NRBTrustsWillsDo Nil Rate Band Discretionary Trusts still have a use?

Nil Rate Band (NRB) Discretionary Trusts were once very common planning and it would have been likely that any will for a married couple with a potential inheritance tax liability would include one. Since the introduction of the transferable NRB on 9 October 2008 however their use has declined.

Whilst their most common use no longer applies, NRB Discretionary Trusts still have a number of potential uses for certain clients.

What is a Nil Rate Band Discretionary Trust?

A NRB Discretionary Trust is simply a discretionary trust that takes assets up to the value of the NRB. Discretionary Trusts are relevant property trusts and therefore their own legal entity for IHT purposes. The assets held in the trust are seen as owned by the trust and not by the trust’s beneficiaries, and therefore are not part of the beneficiaries’ taxable estates.

Previous Uses of a Nil Rate Band Discretionary Trust

Before the introduction of the transferable NRB, if spouses gave all their assets to each other outright, this would be inheritance tax free due to the spousal exemption, but this would inflate the survivor’s estate without the benefit of an additional NRB.

Spouses would have included a NRB Discretionary Trust in their will and pass assets to that on first death. The surviving spouse and others (usually children and remoter issue) would be the potential beneficiaries. The trustees would allow the spouse benefit, usually be way of a loan repayable on the survivor’s death but the trust capital would be outside of the survivor’s estate for IHT purposes and therefore avoid inflating the survivor’s estate.

This method ensured that both NRBs could be properly used and avoid the first to die’s being wasted.

This benefit no longer applies due to the transferable NRB, but there are other cases where a NRB Discretionary Trust could still be considered.

Unmarried Couples and Nil Rate Band Discretionary Trusts

Unmarried couples do not benefit from either the spousal exemption, the Transferable NRB or transferable Residential Nil Rate Band (RNRB).

Where married couples gift their estates to each other (or on life interests for each other), the estate would be considered for IHT on first death and IHT may be payable. The survivor’s estate would also be inflated by this inheritance. On second death, the estate will be considered for IHT again without the benefit of two NRBs and two RNRBs.

NRB Discretionary Trusts may therefore have benefits for unmarried couples. Assets passing to the trust would be outside of the partner’s estate for IHT purposes and avoid inflating it and causing additional IHT liability.

This could be shown by the example below:

John and Jane are a married couple. They have no joint children, but John has children from a previous relationship. They have £300,000 each in assets.

John dies first, leaving his estate to her outright. On his death no IHT is due thanks to the spousal exemption and his unused NRB (and RNRB) are available to transfer to Jane.

Jane dies a couple of months later. Her estate, now valued at £600,000, passes to John’s children. Her estate will benefit from her own NRB and John’s unused transferable NRB. RNRB is not needed but would have applied as her stepchildren are treated as her descendants for RNRB purposes.

Imagine this same scenario, but John and Jane were not married. On John’s death, his estate would not be taxable as it is below the NRB. On Jane’s death, her estate (now valued at £600,000) will only benefit from her own NRB. No RNRB would be available as her late partner’s children would not be treated as her descendants for RNRB purposes. This would mean that £275,000 out of her £600,000 estate would be taxable at 40%.

If John and Jane had used NRB Discretionary Trusts, on John’s death no IHT would be payable as his estate is below the NRB. All his assets would pass to the trust. On Jane’s death, she will only own £300,000 worth of assets. As this is below the NRB, it will pass IHT free to John’s children.

Remarried Widows and Nil Rate Band Discretionary Trusts

Remarried widows can get additional inheritance tax benefits from using a NRB Discretionary Trust. S8A Inheritance Tax Act 1984 provides that a person may only benefit from a single additional NRB. If a remarried widow has an available NRB from their first spouse, if they leave their estate to their new spouse, or alternatively their new spouse passes and leaves the estate to them, only one additional NRB could be claimed on second death. The possible third would be wasted.

The solution would be for both to leave assets equal to one NRB into a Discretionary Trust. This means that should the widow die first, one of their NRBs can be used towards the assets passing to the NRB Discretionary Trust, with the other available to transferred. Should the new spouse die first their NRB can be used towards the assets passing into the trust, allowing the widow to use their own NRB plus the transferable NRB from their first spouse.

Reducing Anniversary and Exit Charges

If a married couple intend to place the estate into a discretionary trust on second death and have assets over the value of the NRB, they could also consider placing assets into a NRBDT on first death.

If their combined estates are over the value of one NRB, if the whole combined estates were placed into one discretionary trust on second death, this would mean that anniversary and exit charges would apply to the discretionary trust.

By placing assets into a NRBDT on second death, this ensures there will be two trusts in existence at second death. They would each have their own NRB and this could have the effect of reducing or completely eliminating the potential anniversary of exit charges of the trusts.

RNRB – Taper Threshold

For a married couple who individually have assets below the RNRB taper threshold (currently £2 million) but combined have assets above the taper threshold, there may be a benefit to using a NRBDT on first death.

In these circumstances if the spouses benefit each other outright with the whole estate this would place the surviving spouse’s taxable estate over the taper threshold and the RNRB available on second death would be reduced.

Anything that passes into the NRBDT would be outside of the surviving spouse’s taxable estate. Having the value of the NRB pass outside of the surviving spouse’s estate could keep them below the taper threshold, or not as far into the taper threshold.

 

 

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