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What to do with a Nil Rate Band Will Trust on Death of First Spouse

24th July, 2020

The Nil Rate Band (NRB) Will Trust is a familiar concept in Will drafting for married couples and civil partners.

It was established for Inheritance Tax (IHT) planning purposes but has a far wider application in practice. IHT is only payable on amounts over a set threshold. The current allowance, also known as the NRB, is £325,000. An individual’s available NRB can be affected by lifetime gifts.

The NRB Will Trust usually only applies on the first spouse’s death and provides for a legacy of assets amounting to the maximum sum the deceased can give under his Will without IHT being payable. These assets are transferred to a discretionary Trust under which the surviving spouse, children, and grandchildren are often the potential beneficiaries. Prior to 2007 if the first spouse left their whole estate to the surviving spouse this would pass free of IHT by way of the spousal exemption rules but the first spouse’s NRB allowance was unused and therefore lost. The use of the NRB Will Trust on the death of the first spouse utilized the NRB reducing the amount of assets within the second spouse’s death estate for IHT purposes.

In October 2007 the Chancellor announced a new regime allowing for the use of two NRBs without the need for any formal tax planning in the Wills. The ‘Transferable NRB’ is now a familiar concept. Contrary to popular belief the regime does not simply double the NRB. The change lies in the ability to transfer the unused NRB between spouses and this is in the form of a claim by the executors of the survivor’s estate for the percentage of the unused allowance (on the first death) to be brought forward and applied to the survivor’s estate.

Each individual now has an additional NRB of £175,000 that can only be used against the family home when it is left to direct descendants called the Residence Nil Rate Band (“RNRB”). However, the RNRB is tapered away if an estate is worth more than £2m. The RNRB cannot be claimed when the family home passes into a discretionary Will Trust (even if children and grandchildren are named as beneficiaries) as this is not classed as passing to direct descendants for the purposes of the legislation.  Any unused NRB can be transferred to the surviving spouse on the second death.

There are many NRB Will Trusts in existence and the question arises on the death of the first spouse ‘should we keep the NRB Will Trust in place or terminate the Trust by paying out the assets to the survivor?’

Despite the changes to the IHT regime there are a number of reasons to retain the Will Trust. The overriding advantage is that the funds within the Trust are protected. If the survivor were to require nursing care and their own resources were diminished by paying care costs, the assets held in the Trust would be excluded from any means tested assessment for calculating the right to Local Authority assistance. The same argument applies should the surviving spouse suffer financial difficulties, for example, if they became bankrupt. The creditors would not be able to seize any assets belonging to the Will Trust.

The protection of assets is particularly important with second marriages. The assets within the Trust are managed by the Trustees and the Trustees have the discretion as to which of the beneficiaries receive funds, in what amounts and when. The Trustees must act unanimously. The NRB Will Trust protects the assets from a second spouse/partner who may otherwise exhaust the funds or leave everything to someone else contrary to the first deceased’s wishes. With the NRB Will Trust, that part of the estate can be protected for any children or other chosen beneficiaries of the first spouse.

A further reason to retain the Will Trust is the stagnation of the IHT allowance. The NRB has been frozen at £325,000 until 2021 at the earliest. Despite concerns about the property market and low interest rates, assets in the estate are likely to appreciate faster than any future increase in the NRB. Trustees have the option of selecting those assets in the estate that are likely to appreciate faster, which if placed into Trust can still be made available for use by the surviving spouse (at the discretion of the trustees) but do not form part of the survivor’s estate. Any growth in the value of the assets remains in the Trust.

The downside of retaining the NRB Will Trust is twofold; the administrative requirements and taxation. The Will Trust should be registered with HM Revenue and Customs who will issue Trust Tax Returns to the Trustees. The Trustees should meet at least annually and the minutes of that meeting retained on file. Any important decisions should be recorded by way of resolution especially decisions to advance funds to a beneficiary.

When a discretionary Trust receives taxable income which is retained within the Trust, the income is subject to tax at 45% (38.1% for dividends) with the exception that the first £1,000 is taxed at the lower rate of 20% (7.5% for dividends). It is possible to reduce the income tax burden by either investing for capital growth only or in income tax free assets such as National Savings Certificates or a single payment Bond. In addition, where income is paid out to a basic rate tax paying beneficiary that beneficiary can reclaim the additional tax which the Trustees have suffered at the higher rate.

Under present legislation the Trustees of a discretionary Trust have a Capital Gains allowance of one half of that of a private individual. For the current tax year (2020/2021) this amounts to £6,150. This is not a great deal for Capital Gains and the Trustees must always bear this in mind when formulating any investment policy.

For IHT purposes, where the discretionary Will Trust has a capital value exceeding the NRB, IHT is levied at an effective rate of 6% of the excess every 10 years and when assets leave the Trust. The Will Trust is specifically drafted so that only assets up to the NRB pass into the Trust initially. The Trustees should keep an eye on the capital value particularly if assets appreciate quickly. It is possible to avoid an IHT charge on excess funds if assets leave the Trust before the first 10 year anniversary thus reducing the value below the NRB again. One of the benefits of leaving assets in the Will Trust is that they will not form part of the survivor’s estate. Even if there is a charge at 6% on the proportion of assets above the NRB this is a minimal tax charge compared to the standard 40% payable on an individual’s estate on death.

It is possible to unravel the NRB Will Trust provided action is taken before the second year anniversary of the first spouse’s death. A Deed of Appointment is executed by the Trustees paying out the funds to the surviving spouse. Under section 144 of the Inheritance Tax Act 1984, this has the effect of rewriting the Will as if the Trust did not exist. Consequently the now unused NRB can be transferred to the executors on the death of the second spouse under the post 2007regime.

Whilst terminating the NRB Will Trust after the death of the first spouse may be attractive from a simplicity point of view, clients must be advised on the various protections they will lose if assets are simply transferred to the survivor. Each family has its own particular dynamics and estate planning as always should be undertaken on a case by case basis

For further information please contact us here.

Clive Pointon – Chester Office

Partner & Head of Wills, Trusts & Tax
Email: [email protected]
Tel: 01244 405513

Lynda Richards – Shrewsbury Office

Wills, Trusts & Tax Partner
Email: [email protected]
Tel: 01743 294122

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