transferable residence nil rate band is also not available to unmarried couples. Each person must consider their own NRB and RNRB independently when planning their estate to ensure that they maximise their tax-free allowances.

Property and Inheritance

Inheritance tax (IHT) considerations for unmarried couples hinge significantly on the types of property owned and how they are treated upon the death of a partner. Key points to note are the lack of spousal exemption benefits and the application of tax-free thresholds.

Main Residence

The main residence is often the most substantial asset individuals own. Under current regulations, an individual's estate, including their home, is entitled to a nil rate band (NRB) of £325,000. A supplementary residence nil rate band (RNRB) can also apply, enhancing the threshold if a main residence is left to direct descendants. However, these benefits might not automatically transfer between unmarried partners, potentially leading to a sizeable IHT bill on the deceased's share of the property.

Rental and Investment Properties

For rental and investment properties, IHT implications can be nuanced. These properties form part of the estate and, if their cumulative value exceeds the IHT threshold, the excess could be taxed at 40%. It's crucial to note that the tax-free allowance remains at £325,000 per person and does not increase for unmarried couples. Thus, they cannot combine allowances in the same manner as married couples or civil partners.

Rental income generated from these properties is also considered part of the estate and may be subject to IHT if the owner passes away. Careful estate planning is advised to mitigate potential tax liabilities.

Tax Treatment of Assets and Gifts

When it comes to inheritance tax, unmarried couples face different implications on the treatment of assets and gifts. It's essential to understand the specific tax consequences of transfers during one's lifetime and how relief may apply to business and agricultural assets.

Lifetime Gifts

Lifetime gifts, or transfers of assets made during an individual's life, can potentially be subject to inheritance tax if the donor dies within seven years of the gift. For unmarried couples, any gifts exceeding the annual exemption of £3,000 could be taxable. Furthermore, inheritance tax may be charged at 20% on lifetime gifts into a discretionary trust, while gifts made upon death could be taxed at a rate of 40%. Specific types of gifts, such as those that fall within the Potentially Exempt Transfer (PET) rules, may not immediately attract tax but could become taxable if the donor does not survive for seven years post-transfer.

Business and Agricultural Assets

Unmarried couples can benefit from certain reliefs when it comes to business and agricultural assets. Business Property Relief (BPR) offers relief from inheritance tax at rates of either 50% or 100% on relevant business assets. On the other hand, Agricultural Property Relief (APR) can provide up to 100% relief for qualifying agricultural property passed on either during lifetime or as part of an estate. It is crucial for the assets to meet specific criteria to be eligible for these reliefs, and timing of the transfer can affect the relief available. Proper planning and advice can help mitigate the potential capital gains tax that may arise on the disposal of such assets.

Exemptions and Reliefs Specific to Unmarried Couples

Inheritance tax (IHT) can present particular challenges for unmarried couples in the UK, as they are not automatically entitled to the same exemptions as married couples.

Spousal Exemption Challenges

For unmarried couples, the significant exemption typically available to married partners, known as the spousal exemption, does not apply. This exemption allows for the transfer of assets between spouses or civil partners without incurring IHT. Consequently, unmarried partners may face a tax liability on any inheritance received from their deceased partner.

Available Exemptions and Reliefs

However, there are some exemptions and reliefs that can mitigate this tax burden.

  • Nil Rate Band (NRB): Each individual has a nil rate band of £325,000 (as of 2019/20), under which no IHT is charged.
  • Residence Nil Rate Band (RNRB): Additionally, there is a residence nil rate band which may increase the threshold before IHT is due, provided a residence is passed on to direct descendants.

While the tax system is more advantageous for spouses and civil partners, unmarried couples can make arrangements such as setting up trusts or owning property as tenants in common to allow for better tax planning.

Inheritance Tax Implications for Family and Descendants

Inheritance tax (IHT) has wide-ranging implications for family members, particularly when it involves direct descendants such as children and grandchildren. Understanding these nuances is crucial for effective estate planning.

Inheritance for Children and Grandchildren

Gifts to children and grandchildren fall within the scope of IHT; however, they may be subject to different rules. Every individual in the UK has a tax-free allowance, known as the nil-rate band. For the 2023/24 tax year, this allowance is usually £325,000, above which IHT is charged at 40%. However, parents and grandparents can pass on property which may increase the threshold to a combined total of £500,000 under certain conditions.

There are also provisions for potentially exempt transfers (PETs), which if the donor survives for seven years after making the gift, will be exempt from IHT. Business property relief may also be available, reducing the tax charge on certain types of business assets transferred to children or grandchildren. This relief can extend to 50% or 100%, depending upon the nature of the business property.

Provision for Dependents

For unmarried individuals with dependants, it’s important to note the absence of the inter-spouse exemption which unmarried couples cannot benefit from. However, direct descendants and dependants may still receive provisions through other means. This can include the use of trusts, which sometimes provides a mechanism to pass on assets while managing how and when the beneficiaries gain access to them.

Family members and stepchildren also fall under direct descendants and dependants, although stepchildren do not automatically receive the same legal status as biological or adopted children. Therefore, it is essential to specify their inclusion in a will to ensure they are considered for any IHT exemptions or reliefs specifically ascribed to children or direct descendants.

Tax Planning and Avoidance Strategies

Effective tax planning is crucial for unmarried couples to minimise inheritance tax liabilities. By understanding and applying certain strategies, one can legally reduce the amount of tax payable upon the transfer of assets after death.

Utilising Trusts

Trusts are a pivotal component of inheritance tax planning. They enable individuals to manage how their assets are distributed after death. For unmarried couples, setting up a trust can be beneficial as it may circumvent the direct inheritance tax charges that often apply to transfers outside of marriage. For instance, a Nil Rate Band Discretionary Trust can utilise the tax-free allowance, currently standing at £325,000, by holding assets up to this amount. Trusts must be created with precision and a clear understanding of the regulations that apply to ensure compliance and effectiveness.

Insurance Policies

Life insurance policies offer another avenue for tax planning. They can be structured to pay out into a trust upon one's death, attracting no inheritance tax when set up correctly. This strategy ensures that beneficiaries can receive a tax-free lump sum, which can be used to cover any inheritance tax liabilities. For example, if an individual's estate is worth more than the £325,000 threshold, a life insurance policy written in trust could provide the funds to cover the 40% inheritance tax due on the excess amount without increasing the value of the estate itself.

These strategies require careful consideration and often the advice of a tax professional to ensure they are implemented correctly and aligned with current tax laws.

Probate and the Administration of the Estate

The probate process is vital in settling the deceased's affairs, ensuring debts and liabilities are cleared before distributing the remaining assets to beneficiaries. This procedure can be more complex for unmarried couples due to the lack of legal recognition of the partnership akin to that afforded to civil partners.

The Probate Process

Probate is the judicial process by which a will is "proved" in a court of law and accepted as a valid public document that is the true last testament of the deceased. If an individual dies intestate (without a will), the Rules of Intestacy apply, and the assets may not be distributed as the deceased would have intended. Unmarried couples do not automatically inherit from each other unless there is a will that specifies such a bequest, which underscores the importance of having a legally valid will for cohabiting partners. The appointed executor or administrator must apply for a Grant of Probate, which gives them the legal authority to handle the estate.

Probate involves several steps:

  • Valuing the estate: All assets (including money, properties, and investments) and debts must be accurately valued.
  • Applying for probate: Obtaining the necessary legal document—either a Grant of Probate or Letters of Administration.
  • Settling liabilities: Debts and taxes must be paid before any assets can be distributed.
  • Distributing the estate: According to the will or the Rules of Intestacy for those who die without a will.

Dealing with Debts and Liabilities

Before assets can be transferred to beneficiaries, all of the estate’s debts and liabilities must be settled. This might include:

  • Mortgages
  • Credit card debts
  • Loans
  • Inheritance Tax

Funds from the estate are used to clear these obligations. Assets may need to be liquidated to settle any outstanding debts. This could complicate matters for an unmarried partner relying on the assets for their future. If the estate is insufficient to cover all debts, it is considered insolvent, and a specific order of priority is followed to pay off the creditors.

It is essential that the executor or administrator strictly follows the legal procedures, paying special attention to HM Revenue and Customs' (HMRC) requirements for reporting and paying any Inheritance Tax due. An unmarried partner does not benefit from the spousal exemption, which allows assets to pass between spouses or civil partners free of Inheritance Tax.

By understanding the nuances of probate and estate administration, unmarried couples can better plan and prepare for the eventual management and distribution of assets, ensuring that their final wishes are executed as intended and that the surviving partner's financial security is considered.

Charitable Bequests and Their Benefits

When an individual leaves part of their estate to a charity, they are making a charitable bequest. Such bequests have significant benefits, particularly from a tax perspective. Gifts to charities are exempt from Inheritance Tax (IHT), allowing the beneficiaries of the remaining estate to potentially benefit from a larger portion of the estate.

Tax Benefits

  • 100% exemption: Charitable bequests are 100% exempt from IHT.
  • Reduced IHT rate: If an individual donates at least 10% of their net estate to charity, the IHT rate on the rest of their estate is reduced from 40% to 36%.

The charitable bequest must be specified in the individual's will and can take various forms such as:

  • A fixed sum of money
  • A specific asset
  • A residual bequest, which is what is left after other gifts and debts have been distributed

For unmarried couples, the understanding of IHT is critical, since they do not benefit from the same IHT exemptions as married couples or civil partners. The entire estate above the IHT threshold is subject to taxation, which can be mitigated through charitable bequests. By designating a charity as a beneficiary, the donor can ensure that their generosity supports a good cause while reducing the tax burden on their estate.

It is also important to note that lifetime gifts to charity are not subject to the 20% IHT rate which applies to other types of gifts. Strategic IHT planning in this manner allows individuals to support their chosen charities in a tax-efficient way.

Looking for an IHT financial advice? Or a pension consultant? Get in touch with Assure Private Wealth and one of our tax professionals will be able to help.

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Call us for a friendly chat on 02380 661 166 or email: info@apw-ifa.co.uk

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