Private Client Team

• Ian Bradshaw - Head of Private Client Department
• Clare Jeffries - Partner
• Diana Rawstron - Consultant

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THE INHERITANCE TAX NIL RATE BAND – HOW TO MAKE THE MOST OF IT

JUNE 2009

The announcement in October 2007 that the Nil Rate Band for couples was doubling was disingenuous.  The Nil Rate Band is the amount that every individual can leave free of inheritance tax on death. It has not doubled and the changes made with effect from 9 October 2007 have no effect whatsoever on single people who have never been in a marriage nor in a civil partnership that has ended with death.

What has changed is a new flexibility in the use of Nil Rate Bands by allowing an effective transfer of any unused portion of a Nil Rate Band to a surviving spouse or civil partner.

Each spouse or civil partner has a Nil Rate Band available to their Estate, but it was common for a Nil Rate Band to be wasted by the first partner to die leaving their Estate in its entirety to the surviving spouse.   When the Estate eventually passed to chargeable beneficiaries such as children, there would be just one tax free threshold to set against the whole.  This increased the eventual Inheritance Tax Bill by over £100,000 simply by wasting the Nil Rate Band of the first spouse to die.

It used to be the case that the Wills of married couples would almost invariably include a Nil Rate Band Discretionary Trust.  The purpose of the Trust was to capture the available tax-free threshold of the first spouse to die so that this was not wasted but so that the surviving spouse could have access to the assets if needed. 

Transferable Nil Rate Band

The new rules makes it much easier for married couples to make use of both Nil Rate Bands.  It is now possible to transfer any unused percentage of a nil-rate band to the estate of the surviving spouse.  It is not the Nil Rate Band at the time of the death of the first spouse which is relevant, but the unused proportion of that Nil Rate Band. This proportion is carried forward and set against the Nil Rate Band relevant at the time when the survivor dies.  The following example shows how the new provisions operate:

When H died the tax-free threshold was £325,000, and H had not used any of his Nil Rate Band either by lifetime gifts or in his Will.  This means that 100% of the tax-free threshold remained available.  If when W dies a few years later, the tax-free threshold has increased to £500,000, the ultimate beneficiaries will have £1 million tax-free to set against the joint estate.

There are restrictions, the most obvious being that the maximum to be set against any person’s estate is twice the Nil Rate Band at their death.  Where somebody has been pre-deceased by more than one spouse who has not used their Nil Rate Band in full,  the extra Nil Rate Band available to the surviving spouse’s Estate is limited to 100% of the Nil Rate Band at the time when the survivor dies.  This can, however, be made up by unused proportions of more than one spouse who pre-deceased.

It may, however, surprise you to know that the unused proportion of Nil Rate Band can be transferred for the benefit of the estate of the surviving spouse regardless of whether the first spouse to die had assets in their own estate equivalent to that value. So even if H had only £1000 in his own name when he died, there can be a doubling of the Nil Rate Band on W’s death.

For husband and wife it does not matter how long ago the first spouse died.  In the case of a civil partnership, the first death must have occurred on or after 5th December 2005, the date on which the Civil Partnership Act became law in the United Kingdom. 

Do I still want a Nil Rate Band Discretionary Trust in my Will?

Nil Rate Band Discretionary Trusts – First Death already occurred

If the first spouse died over two years ago and a nil rate band discretionary trust is in place, then nothing can or should be done.  It is too late now to make any changes. It would be a mistake to think that the trust is no longer needed and so to appoint all of the assets out to the widow because her late husband’s nil rate band has now been used because of the existence of the trust, so the effect of that would simply be to increase her estate without giving her the benefit of a transferable nil rate band. 

If the first spouse died within the last two years, then it will normally be possible to end the nil rate band discretionary trust by appointing the trust assets to the survivor before the second anniversary of the first death (but not within the three months immediately following the death for tax reasons).  The effect will be that the nil rate band has not been used on the first death and so the amount available for eventual transfer is increased. 

Will Planning where both spouses are still alive

Where husband and wife have made Wills that incorporate nil rate band discretionary trusts, there is no need to change the Wills.  On the death of the first spouse to die the trustees can simply wait three months and then appoint the whole of the nil rate band to the surviving spouse.  

Some clients may prefer to remove the relative complexity of the nil rate band discretionary trust from their Wills, in which case they can of course do so. 

In principle, Wills will now need to be drawn to maximise the spouse exemption on the first death but in the expectation that, if it is possible to do so, the surviving spouse will make gifts as soon as practicable after the first death; (reservation of any benefit to the giver must be avoided and gifts should not exceed the nil rate band if made into trust, to avoid the 20% lifetime IHT charge).  However there will still be circumstances in which a nil-rate band discretionary trust is advisable within a Will.  Here are 10 such circumstances:-

1. The law might change yet again, so that the flexibility afforded by a Nil Rate Band Discretionary Trust will enable your executors to act in the best interests of the family as a whole, both from a tax and a personal point of view.
2. Where a couple are young and have young children, they have to contemplate the possibility that a surviving spouse would remarry and have another family.  They may wish to ensure that the Nil Rate Band is ring-fenced for the benefit of their own children in circumstances in which there is otherwise the possibility that none of their assets may be preserved for their own family.
3. Wealthy couples may be averse to making outright gifts on the first death.  Their children may already be wealthy but their grandchildren are too young to benefit and so a trust of the Nil Rate Band for grandchildren may be attractive.
4. General discretionary trusts, if intended to run for many years, will benefit from the creation of a Nil Rate Band discretionary trust in the first Will.  This is because the principal charge at 6% every ten years is levied on the amount on which the value of the trust exceeds the nil rate band at that time.  Two trusts are therefore better than one because there will be twice the nil rate band available. 
5. A Trust allows income to be distributed to a wide variety of beneficiaries.  If they are not higher rate taxpayers, they can reclaim all or part of the income tax which has been paid by the Trustees on the income.  This can result in a significantly lower level of income tax than would be payable by the surviving spouse on those assets if the Trust had not been established.
6. Agricultural or business property gives rise to tax saving opportunities.  Such property put into a discretionary trust on the first death may be bought back by a surviving spouse and be tax free again in the estate of the second spouse to die.  To put such assets into a Nil Rate Band trust also crystallises the 0% tax rate while still applicable as it cannot be guaranteed for the future. 
7. Second marriages can make good use of trusts, in making sure that a Nil Rate Band is not wasted.
8. Care home fees continue to be a concern with an ageing population.  Setting aside assets equal to the Nil Rate Band on the first death takes those assets out of the hands of the surviving spouse so that they would not be taken into account in assessing that spouse’s contribution to the costs of care.   
9. If a property is jointly owned by husband and wife, then on the first death a share of the property can pass into a trust so that the property is owned by the surviving spouse and the trustees.  On the later death of the surviving spouse, a discount on the value of their share will be allowed for inheritance tax purposes.  The discount can be as high as 15% - whereas if the property were owned entirely by the surviving spouse no discount would be applied.  At the second death the property is likely to pass to non-exempt beneficiaries such as children and so the discount could prove valuable.
10. A Nil Rate Band trust has its own capital gains tax allowance (albeit half that of an individual)

We hope this is helpful.  Please do contact us to discuss your particular circumstances.

Clare Jeffries
Goodman Derrick LLP
90 Fetter Lane
London EC4A 1PT
Tel: 0207 421 7942
E-Mail: cjeffries@gdlaw.co.uk

This note is intended to provide general information about some recent developments which may be of interest.  It is not intended to be comprehensive nor to provide any specific legal advice and should not be acted or relied upon as doing so.  Professional advice appropriate to the specific situation should always be obtained.