Finance and marriage – should go together like a horse and carriage
TAKING care to maximise income and capital gains tax allowances and reliefs may not seem like rocket science but over the years it can save a great deal of tax. In a world where “clever clever” tax mitigation is increasingly frowned upon there is a lot to be said for this low key approach. There is some relatively straightforward planning available to spouses and the same planning is available to civil partners.
INCOME TAX
The personal allowance, or amount you can earn tax free, is currently £7,475 unless you earn more than £100,000 (from which level the allowance quickly drops to zero), with more generous allowances for those aged over 65 on lower incomes. Most people (except those born before 6 April 1935, for whom married couple’s allowance might be available) are not entitled to enhanced allowances based on the fact that they are married. But in many cases it is still possible for spouses to share assets between themselves so that they can both make maximum use of income tax allowances and reliefs. In circumstances where only one party to the relationship is a high earner, this can make a considerable difference to the annual family income tax bill.
CAPITAL GAINS TAX
Spouses who live together can transfer assets between each other without triggering a capital gains tax charge. Instead, the spouse who receives the asset “inherits” the other spouse’s acquisition cost. Such transfers can maximise the use of the annual capital gains tax allowance (£10,600 in the current tax year 2011-2012) and the lower rates of capital gains tax (18 per cent instead of 28 per cent) that apply to lower rate income tax payers.
INHERITANCE TAX
Spouses can pass assets to each other during marriage or on death without having to pay inheritance tax (unless the donor spouse is UK domiciled and the recipient is not). If a spouse dies and has not used all of their inheritance tax “nil rate band” exempt amount (£325,000 in 2011-12), they can pass whatever proportion of their nil rate band remains to the surviving spouse to use on their death (even if the surviving spouse subsequently remarries – although there are restrictions on the number of nil rate bands that any one person can use). This means that, in combination with their own relief, the nil rate band will be up to £650,000 for the surviving spouse on their death. The fact that there is no general exemption available to people who are simply co-habitees or in long term relationships can cause hardship on the first death, as the rate of inheritance tax above the nil rate band is 40 per cent. This is often compounded where people die intestate (i.e. without a will). Note also that unused nil rate band cannot be passed between co-habitees.
WHERE THERE’S A WILL
If a person dies without a will their estate will be divided in accordance with statutory rules, which make provision for the surviving spouse and children (and/or other relatives depending on the circumstances).
Application of the statutory rules on intestacy can sometimes be highly tax inefficient due to not maximising the inheritance tax spouse exemption. Even more importantly, it can result in property not passing in accordance with the deceased person’s wishes. So it is important to keep an up-to-date will. If you are unmarried but cohabiting a will is essential: the statutory rules make no automatic provision for co-habitees. Although some co-habitees may be able to make a claim against the deceased’s estate, it will not always be possible to do so, and the cohabitant will often not be entitled to as generous provision as a spouse who makes such a claim.
It is also important to make a new will on marriage because, except for wills made in contemplation of marriage, a will is revoked by marriage.
People should also make a new will on divorce. An existing will remains valid, but the position, unless the will states otherwise, is that the divorced spouse is treated as having died before the deceased person, so they won’t inherit anything.
BANK ON IT
On death, joint bank accounts usually pass automatically to the surviving joint owner, and can therefore provide ready access to funds in advance of other assets passing under a will and through the probate process. During the marriage, joint bank accounts are a common way to share household expenses equally, or to allow a stay-at-home parent easy access to fund day-to-day expenses. On separation, the parties (particularly the stronger financial party, if they are the one who “tops up” the balance) should keep a close eye on spending from the account. If there are significant funds in the account, or the risk of funds being removed without both parties’ consent, it is possible to freeze the account.
SOMETHING FOR THE CYNICS
Pre-nuptial agreements are not binding under English law, but are one of the circumstances that the courts will consider when deciding how to divide the matrimonial finances on divorce. There has always been some uncertainty as to the weight the courts will place on pre-nuptial agreements and in the recent case of Radmacher v Granatino, the Supreme Court sought to clarify the position. In the Radmacher case, it was found that the courts should “give effect to a nuptial agreement that is freely entered into by each party with a full appreciation of its implications unless in the circumstances prevailing it would not be fair to hold the parties to their agreement.”
Therefore, the assumption must be that an agreement entered into in circumstances in which the parties understood what they were doing will be upheld by the courts, provided that the agreement meets the weaker financial party’s needs and is not patently unfair.
Bart Peerless is a private client partner and head of the private wealth sector group and Sarah Higgins is a family partner and head of the family group, both at Charles Russell.