'Spouse Exemption' Inheritance Tax Act 1984 (IIP Trust)
There is a provision known as the 'spouse exemption' in the Inheritance Tax Act 1984 which specifically allows for trust proceeds to be appointed by the trustees to the spouse of the insured person without giving rise to any liability or potential liability to Inheritance Tax.
This is provided the spouse to whom any benefits are appointed is UK domiciled and that the benefits are appointed to him or her either during their spouse’s lifetime, or within two years of their deceased spouse’s death. (See HM Revenue & Customs)
There is normally no liability to Inheritance Tax if benefits are paid to a UK domiciled legally-married spouse. ('UK domiciled' simply means that you are ordinarily resident in the UK and that you intend to spend the remainder of your life in the UK.)
However, if there is no surviving UK domiciled spouse, the whole of the deceased person’s estate, without upper limit, over the 'nil rate' band (£312,000 in 2008/2009) will be taxed at a flat rate of 40%.
(A spouse who is non-UK domiciled has an extra allowance, currently £55,000 on top of the nil-rate band before he or she would have to pay tax on the proceeds of their deceased spouse’s estate, but above that amount, the whole of the excess of the estate is once more, taxable at 40%)
(The domicile of the insured person is irrelevant. The 'spouse exemption' will operate if the recipient, surviving spouse is UK domiciled, even if their deceased husband or wife - the insured person - was not UK domiciled.)
If the trustees appoint benefits away from a default beneficiary to any of the other beneficiaries, whether to another of the default beneficiaries, or to a potential beneficiary, such an appointment would normally be classed as a 'potentially exempt transfer' (PET) from the default beneficiary or beneficiaries, concerned.
This means that an Inheritance Tax liability, possibly very significant, could arise in the event of the death of one or more of the original default beneficiaries, (from whom benefits have been appointed away, known as a 'dis-appointed beneficiary') within seven years of the date of the appointment away.
However, as explained above, providing the recipient spouse is UK domiciled, and assuming the trustees appoint benefits to him or her either during their spouse's lifetime or within two years of the date of death of their deceased spouse, the 'spouse exemption' guarantees that the appointment of benefits to the spouse will be a totally exempt transfer, and not classed as a PET.
There would therefore be no possibility of any Inheritance Tax liability subsequently arising in the event of the death of a 'dis-appointed beneficiary' within seven years of the appointment.
If, (as is usually the case) it is intended that children should receive the proceeds of any life policies in the event of the death of both of their parents, the children should be named as the default beneficiaries.
The (legally-married, UK domiciled) spouse should not be named as a default beneficiary, but should be among the class of potential beneficiaries.
If there is no surviving parent, and assuming children are named as the default beneficiaries, they will be able to receive benefits without any Inheritance Tax liability.
If the (UK domiciled, legally-married) spouse is among the class of potential beneficiaries, and if he or she survives their deceased partner, they would, under the 'spouse exemption', be able to receive the benefits, with no liability whatsoever to Inheritance Tax.
It is important to note that partners who are 'common-law' spouses, and who are not legally married, do not benefit from the 'spouse exemption'.
