Inheritance tax warning as marriage cuts IHT allowance in half

Older people who start a new relationship after being divorced or widowed can face complicated family circumstances. While most will want their wealth to go to the children from their original marriage, this can prove tough in practice.

If their partner moves into the family home, there will be a debate over whether the new partner will be allowed to stay there if they outlive the parent, causing huge conflict. It can also trigger an unexpected inheritance tax bill from HM Revenue & Customs (HMRC).

This is a growing challenge facing many Britons, as more people start relationships in later life and created “blended families”. It is particularly tricky if the parent marries a much younger partner.

Parents and grandparents can take steps to safeguard inheritances, but it helps to start planning early.

It is common for people to want to make sure their children still get their inheritance after beginning a new relationship, said Jenny Walsh, a partner specialising in wills and probate at Osbornes Law.

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“The danger is that if you die and leave everything to your new partner, they could remarry and leave the assets to their new partner.”

If that happens, the original children risk getting no inheritance at all.

She said people can get round this by setting up a trust. “The most popular option is a life interest trust which allows you to leave the assets, such as the marital home, in trust. 

“This means that the partner can continue to live there, but the property still goes to the children on death.”

You can also create a life interest trust to cover other assets such as cash, savings and shares. “The surviving partner would receive the income from those assets, but the capital will pass to the children on the death of the surviving partner,” Walsh added. 

Life interest trusts offer an inheritance tax planning benefit, too. “You can still claim the spousal exemption for IHT purposes from HMRC, when the first spouse dies.”

This type of trust can also include a degree of flexibility, so that the capital can be released to the new spouse at a future date if this was ever required. It would need to be specified within the terms of the trust, and set out in the will, Walsh said.

Another way to protect children when entering a new relationship is to set up a discretionary trust, where the assets are held at the discretion of the trustees.

“This is less popular as it leaves the remaining spouse at the mercy of the trustees, plus you cannot claim the spouse IHT exemption.”

Walsh said the simplest method is to trust your new spouse or partner to leave your assets to the children, but this adds an element of risk. “Family relations and assets can change over time in ways the deceased spouse could never have anticipated.”

Leaving assets directly to the children may leave the new spouse or partner at their mercy, especially when the family home is involved. 

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“The surviving partner may not like the idea of having to ask the children for permission to sell the property.”

If assets are left to the children then they could force the new spouse to move out of the family home when their parent dies, if adequate protection is not put in place for the new spouse.

Another risk when a married couple separates is that the children could face an IHT bill at the point of their mother or father’s death, if the total the value of their assets exceeds the threshold for paying IHT.

If they are no longer married, the surviving partner would not be able to claim the spouse exemption, which allows married couples to pass up to £325,000 of wealth to their partner totally free of IHT.

Nor can they claim the £175,000 main residence exemption, which applies when passing on a family home to direct descendants such as children and grandchildren.

Walsh said one way round these issues is to sign a prenuptial agreement before getting married.

“This is a good way of regulating the assets each party brings to the second marriage, to protect the children. Both parties must take separate legal advice.”

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