Since the introduction of the transferable nil-rate band, the use of the nil-rate band discretionary trusts is now appears limited for estate planning. However, it remains an important tool in effective estate planning.
By way of reminder, the nil-rate band (NRB) discretionary trust was generally used by a married couple or civil partner (as defined by the Civil Partnership Act 2004) in their Wills to ensure that the surviving spouse had access to their deceased spouses NRB as well as their own NRB.
However, the transferable NRB now means that upon the death of the surviving spouse their personal representatives not only have the deceased’s NRB but potentially they can also use 100% of their deceased spouse's NRB. For 2018/19 this means a potential of £650,000 (£325,000 x 2) can pass free from inheritance tax (IHT) upon the death of the surviving spouse.
So consider Mr & Mrs Scown. Upon Mr Scown’s death he leaves all of his estate to Mrs Scown. Since this is covered by the inter spousal exemption none of Mr Scown’s NRB has been used. This means that upon Mrs Scown’s death she will have her own NRB as well as 100% of Mr Scown’s NRB leaving a total available of £650,000 to pass free from inheritance tax (IHT).
If, however, upon his death Mr Scown left half the value of the NRB to his children he would have used 50% of this NRB. This would mean that upon Mrs Scown’s death she would have her NRB as well as 50% of Mr Scown’s.
Since the 2017 tax year, individuals will receive a further ‘Main Residence Nil-Rate Band’ to offset against a main residence. The band started at £100,000 and increases £25,000 each tax year to £175,000 in 2020/21. The band will also be transferrable between married couples or civil partners (as defined by the Civil Partnership Act 2004).
Despite the availability of the transferable NRB, the NRB discretionary trust still has many valuable uses in protecting assets which are relevant in a number of different situations.
Where low asset values are likely to increase
Where assets are likely to increase in value faster than the NRB then creating a NRB discretionary trust could provide IHT benefits. Upon the first death the value of assets is assessed against the NRB at the time of the transfer. If, however, everything passes to the surviving spouse and the value of the assets grow faster than the NRB, upon the surviving spouses death there may an IHT liability which would not have occurred had the NRB discretionary trust been used.
Making the most of Business Property Relief (BPR) and Agricultural Property Relief (APR)
The NRB discretionary Will trust should also be considered in respect of assets which attract BPR or APR. It is important to ensure that if this relief is available for IHT purposes that it is not lost. By transferring BPR or APR assets into a NRB discretionary trust the relief is captured upon the assets entering the trust. However, if instead the assets were passed outright to the surviving spouse they would pass free from IHT under the spouse exemption but if the assets were subsequently sold and converted into cash or if they did not subsequently qualify for the relief then upon the surviving spouses death valuable relief would be lost.
Consider Mr & Mrs Hargreaves. Mr Hargreaves runs a company in his own name which satisfies the conditions of BPR. Mr Hargreaves decides that due to his poor health he can no longer run the company and he therefore sells it for the sum of £2million cash. Upon his death Mr Hargreaves will therefore have the cash sum of £2million in addition to the remainder of his estate. Since he converted the business into cash there is no BPR available. IHT will then be charged accordingly.
If, however, Mr Hargreaves created a lifetime NRB discretionary trust when he decided that he could no longer run the company and transferred the company into trust, BPR would be captured upon entering the trust and there would be no immediate charge to IHT. The trustees would then be the legal owners of the company and could then run it accordingly or dispose of it at a later date if appropriate. Providing Mr Hargreaves survives the period of 7 years from the date of making of making the gift then the value of £2million will not form part of Mr Hargreaves estate upon his death.
If any descendants are in an unstable marriage, the NRB discretionary Will trust can ensure that assets remain in the blood line and do not form any part of a potential divorce settlement. This is illustrated in the following example.
Take Mr and Mrs Horn who create Wills passing their whole estate to each other and then upon the second death to their 2 children in equal shares. Upon the death of both Mr and Mrs Horn, their son will receive a 50% share of the estate and this value then forms part of his assets. If he then subsequently divorces any divorce settlement is based on the total value of assets which will include the value of his inheritance. However, had Mr and Mrs Horn instead put their estate into a NRB discretionary trust their son would have access to the trust fund but he would not own any part of it and it could not be included when valuing his assets.
There may also be concern that a surviving spouse may marry again. If all assets are passed directly to the surviving spouse and they subsequently marry such assets may not pass in full to the children as was originally intended. A NRB discretionary Will trust will protect assets from such a situation.
Protection of vulnerable beneficiaries
If there are vulnerable children who are likely to inherit they may not be capable of managing large sums of money effectively. In order to protect those assets from potentially being squandered away, a NRB discretionary Will trust will ensure that there are trustees appointed to control the trust fund.
Beneficiaries who are in receipt of means tested benefits would potentially have their benefit entitlement reduced or find that it ceases completely if they receive a lump sum payment from as a form of inheritance. Their benefit entitlement would be protected if assets were held in a NRB discretionary Will trust rather than passed as an outright gift.