A nil rate band trust is a flexible trust contained within a Will that allows the testator to leave their available nil rate band into trust under the terms of the will.
Prior to the Finance Act 2008, it was not possible to transfer the nil rate band allowance between spouses and civil partners on death. If a nil rate band trust was not included in the will, the nil rate band of the first to die would be lost therefore the inclusion of nil rate band trusts within wills of spouses and civil partners was useful for inheritance tax planning.
The introduction of the Finance Act 2008 introduced transferable nil rate bands which allows the transfer of any unused portion of the deceased spouses nil rate band to the surviving spouse. Then when a surviving spouse or civil partner dies, their nil rate band will be increased by the portion on the nil rate band that was not used on the earlier death of their spouse or partner.
So where does this leave nil rate band trusts? Well, they are still extremely useful in many situations and of course, also ensure assets within the trust are protected.
Second Marriages of Widows/Widowers
In marriages where one of the spouses has been married before and widowed, there is the potential for more than two nil rate bands to be used. However, under current UK legislation only one nil rate band can be transferred. As the pre 2008 way of estate planning, the use of nil rate band trusts can ensure that potentially three nil rate bands can be taken advantage of. For example;
Mr and Mrs Brown are married. Mrs Smith was previously widowed and can therefore benefit from her own and her deceased husbands nil rate band. Mr Brown also has a nil rate band available to his own estate. If Mrs Brown dies first and leaves her estate outright to Mr Brown then on Mr Browns death, he can claim his own nil rate band and Mrs Browns nil rate band but the nil rate band of Mrs Browns first husband would be lost.
However, if Mrs Brown leaves her estate on a nil rate band trust then the maximum amount she can leave into that trust will be her nil rate band and that of her first late husband. On Mr Browns subsequent death, he will also be able to claim his own nil rate band. Therefore, their joint estates will have benefited from all three nil rate band allowances.
James and Sarah are married and own £300k each. The have no children together but James has children from a previous relationship.
James dies first leaving his estate to Sarah outright. On his death no IHT is due thanks to the spousal exemption and his unused NRB (and RNRB) which are transferable to Sarah. On Sarah’s death, she passed her estate of now £600k to James’ children. As her estate benefits from her own NRB and James’ unused NRB, no IHT would be payable on her death. Whilst her estate does not need RNRB, stepchildren are classified direct descendants for the purpose of RNRB.
Let’s look at his scenario again but imagine that James and Sarah are not married. On Jame’s death no IHT would be payable as his estate is below the NRB. On Sarah’s death however, her estate will only benefit from her own NRB. This would mean that £275k out of her £600K estate would be taxable at 40%. Her estate would also not qualify for RNRB as her late partners children would not come under the definition of direct descendants for RNRB purposes.
If James and Sarah had used NRB discretionary trusts, on James' death no IHT would be payable as his estate is below the NRB. All his assets would pass on trust. On Sarah’s death, she will only own £300k worth of assets. As this is below the NRB, it will pass IHT free to James’ children.
RNRB Taper Threshold
For a married couple who individually have assets below the RNRB taper threshold (£2 Million) but combined have assets above the taper threshold, there may be a benefit of using a nil rate band discretionary trust on first death.
In this situation, if the spouses gift each other outright the whole estate, this would place the surviving spouses taxable estate over the taper threshold and the RNRB on second death would begin to be reduced.
Anything that passes into the nil rate band discretionary trust would be outside of the surviving spouses taxable estate which could keep them below the taper threshold or perhaps ensure they benefit from more of the RNRB.
What is a nil rate band discretionary trust?
- A discretionary trust that takes assets up to the value of the nil rate band
- Is a relevant property trust and therefore their own legal entity for IHT purposes
- Assets held in trust are seen as owned by the trust and not by the trusts beneficiaries.
- The trust will commonly name the surviving spouse and others (usually children and remoter descendants) as potential beneficiaries of the trust
- The trustees allow the surviving spouse access to capital often by way of a loan that is repaid on the survivors death and could also provide for a childs education and welfare
- A letter of wish should be drafted alongside the will to guide the trustees on how they should act