Inheritance tax shock as 3.6m couples at risk of unexpected bill - 'stressful and expensive'

Official figures have shown the total number of cohabiting couples has increased from around 1.5 million in 1996 to around 3.6 million in 2021, an increase of 144 per cent.

An expert has urged cohabiting couples to "be aware" as the law and tax rules treat couples who live together differently to those who are married. Cohabiting couples often have fewer rights and benefit than they may think which can cause an expensive shock in certain situations.

There are several tax benefits to being in a legally recognised relationship which are not afforded to cohabiting couples.

With the use of these tax exemptions, married couples can save thousands on their inheritance tax bill.

Ben Glassman, financial planning partner at UK wealth management firm Evelyn Partners explained that when a surviving partner is left with a loved one's estate, the IHT bill will have to be settled before probate is granted.

In some situations the surviving partner may not have the assets outside of the conjugal home to pay this tax liability.

So, if a partner is left a share of their jointly owned house that far exceeds this value, they could end up having to sell it to pay the tax – an "unwelcome prospect at a time of bereavement".

Glassman said: "Married couples and civil partners can transfer assets such as cash, investments and property between them, without giving rise to any tax liabilities.

"These 'inter-spousal transfers' create numerous tax planning opportunities to maximise the use of two sets of tax allowances. Movement of assets between cohabiting couples is a disposal for capital gains, and possibly inheritance tax, purposes and could negate the benefits of this exercise."

The tax expert explained married couples can make use of their full £40,000 combined ISA allowances by switching investments or cash as required, without any CGT or inheritance tax implications.

Married couples can also switch shares held outside of ISAs between each other to benefit from two sets of annual dividend allowances, which could be particularly beneficial as these have been halved so that only £1,000 of dividends per person can be received tax-free.

That halves again to just £500 from April 6, for the new tax year.

They can also reduce or eliminate entirely potential tax on profits crystallised on the sale of assets through using two sets of annual capital gains tax exemptions, which again gains significance this year as the individual CGT allowance was halved again to £3,000 from April 6, he said.

Glassman warned unmarried and cohabiting partners are not automatically entitled to any of their partner’s property, financial assets, or belongings if they die intestate unless they can be shown to be jointly owned.

He said: "They do have the legal right to claim against their partner’s estate if they’ve been cohabiting for more than two years, but this could be protracted, stressful and expensive – particularly if there are blood relatives of the deceased with a strong claim under intestacy rules.

"Writing a will is in some ways the answer to this but that is something very few unmarried couples do. Estimates show that while more than half of married couples make a will, among cohabiting partners it is just 26 per cent.

"A spouse has an automatic claim to most of their partner’s assets on death, and while this might not be a reason to get married it is another aspect of the financial security that marriage provides, particularly where one partner holds most of the couple’s wealth."

The tax expert did suggest a way that cohabiting couples can get around this and protect their assets is to enter into an official agreement.

He continued: "The best way to protect their assets is to establish a cohabitation agreement when they decide to move in together. A cohabitation agreement can also be established even if you have been living together for a long time.

LATEST DEVELOPMENTS:

• Jeremy Hunt warns 'double death tax' could add £26k to inheritance tax bill
• Inheritance tax overhaul floated as part of Labour's secret £10billion HMRC raid
• Thousands 'dragged' into paying 40% inheritance tax charge

"You can add anything you like into the agreement (as long as you both agree to it) and this can help to make sure that you are treated fairly in the event of separation or death. If you decide to get married in the future, the cohabitation agreement can quite easily be turned into a prenuptial agreement."

The Office for National Statistics have shown that the highest levels of cohabitation prior to an opposite-sex marriage were recorded with nine in 10 couples having previously cohabited.

Glassman explained that this suggests that many more couples are spending a long period cohabiting whether it’s a prelude to marriage or not.

Even if they intend to get married, people need to be aware of how the law and tax rules treat couples who live together differently to those who are married, with often fewer rights and benefits conferred than they might think.

He said: "Labour has promised in its manifesto to ‘strengthen the rights and protections available to women in co-habiting couples’ – but it’s not at all clear what this might entail and efforts by Labour to make material changes here could be fraught with difficulty.

“Those who do get married, meanwhile, can often do themselves a favour by recognising some of the tax advantages that come their way as a result.”