Nil rate band discretionary trusts: don’t ignore them
We often receive instructions from clients whose deceased partner’s Will includes a nil rate band discretionary trust (nrbt) which was not set up or terminated following their spouse’s death. We set out the problem and explain why nrbts must not be ignored.
Pre-2007 popularity of nrbts
Nrbts were frequently included in Wills made before 2007 in order to use the inheritance tax nil rate band of each of a married couple and thereby significantly reduce the couple’s combined inheritance tax bill. After 2007 the use of nrbts declined significantly following the introduction of the transferable nil rate band for spouses and civil partner. This meant that (in most cases) using the nil rate band on the first death no longer achieved an inheritance tax saving.
Why do some Wills still include nrbts?
In some cases a couple may not have reviewed their Will since it was made pre-2007. In other cases a review may have been carried out, but if no other changes were required, a couple would usually be advised that there was no need to make a new Will to remove a nrbt. This is because, as it is a discretionary trust the nrbt is very flexible, which enables a decision to be made at the time of the first death.
Decision on the first death
This decision can take into account all the circumstances then in force. The trustees can decide if the trust should be retained or if it should be terminated in favour of the surviving spouse or another beneficiary. If the trust is terminated in favour of the surviving spouse within two years of the first death then spouse exemption is available on the first death and a full transferable nil rate band is available.
Why retain a nrbdt after review on the first death?
In some circumstances it is advantageous to retain the trust. Perhaps, for example, at the time of the first death the surviving spouse has become frail and anticipates that they might require residential care. If the trust is retained the assets in it will be disregarded in assessing the amount of the financial help that the surviving spouse might require from the local authority towards payment of their care fees. Similarly, the estate might include an asset at the time of the first death that is likely to increase significantly in value in the coming years (a plot of land where planning permission for development is expected to be granted, for example). In that circumstance it may be advisable to appropriate the asset to the nrbt in order that the expected increase in value can take place outside of the surviving spouse’s estate.
If the trust is to continue then it is necessary to transfer the trust assets into the names of the nrbt trustees. This may require legal documentation, such as an assent or transfer (in the case of land). The trust may be set up by loaning the assets that would otherwise comprise the trust funds to the surviving spouse, either by an unsecured loan or by a loan secured over the first spouse’s property. If this option is chosen a trustees’ resolution recording the agreement to proceed in this way will be necessary (at the very least) and loan documentation should be drawn up, possibly including an equitable charge over the deceased’s property interest.
When would you bring the nrbt to an end on the first death?
If there are no special circumstances similar to those outlined above, then the best course of action might be for the assets in the nrbt to pass to the surviving spouse as they can then use the transferable nil rate band on the second death when it may have increased. The surviving spouse would also not need to worry about an ongoing trust. If the trust is to be terminated in the surviving spouse’s favour then it is essential that this is done within two years of the first death so that the transferable nil rate band is available. A formal deed of appointment will need to be drawn up to implement this.
What if nothing at all is done on the first death?
If more than two years have passed since the first death it will not be possible for the deceased spouse’s nil rate band to be claimed by the surviving spouse. Although it is possible for the nrbt to be constituted retrospectively, it is easier, less time consuming, cheaper and generally preferable to take action immediately after the first spouse dies when all options are still open.
If your client’s deceased spouse had a nrbt in their Will, the client should be advised to take action as soon as possible as ignoring the nrbt will store up problems for the future.