Are nil rate band discretionary trusts redundant?

The law relating to inheritance tax and nil rate bands for spouses (including civil partners) has changed.

What is the nil rate band?

This is the amount of a person’s estate (currently the first £312,000) which is charged at 0% inheritance tax.  Inheritance tax is charged at 40% on the value of the estate exceeding the nil rate band.

What was the problem?

If you leave everything to your spouse it is exempt from inheritance tax.  Before 9 October 2007 this meant that your nil rate band was not used.  When the surviving spouse died they could only use their own nil rate band against both their own assets and the assets they inherited from their spouse, for example:

Each spouse has £300,000 worth of assets.  First spouse dies in June 2006 when the nil rate band is £285,000 leaving everything to surviving spouse.  Spouse exemption means none of the nil rate band is used.  If the surviving spouse died in July 2007 they had a nil rate band of £300,000 but £600,000 worth of assets.  Inheritance tax at 40% would be payable on the remaining £300,000.  

What used to happen:

In order to use the first to die’s nil rate band a ‘nil rate band discretionary trust’ (NRBDT) was often included in a Will.  This provided for assets up to the value of the nil rate band to be put into a trust which could benefit the surviving spouse and others without adding to the surviving spouse’s estate.

What does the new law say?

When a surviving spouse dies after 9 October 2007, the nil rate band available at their death can be increased by the percentage of the nil rate band that was not used on the death of their spouse.  The percentage is applied to the level of the nil rate band when the survivor dies.

In the above example, if the surviving spouse died in November 2007 their executors could make a claim to transfer the nil rate band of the first to die.  As none of the nil rate band was used on the death of the first spouse, 100% is available for transfer.  Applying this to the nil rate band when the surviving spouse died, there would be £600,000 available as a nil rate band and no inheritance tax would be payable.

Should NRBDTs now be removed from Wills?

Some arguments for removing these trusts are:

• Removing them from your Will would simplify the administration of the estate.
• If they are not removed there may be set-up and administration expenses.
• The nil rate band in force at the date of the survivor’s death may have increased by more than the value of the assets in the trust.
• The surviving spouse’s interests are at the mercy of the trustees (although if there are clear letters of wishes and trustees are carefully chosen this should not be a problem).

However:

There are also a number of reasons why a NRBDT may still be useful:

• It will protect assets from business creditors or divorce settlements.
• Assets in the trust will not be taken into account for means testing if your spouse needs to go into a nursing home.
• The assets may increase in value faster than the nil rate band (which could by future legislation even be frozen or reduced).
• It will protect the intended ultimate beneficiaries, for example if the surviving spouse remarries without making a new Will.

What should I do?

Don’t panic.  There are means by which your executors can, within two years of your death, either effectively add a NRBDT to your Will, or bring a NRBDT to an end which will have the same consequences for Inheritance Tax as if the Will had been rewritten.

Whether a trust is the right thing for your Will will depend on your personal circumstances.  If you wish to discuss this further please contact a member of our wills, probate and trusts group and we will be happy to help you.