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The Nil Rate Band (NRB) and Inheritance Tax (IHT)

The Nil Rate Band (NRB) Will trust on the death of the first spouse- to keep or not to keep

When advising clients and drafting wills solicitors often make use of The Nil Rate Band (NRB) in a Will Trust for married couples and civil partners.

The NRB is the rate under which 0% of Inheritance Tax (IHT) applies on death. IHT is only payable on amounts over a set amount which can vary but in recent years has been fixed and is expected to be fixed for some years yet. The current allowance is £325,000. An individual’s available NRB on death can be affected by lifetime gifts made by them.

A NRB Will Trust usually only applies on the first spouse’s death and often provides for a legacy of assets equal to the maximum sum the deceased can give under his Will without IHT being due. The assets placed in to the NRB Will trust are taken from the deceased’s estate and transferred into a discretionary Trust under which typically (others can be named) the surviving spouse, children and grandchildren as the potential beneficiaries.

Before 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- meaning a typically higher IHT liability when the 2nd spouse dies. The use of the NRB Will Trust on the death of the first spouse used the NRB for the 1st spouse to pass thus reducing the amount of assets within the second spouse’s death estate for IHT purposes and therein the size of the tax bill for the family as a whole.

In October 2007 the government in place created what we now know as the ‘Transferable NRB’ which permitted the transfer of the 1st spouses NRB to the estate of the 2nd spouse on their death. This means that there is now established in law a facility 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 carried over to the survivor’s estate.

Another type of NRB came in to law in April 2017- this is known as the Nil Rate Residence Band (NRRB) and allows people to pass their main home to their children and/or grandchildren on top of the NRB which can be applied against assets such as savings, shares or bank accounts and is not limited to but can be applied against property as well. The NRRB is currently set at £175,000.00 and is due to rise with inflation but is limited for estates valued in excess of 2 million. 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.

Many people made wills and created NRB Will trusts before the law changed in October 2007 and the question now 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 helpful changes to the IHT rules in October 2007 and April 2017 there are a number of reasons to retain the Will Trust. The main advantage is that the funds within the Trust are protected. If the survivor were to need nursing care and their own resources were diminished by paying care costs, the assets 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 assets belonging to the Trust.

A will trust can be particularly helpful where there is the possibility of a second marriage for the surviving spouse. The assets within the Trust are managed by the Trustees and they 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- such as outside of the family which may be against the wishes of the first spouse to pass away. With the NRB Will Trust, the assets within the trust can be protected for any children or other chosen beneficiaries of the first spouse.

Another consideration in deciding whether to keep the Will Trust is the current IHT allowance. The NRB has been frozen at £325,000 until 2026 at the earliest. Despite concerns about the property market and low interest rates, assets in the estate are likely to increase in value 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.

There are a couple of downsides to retaining the will trust;
1. The administrative requirements.
2. 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 once per annum 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. Solicitors are typically employed to draw up documents to record agreements or resolutions or appointment of assets to one or other of the beneficiaries.
Income that arises on assets with a discretionary trust such as interest earned on savings or investments is 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.
Trustees and beneficiaries also have to consider Capital Gains Tax which may be due if they sell or transfer assets on behalf of the beneficiary. For the current tax year (2021/2022) this amounts to £6150.00. This is not a great deal for Capital Gains and the Trustees must always bear this in mind when formulating any investment policy. Specialist advice should be taken from a financial adviser/accountant as to the most tax efficient way to manage the trust.

Trustees may also have an IHT liability to deal with in the management of the trust.

The main situations when Inheritance Tax is due are:

• when assets are transferred into a trust.
• When the trust reaches a 10 year anniversary from when it was set up (there are 10-yearly Inheritance Tax charges)
• when assets are transferred out of the trust (known as ‘exit charges’) or the trust ends
• when someone dies and a trust is involved when sorting out their estate.

It is possible to cancel the NRB Will Trust if it is thought to be overly complicating matters or not needed 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 2007 rules. It is also possible to execute a Deed of Variation to vary the will in some other way but careful planning should occur to ensure that the most appropriate steps are taken.

Adcock’s Private Client team will be happy to provide further detailed advise on the matters detailed above should you require it. Call today 01543 442100.

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