The nil rate band (NRB) is the threshold above which Inheritance Tax is payable. The current amount of nil rate band is £325,000 per individual. This means you can pass on assets up to this value without incurring an Inheritance Tax bill. The nil rate band will increase in line with inflation from April 2021.
Nil rate band trust
A nil rate band trust is a flexible trust contained within a Will that allows you to leave your available nil rate band onto trust under the terms of your Will. This type of trust was initially established for Inheritance Tax purposes but, as you will see below, continues to have wider uses.
Before the introduction of the Finance Act 2008, the inclusion of nil rate band trusts within the Wills of spouses and civil partners was good Inheritance Tax planning because it was not possible to transfer the nil-rate band allowance between spouses and civil partners on death. If a nil rate band trust was not included in the Will in this way, the nil rate band of the first to die would be lost.
Introduction of transferable nil rate bands
The Finance Act 2008 introduced the concept of the transferable nil rate band which allows the transfer of any unused portion of the deceased spouse’s nil rate band to the surviving spouse. Then when a surviving spouse or civil partner dies, the nil rate band in place at their death will be increased by the portion of the nil rate band that was not used on the earlier death of their spouse or partner. Since this became possible in 2008, it has led to a decrease in the use of nil rate band trusts in Wills for this purpose.
However, many Wills still contain nil rate band trusts. There are still many situations where they can perform a useful purpose as an effective estate planning tool, since the most significant advantage is that the assets within the trust are protected.
Later life care
Planning for later life care could be one such instance. For example, a husband dies and leaves his estate outright to his wife. In later life, when his wife gets older, she may need later life care. When this happens her estate – including everything she inherited from her husband – is included in her means test assessment which helps decide whether she pays for her care.
However, if the husband had put some of this amount into a nil rate band trust with his wife as beneficiary, the amount would exist outside the estate and would not be included in the amount on which the means test assessment was made. This would give the wife more choice in how she used that inherited amount, as it would not have to be directed towards her care fees.
Intergenerational wealth transfer
A nil rate band trust can be used in situations where someone would like to leave an Inheritance Tax-free amount to someone other than their spouse. They can stipulate that they would like to leave the funds in trust, for example, for their children or grandchildren or anyone else they would like to be a beneficiary of their estate.
This might occur in a second marriage where a spouse has children from a previous relationship who they want to be beneficiaries of the estate on their death, rather than leaving everything to their surviving (second) spouse.
Potential for more than two nil rate bands
In marriages where one of the spouses has been married before and widowed, there is the potential for more than two nil rate bands to be used. However, under current UK legislation, only one nil rate band can be transferred. Rather like the old way of estate planning prior to 2008, the use of nil rate band trusts can ensure that advantage is taken of potentially three nil rate bands.
For example, Mr and Mrs Smith are married. Mrs Smith was previously widowed so she can benefit from both her own nil rate band and that of her deceased husband. Mr Smith also has a nil rate band available to his own estate. If Mrs Smith dies first and leaves her estate outright to Mr Smith then on Mr Smith’s subsequent death, he can claim his own nil rate band and Mrs Smith’s nil rate band. In this case, the nil rate band of Mrs Smith’s late husband will be lost.
If, however, Mrs Smith leaves her estate onto a nil rate band trust, then the maximum amount that she can leave onto that trust will be her available nil rate band and that of her late husband. The nil rate band trust captures both. On Mr Smith’s subsequent death, he will also be able to claim his own nil rate band. In this case their joint estates have benefited from all three nil rate band allowances rather than two.
What are the downsides?
The downsides of nil rate band trusts can include the administrative inconvenience, the costs of preparing annual accounts and tax returns and potentially dealing with the investment and management of the trust assets. However, for many people, the advantages of protection and flexibility offered by the trust structure outweigh the disadvantages.
Whether you are deciding to include or remove a nil rate band trust within your own Will or whether you are considering terminating a trust following the death of a first spouse, it is important to take professional advice. Every family has its own individual dynamic and these trusts can continue to serve a very useful purpose in the right circumstances.
If you would like some advice on this topic, please get in touch.