Client Guide: Married couples and civil partners and Inheritance Tax

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The nil rate band discretionary trust

Married couples and civil partners often make Wills which provide that when the first of them dies, his or her estate passes in total to the surviving spouse or civil partner, and on the death of the survivor the combined estate passes to their children or other beneficiaries.  This ensures that the survivor is adequately provided for according to the assets available.

There is no Inheritance Tax (IHT) on the first death as property that passes between spouses and civil partners is free from tax. However, prior to 9 October 2007 when the survivor died tax was payable at 40% on the amount by which the estate exceeded the ‘nil rate band’, at present £325,000 (for the tax year 2014/2015).

In order to maximise the IHT relief available, married couples or those in a civil partnership were strongly encouraged to make Wills incorporating nil rate discretionary trusts to ensure that both individual inheritance tax allowances were fully utilised.

The transferable nil rate band

The current law is that for deaths after 9 October 2007, spouses and civil partners are able to transfer the unused allowance from the first death so that any part of the nil rate band that was unused when the first person passed away can be carried forward to be used on the second death.

It does not matter how long ago the first person died as long as it was after 12 November 1974.  If the first death was before this date, then the full nil rate band may not be available to transfer.

For example, if a husband died in 2005 and left everything to his wife and the wife died in July 2013, on her death her executors can claim not only her own tax allowance, but her husband's also.  If the full nil rate band was unused on the husband's death, then on the wife's death the amount free of tax is doubled to £650,000. 

The unused allowance to be carried forward is calculated as a percentage to be set against the nil rate band on the second death.  If a wife died in August 2007 and left £75,000 to her children and the remainder to her husband, then because the tax allowance available in August 2007 was £300,000 she has used one quarter of her available nil rate band.  If her husband died in July 2013, then his executors could apply for a transferable nil rate band of £325,000 plus an uplift of three quarters of this (£325,000 x ¾  is £243,750), making a total tax free allowance of £568,750.

What if your Wills contain nil rate band discretionary trusts?

You may wish to keep your Wills as they are because, although the nil rate band discretionary trusts in your Wills no longer have an inheritance tax advantage, a discretionary trust is a flexible way of providing for a group of beneficiaries, which would usually include the surviving spouse and the children and grandchildren.  A discretionary trust differs from an ordinary trust in that the beneficiaries are not entitled as of right to the trust property.  The trustees choose which of the beneficiaries should benefit from the trust and in what manner.

If after the first death, the surviving spouse or civil partner is in need of money, part or even all of the trust fund can be made available to him or her.  This needs to be done within two years of the date of the first death for IHT purposes.  On the survivor's death, his or her executors would then be entitled to apply for the part of the nil rate band left unused on the first death. 

Alternatively, if the surviving spouse does not require the money being held in the discretionary trust, the trustees may decide to keep the discretionary trust in place.  If the value of the discretionary trust is the full value of the nil rate band available on the first death, then there will be no transferable nil rate band on the survivor's death.

If you would like to review your Wills in light of the change in the law, you can contact us at Blake Morgan to discuss the options.

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