Before October 2007 married couples were regularly advised that having a nil rate band Discretionary Trust in their Wills would help to reduce their Inheritance Tax liability. For a couple with the joint estate of £650,000 the saving would have been as much as £130,000! The relatively modest additional cost of having a Will that was more complex than usual appeared to be a bargain. Then the Government changed the rules. Married couples were allowed to transfer any part of the nil rate band that had not been used on the first death so that it could be used on the death of the survivor. When reviewing their Wills couples who have a provision for a nil rate band Discretionary Trust will want to consider whether they should continue with it.
What is a nil rate band Discretionary Trust?
At present the amount that anyone can leave without having to pay Inheritance Tax is £325,000. This is called the nil rate band, because technically it is not an amount that can be left free of Inheritance Tax, but one upon which the tax is charged at nil percent. A nil rate band Discretionary Trust is an arrangement in which this amount is given to Trustees who are then given a discretion as to who is to ultimately benefit. The discretion is usually limited so that only particular classes of individuals may benefit. These will usually be the surviving spouse, children and grandchildren, although the discretion can be wider in appropriate circumstances. In most of the Wills that were drawn up prior to October 2007 the Trustees were given a power to lend all or part of the Trust fund to a surviving spouse. In this way the survivor could have the use of the assets, without actually owning them.
How did a nil rate band Discretionary Trust save Inheritance Tax?
Under Inheritance Tax rules any money or assets that are left to a spouse are free of tax. However when the spouse dies Inheritance Tax is payable on the whole of the property owned at the date of death, including anything inherited from a late husband or wife. If therefore one takes the example of a married couple with total assets of £650,000 and assumes that they each own one half of those assets then, when the first of the couple dies, if the whole of the deceased’s assets are passed to the spouse no tax will be payable. However, when the survivor dies he or she will have an estate of £650,000. Under the old rules tax on the first £325,000 will be payable at nil percent, but on the second £325,000 tax will be charged at 40%, giving a tax Bill of £130,000. However, if the estate of the first to die is left to Trustees in a Discretionary Trust, tax on that £325,000 remains chargeable at nil percent. The surviving spouse can be loaned the Trust fund so that they can have use of the money, or other assets. When the survivor dies any loan received from the Trust is repayable and the survivor’s own estate is also £325,000 so that no tax is payable then either.
How is this affected by the change in rules?
If one uses the above example where the first to die leaves all of his or her assets to the spouse none of the nil rate band is used. This transfers to the survivor who then has 2 nil rate bands that they are able to use. Accordingly the survivor can leave up to £650,000 with tax charged at nil percent. In this example, even where the couple leave all of their estate to their spouse no tax would be payable. The nil rate band Discretionary Trust does not therefore achieve any tax saving.
Are there any other benefits of nil rate band Discretionary Trusts?
The saving of Inheritance Tax was only one reason for using nil rate band Discretionary Trusts in individuals Wills. For example, in the case of a second marriage, a spouses may want to make sure that the survivor of them is able to enjoy the whole of their joint estate, but on the death of the survivor may also want to make sure that children by a first marriage receive the full share of their late parent.
Similarly individuals might want to endeavour to protect part of their estate from being swallowed up in Social Care Costs if the survivor needs to go into a Rest or Nursing Home. Because the survivor does not own the Trust Fund it is not an asset that must be used for the payment of necessary fees.
These are only two examples of how Discretionary Trust can be used for non-Inheritance Tax purposes. As the circumstances of each couple are different there can be many other reasons why the use of such a Trust is advisable.
Are there disadvantages of nil rate band Discretionary Trusts?
The biggest disadvantage of such a Trust is that the surviving spouse does not own the trust fund. While the fund may be lent to the survivor the Trustees will continue to own the money or assets that comprise the fund and have an interest in how they are being used. If the assets include a share in property the Trustees will own that share and will need to be involved in any property transaction. Many people find such circumstances to be an intrusion into their privacy. Of course, if the survivor and the Trustees do not get on there is scope for some real difficulty, particularly given the discretionary nature of the Trust.
There may also be adverse tax implications and additional costs in some circumstances.
Is there anything that can be done if the person making the Will has already died?
It should be possible for the trust property tobe appointed to the surviving spouse without any adverse tax implications, provided that this is done between 2 months and 2 years from the date of death.
What should we do if we have a nil rate band Discretionary Trust Will?
You will want to give some serious thought as to whether such an arrangement is still appropriate to your particular circumstances, bearing in mind that it is unlikely that it will have any tax benefit now. Of course, the best course of action is to take expert, professional advice.