2007 and 2017
Two Key Milestones for Inheritance Tax Planning – Are You Up To Date?
The Nil Rate Band, currently set at £325,000, is the chargeable value of your estate which attracts a 0% inheritance tax rate.
Prior to 9 October 2007, when you died, your Nil Rate Band would die with you if you had not utilised it, which was a trap that caught many married couples and civil partners. Due to the 100% inheritance tax exemption for any assets passing between married couples or civil partners, it often meant that a further tax-free allowance in the form of the Nil Rate Band was not required.
If the first spouse or civil partner were to die, leaving all of their assets to their surviving spouse or civil partner, this meant that their Nil Rate Band was being wasted because the estate was already covered by the 100% exemption. It subsequently meant that when the surviving spouse or civil partner died, they effectively had combined assets from their predeceased spouse or civil partner, and thus had increased the value of their own estate, but only had their own Nil Rate Band to apply.
Any assets over and above their own Nil Rate Band could then have been subject to a 40% inheritance tax liability.
To avoid wasting the first Nil Rate Band, many couples incorporated Nil Rate Band Discretionary Trusts, or Nil Rate Band Trusts, within their Wills.
This means that when the first of the couple dies, any assets up to the value of the Nil Rate Band would be directed into a discretionary trust, rather than outright to their surviving partner. Trustees would be appointed within their Will to hold the funds on trust for a class of beneficiaries, which usually includes the surviving partner and any children or grandchildren. During the period of the trust, the Trustees would have discretion to release any income produced, or capital, from the trust for the benefit of any one of the beneficiaries.
By utilising such a trust, it means that when the surviving partner dies, their estate does not include these initial assets up to the value of their partner’s Nil Rate Band amount, and thus reduces the chargeable size of their own estate.
With regard to assets in their own estate, the second partner would then still have their own Nil Rate Band to apply before calculating whether any inheritance tax would be payable.
By using such trusts, it ensured that the maximum benefit was being gained from the tax planning opportunities available and to ensure that as much capital as possible passed on to future beneficiaries.
Post October 2007
Since 9 October 2007, the law regarding inheritance tax for married couples and civil partners has changed rather dramatically.
When the first spouse or civil partner dies, all assets can still pass to the survivor free of inheritance tax, thanks to the 100% exemption, but now the first partner’s Nil Rate Band is transferable to the second partner.
This means that when the second partner dies, they will now be able to claim not only their own Nil Rate Band amount, but also that of their late partner. To put this into context, using today’s Nil Rate Band allowance, when the second partner dies, their Executors would effectively be able to claim £650,000 as a Nil Rate Band allowance, which would attract an inheritance tax charge of 0%.
Theoretically this meant that the need for Nil Rate Band Discretionary Trusts was no longer required for the purposes of effective inheritance tax planning.
However, if you die leaving a Will which still contains a Nil Rate Band Discretionary Trust, this arrangement will still take effect on your death. Whilst many Wills can be varied after the date of death, with the agreement of all beneficiaries, this is often not an option available to Wills containing such trusts, due to the nature of the possible beneficiaries of the trust.
Utilising such trusts in practice can incur ongoing running costs, both legal and financial, which is something that many couples simply do not wish to have to endure.
Where does that leave Nil Rate Band Discretionary Trusts?
Despite not having quite the same appeal for inheritance tax purposes, these trusts can still have their uses to address other concerns, such as protecting assets from second marriages.
However, if the reason for including such trusts in your Wills was primarily for the purpose of inheritance tax planning, we would highly recommend that you review your Wills.
Many Wills which include these types of trusts can be replaced with relatively straight forward Wills, as there is now the legal framework in place for effective inheritance tax planning to be achieved.
Post April 2017 – Additional Residence Nil Rate Band & Discretionary Nil Rate Band Trusts
As of 6 April 2017, there will be an additional Residence Nil Rate Band available to those wishing to leave their property to their lineal descendants. Initially this Residence Nil Rate Band will be £100,000 but will gradually increase to £175,000 by 2020/21 and thereafter be adjusted in line with the consumer prices index.
If your Will includes a Nil Rate Band Discretionary Trust, which usually would comprise of your interest in a property and other liquid assets, your estate will not be able to claim this additional Residence Nil Rate Band. Even if the class of beneficiaries in the trust include your children, the gift will not qualify to benefit from this additional inheritance tax planning opportunity.
It could be said that these types of trust have now come full circle, having been introduced as a way of mitigating inheritance tax but yet come April 2017, could actually be the cause of an increased charge to inheritance tax.
If you are unsure whether these changes will affect you, or whether you need to review your current Wills, please contact us so that we can discuss your individual circumstances with you further.
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