Nil Rate Band will trusts allowed a married couple to capture both nil rate band allowances.
Nil rate band discretionary will trusts were a popular tax planning tool for married couples pre-2007. Then (2007) a change in Inheritance Tax (IHT) laws rendered the main reason for using nil rate band discretionary will trusts largely redundant.
How did Nil Rate Band Discretionary Will Trusts work?
Under the pre-2007 IHT regime, a married couple that gifted everything to each other on first death would in effect ‘waste’ the nil rate band of the first to die (as the estate passing to the surviving spouse was free of IHT anyway due to the spouse exemption). On second death, there would be just one nil rate band available, the first having been ‘lost’.
Step forward the nil rate band discretionary will trust! How these work(ed) is/was by placing the nil rate band on sum on first death into a discretionary trust, the balance beyond that passing to the surviving spouse outright. There was still no tax payable on first death, and the estate of the surviving spouse was reduced by the nil rate band sum that was settled on the discretionary trust. In effect, it ‘rolled over’ the first nil rate band, to give a married couple a combined nil rate band on second death of x 2 (nil rate band).
The trusts would often receive a share of the matrimonial home as its main asset. And so, ensuring it was owned as tenants in common was imperative to avoid the house passing automatically by the right of survivorship, and therefore not being available to be utilised within the trust.
Many simplified things further by having all assets pass to the surviving spouse, who would then enter into a ‘loan’ back to the trust for the nil rate band sum. This debt could then be claimed as such on the death of the surviving spouse – again effectively creating x 2 nil rate bands at that point.
The Transferable Nil Rate Band (2007)
The introduction of the ‘transferable nil rate band’ in 2007 left the nil rate band discretionary trust wills almost redundant. This change now means that married couples (and civil partners) can simply ‘claw back’ the unused nil rate band from first death, and include it in the IHT calculations of the second to die. In effect, the law now does what nil rate band discretionary will trusts did before.
“ Example – married couple with 2 grown up children. Combined estate of say £1mil. Typically spouses will gift everything to each other, and then to children on second death. Lets use current nil rate band amounts for examples (as regards claw back) both pre and post 2007.
So pre 2007, no tax payable on first death due to the spouse exemption. Surviving spouse then has an estate of £1mil, and/but the nil rate band on first death was wasted as the estate was free of IHT anyway due to the spouse exemption. Surviving spouse dies, one nil rate band claimed (say £325k for this example) leaving taxable estate of £675k!
However, by gifting the nil rate band into a discretionary will trust (to which the surviving spouse had access, it utilised rather than wasting the other wise unused nil rate band amount from first to die. This meant that survivors estate was reduced to £675k. On their death, this was reduced by their own nil rate band (in this eg £325) so the taxable estate was down from £675k to just £350k.
Under the ‘new regime’, if everything passes to surviving spouse (which remains free of IHT because of the spouse exemption), the nil rate band can simply be transferred to the estate of the surviving spouse thereby giving 2 nil rate bands. So, on the example figures above, although the survivors estate would be back to £1mil, they nil rate bands available are £650k reducing the taxable estate to £350k – as would have been the case the with the nil rate band discretionary trust wills.
However – it gets better! In addition to the transferable nil rate band, married couples and civil partners can now also claim a ‘residence nil rate band’ against property passing to children of a further £125k for each estate, AND, that too can be transferred to the estate of the surviving spouse. In short therefore, the combined tax free threshold (nil rate band) for married couples and civil partners is now up to £1mil
To Transfer the Nil Rate Band it must be ‘unused’
To utilise the facility of claiming back the nil rate band from the death of the first spouse, that nil rate band must be ‘unused’. So, that means no chargeable beneficiaries benefited from the estate of the first to die. Put another way, an exempt beneficiary got everything – (in the example above) of being the surviving spouse.
One common option pre-2007 to mitigate IHT (rather than creating nil rate band discretionary trusts) was to gift on first death to children. The problem with this was of course that it might then compromise the financial security of the surviving spouse. If there were substantial cash assets, that risk was reduced or removed even.
Making similar provision on first death does not now carry the same benefits as it erodes the ‘unused’ element of the first nil rate band. An option for the survivor (where there is excess cash) is to consider lifetime gifting. That way, the transferrable nil rate band remains intact, and subject to the rules around potentially exempt transfers (PETs), the gift may become totally free of tax too (NB the 7-year rule and Taper Relief).
How do I Claim the Transferrable Nil Rate Band?
This is applied on second death. When claimed (dependent upon figures) it may take the estate of the second spouse into the ‘Excepted Estates’ regime making the probate application simpler. If a full IHT return is required, then the relief is ‘claimed’ in the return.
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