The nil-rate band (NRB) can be a valuable tool in estate planning for both lifetime gifts and tax-efficient distribution of assets on death. The NRB is the inheritance tax-free threshold. It applies both in lifetime and on death. Inheritance tax (IHT) is only charged on the portion of assets or transfers that exceed the available NRB. These are taxed at 40 per cent.
As shown in Table 1, the NRB used to see yearly increases. However, it has been frozen since April 2009 and is currently not scheduled to increase until April 2018.
Transferable nil-rate band
The introduction of the transferable nil-rate band (TNRB) in 2007 allows the estate of an individual who has been widowed to benefit from the unused portion of the deceased spouse’s NRB.
The bulk of the estate is often tied up in the family home. By transferring all assets to the surviving spouse, there is no IHT liability on first death and up to two NRBs can then be used on second death.
The TNRB applies to death transfers only. The available TNRB is established by first calculating the percentage of NRB unused on first death. This percentage is then carried forward and applied to the standard NRB at the surviving spouse’s death. An example is outlined in Box 1.
It is the percentage of unused NRB that is transferable, regardless of the actual value of the deceased spouse’s estate.
In order to claim the TNRB the personal representatives of the second to die will have to provide evidence to HMRC to show that the NRB was not fully used on first death.
The continuing case for discretionary will trusts
The introduction of the TNRB in 2007 reduced the need for discretionary will trusts to utilise the NRB on first death. However, discretionary will trusts provide a degree of certainty and so are still commonly used for asset protection purposes.
Individuals may wish to leave assets outside of their spouse’s estate, for example, for long-term care benefits, or to prevent the assets leaving the family through a claim by a third party, such as the survivor’s subsequent remarriage or bankruptcy. Interest in possession discretionary trusts can ensure future generations maintain their interest in the capital assets while allowing the surviving spouse a regular income in lifetime.
There remains an IHT reason for will trusts too: the NRB has been frozen at £325,000 until at least 2018 and it appears that any subsequent increases are also unlikely to be generous. Where joint assets are already close to £650,000, consideration should therefore be given to using the first NRB, for example by establishing discretionary trusts with the surviving spouse as a potential beneficiary. While this would use up more of the NRB on first death, any subsequent growth would be held outside of the survivor’s estate. An example of this is shown in Box 2.
The maximum TNRB available to any one person is 100%. Where a widowed individual marries for a second time and has transferable NRB from their first marriage, they should consider using this to ensure the excess is not wasted.
Both spouses need to consider their first death legacies to avoid the survivor having excess, unusable, nil-rate bands, as shown in Box 3.
Trusts under further fire?
Periodic and exit charges are currently under consultation and may make larger trusts less attractive from a tax point of view. Multiple trusts have been used to mitigate an IHT liability on 10-year anniversaries since the Rysaffe case in 2003 but it is likely that multiple trust planning for this purpose will become redundant in the near future. However, the peace of mind that will trusts can provide should not be overlooked.
Danny Cox is head of financial planning at Hargreaves Lansdown
