Divorced and remarried parents risk unintentionally cutting children from their first marriages out of getting their inheritance tax-free, experts have warned.
Inheritance tax (IHT) is among the least popular levies in the UK, not least because the bill is received at a time when people are suffering a loss, whilst also often being complicated to navigate.
Although fewer than one in 20 estates currently pay it, rising property prices and frozen tax thresholds mean more families are being pulled into its scope, often without realising they are at risk.
For divorced and remarried families, the danger is particularly acute. As family structures become more complex, the IHT system has struggled to keep pace.
Experts say the result can be large and unexpected tax bills, alongside disputes between surviving spouses and adult children.
Here, The i Paper takes a look at the challenges facing divorced and remarried households.
How could those remarried be affected by IHT?
IHT is charged at a rate of 40 per cent on assets above the £325,000 nil-rate band, with an additional £175,000 allowance if the main residence is passed to direct descendants.
In straightforward cases, married couples can combine allowances, potentially passing on close to £1m without triggering IHT.
For divorced and remarried families, those allowances do not always stretch as far as expected.
The standard allowance can’t always be fully used if assets are split between multiple spouses/ex-spouses, particularly where estates are divided between a current partner and children from an earlier marriage.
Remarried individuals often leave parts of their estate to second spouses, which can reduce the portion that can pass tax-free to children from the first marriage.
Although transfers to a current spouse are exempt from IHT, using that exemption can prevent allowances being used in a way that benefits children directly.
What happens when people are widowed
Marriage will revoke a will, so if someone remarries and dies before they make a new will they die intestate (without a valid will) and under these laws their current spouse at death will almost always get a significant chunk.
Rowan Morrow-McDade, tax director at Alexander and Co Chartered Accountants, said this issue is particularly overlooked where both partners have been widowed before forming a new relationship.
He said: “If two individuals in a relationship have previously been married and were widowed, they can in theory have two nil-rate bands available, theirs plus their own deceased spouses. This can give them £650,000 each of nil-rate band.”
A new marriage can unintentionally undermine that position, he warned.
“If they got married and one spouse died and left everything to the other, a £325,000 nil-rate band would be wasted.”
In some cases, he added, the most tax-efficient approach can feel counter-intuitive.
“Therefore, it can make sense to either not get married, or if they do, for each spouse to pass £650,000 of assets to their children, to use up both their nil-rate band and their inherited nil-rate band.”
Experts have urged the importance of planning.
Ian Dyall, head of estate planning at Evelyn Partners, warned: “People can use the nil-rate band of their previously deceased spouse if they are a widow/er and remarry, however it won’t happen without planning.”
When ex-spouses fall outside the system
A common misconception is that former spouses retain some protection under IHT rules. They do not.
Only current spouses/civil partners benefit from the spouse exemption. This can lead to unintended IHT bills on portions meant for children from a first marriage.
Judith Kerese, a lawyer at Stowe Family Law, said: “Generally speaking, there is an exemption from IHT liability to a spouse. Any provision made to an ex-spouse will be liable to IHT if this exceeds the person’s nil-rate band.”
She said most divorces are intended to create certainty, adding: “In most cases, ex-spouses and ex-civil partners obtain a financial order following separation, which provides a clean break in life and death.”
Problems tend to arise when wills are not updated after divorce, or when informal promises are made that have no legal or tax effect.
Protecting children while providing for a new partner
For many parents, the most difficult challenge is balancing the desire to provide for a second spouse with the wish to protect children from a previous relationship.
Trust planning is often used to manage this risk. Pension and trust planning also matter as certain assets bypass spouses but may still count towards the estate for IHT purposes, adding further complexity.
Morrow-McDade said immediate post-death interest trusts (IPDI) are commonly used where one spouse wants to ensure assets ultimately pass down their bloodline.
“When a spouse wants to protect their bloodline, they can transfer their assets on death into an IPDI.
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“This gives the surviving spouse the right to benefit from the asset during their lifetime, but on their death, it goes directly to the children.”
He said the risk of doing nothing is greatest where remarriage is likely.
If the husband leaves everything to the wife, and she remarries, his share of the house might be given to either the second husband or the wife and second husband’s children.
Using a trust can prevent that outcome. “By placing his share of the house in an IPDI, the wife has the right to live in it whilst she’s alive, but on her death, it would automatically pass to his children.”
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