Until 2007, nil rate band Will trusts were used routinely to ensure that the Inheritance Tax free allowances belonging to the first of a couple to die were not lost on the first death. This was done by including a legacy of the Inheritance Tax free amount to a class of beneficiaries including the surviving spouse and usually also the testator’s children and grandchildren. If the surviving spouse required the use of the assets for the remainder of their lifetime then they could be loaned to them and that loan would be treated as a debt on their estate on the second death, thereby reducing the Inheritance Tax burden and making use of the inheritance tax-free allowances belonging to both spouses.
In 2007, legislation was enacted which meant that this arrangement was no longer necessary. It became possible to transfer the inheritance tax-free allowances belonging to the first to die to the estate of the survivor to set against the ultimate Inheritance Tax bill on the second death. As a result of this change, nil rate band (NRB)will trusts are used much less commonly than they used to be. However, there are still various circumstances in which they can be useful. These are described below.
Unmarried couples
Unmarried couples do not benefit from the spouse exemption for inheritance tax and cannot benefit from the transferable NRB. As a result, a nil rate band trust can be beneficial for wealthy unmarried couples. On the first death, assets up to the NRB can be passed to a trust for the benefit of the surviving partner. This means that the trust assets will be outside of the surviving partner’s estate for inheritance tax purposes, so their estate will not be inflated by an inheritance from their deceased partner. Effectively, this means that the survivor can benefit from an additional NRB without adding any extra Inheritance Tax liability to their own estate.
Widowed testator who has remarried
If the testator was previously widowed and has remarried, their estate can potentially benefit from an additional nil rate band belonging to their deceased spouse. However, only two nil rate bands can be used at any one time. In order to avoid the additional, third nil rate band being lost, the testator should leave the NRB amount on trust on their death, and the rest of the assets to their current spouse outright. On their current spouse’s death, they can then also benefit from two NRB’s, making a total of three NRB’s overall. Using a slightly different structure, it is even possible to benefit from four NRBs this way, if both spouses were previously widowed.
Leaving assets to children or other beneficiaries
Very straightforwardly, if the surviving spouse does not need all of the assets after the first death, the NRB can be used to pass that amount to other family members such as their children, direct. This can be done in the form of either a trust or a legacy if the children are older. Using a trust enables a “wait and see” approach and the circumstances of the surviving spouse can be assessed at the time before deciding how best to deal with the trust assets. The surviving spouse can be included as a potential beneficiary of the discretionary trust, along with the children.
Reducing IHT on a second death discretionary trust
If the intention is that, on the second spouse’s death, their residuary estate will be held on a discretionary trust then for Inheritance Tax reasons it may be a good idea to include a nil rate band trust in the will of the first spouse to die. The ongoing inheritance tax charges following the second death will then be reduced, because there are two trusts and two nil rate bands instead of one.
Preventing loss of RNRB with nil rate band Will trusts
NRB trusts can also be used to direct assets away from the surviving spouse, so that on the second death, their estate will not exceed the taper threshold when calculating the residence nil rate band or RNRB. This is an allowance of £175,000 per person and this amount is free of inheritance tax when a testator leaves their home to their children or other descendants. The taper threshold for the RNRB is £2 million, and if an estate exceeds that amount then their RNRB is tapered away. If the estate is over £2.7 million on the second death for a couple then no RNRB will be available at all. If leaving assets to the surviving spouse directly on the first death is likely to push their estate over the taper threshold then it may be beneficial to direct assets to a nil rate band trust on the first death instead, to keep the asset values under the threshold.
Chiltern Wills is a will writing business based in Beaconsfield and run by former London solicitor, Rebecca D’Arcy. Call or email us for a free initial chat about how we can help you with Wills, powers of attorney or probate.
