Teaching young lawyers old tax tricks
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John Bunker discusses using nil rate band discretionary trusts to assist with resident nil rate band planning
We have become so used to the transferable nil rate band (TNRB) for inheritance tax (IHT) in the last ten years, some younger UK practitioners will be unfamiliar with the nil rate band discretionary trust.
NRB D/Ts were one way, prior to October 2007, of getting ‘two bites of the cherry’, two IHT NRBs. While many have continued using NRB D/Ts as a valued planning tool, they could have a whole new lease of life following the introduction of the residence nil rate band (RNRB) for IHT. This opens a new chapter in IHT planning, major re-thinking of strategies required, so where do NRB D/Ts fit in?
RNRB is lost by taper when an estate is over £2m. For capital over £2m an effective marginal rate of IHT of 60 per cent, follows losing relief – £1 for every £2 over £2m – on top of the normal 40 per cent IHT. So a big issue for many spouses is how they avoid their combined estates on the second death going over the limit. Taking some capital out of the IHT picture on first death, by ‘using’ the NRB, reduces the second estate. NRB D/Ts do this while still giving the surviving spouse use of the capital if needed.
NRB D/Ts ‘use’ the NRB through the NRB’s value, currently £325K, being transferred to the trust, which remains as a discretionary trust for at least two years from the date of death. Thus it stays a relevant property trust taxable within the separate regime which runs parallel to those life interest trusts taxed on a life tenant’s death (which are aggregated with the free estate).
NRB D/Ts can help secure a third NRB in one of two situations, given the principle that you can only transfer one full NRB (however many times widowed):
If either spouse was widowed before, their late spouse’s NRB can be transferred to their estate, if they then have an NRB D/T to ‘use’ their own NRB if they die first, so that it is not transferred.
- If a surviving spouse should remarry, and their deceased spouse’s NRB has been ‘used’ with an NRB D/T, the NRB from their new marriage is available to be transferred to their spouse.Other planning benefits from using an NRB D/T include:
There are flexible options with NRB D/Ts in two years after the first spouse’s death, including a D/T in a will gives flexibility to use it, or adapt, with four options:
Investing currently £325K so that asset growth beats the ‘frozen’ NRB – not increasing until April 2021. Any growth in value of trust property over these four years would be a bonus.
Maximising the benefits of business and agricultural property relief (BPR/APR) by using an NRB D/T is great IHT planning. If there are assets qualifying for 100 per cent relief they can be put into the NRB D/T (provided the trust specifically includes these types of assets) in addition to other assets worth £325K. If BPR/APR is only at the 50 per cent rate then £650K of those assets can go into the trust. If the business/farm is then sold, or loses its relief during the surviving spouse’s lifetime, the relief is preserved rather than lost.
Keeping it as a discretionary trust – remaining within the RPT regime. Assuming there’s a property in joint names of A and B, the NRB could be satisfied by transferring all/part of the deceased A’s share to the trust or transferring the property to the survivor (B)’s sole name subject to a debt to the D/T. A half share worth less than £325K, means other assets (if any) can satisfy the legacy balance.
Keeping an RPT, but converting to a ‘life interest’ after the second anniversary of A’s death. The life interest, not being within two years, is not ‘read back’ into the will. Thus it still ‘uses’ A’s NRB. This helps practical administration and CGT-claiming PPR relief.
Converting to a life interest for the spouse within two years, securing the spouse exemption, as it is read back into the will, and does not use the NRB. Thus B will rely on the TNRB to set two NRBs against her/his estate. This option, as for the third option, can be used effectively for asset protection, including the option to advance capital to ‘top up’ care fees.
Winding the trust up within two years of death, distributing absolutely to the spouse or others. Anything going to B is in B’s estate which benefits from a TNRB on death as the NRB is not used. Attractive for saving costs and simplicity, careful advice is needed on the loss of the asset protection benefits that all three other options provide, and the IHT planning benefits in the first and second options.
John Bunker is head of private client knowledge management at Irwin Mitchell