Leaving assets to charity
Gifts to charity will be exempt from Inheritance Tax (IHT). If at least 10% of an individual’s net estate is left to charity, any IHT due on the remainder of the estate will be paid at a reduced rate of 36% instead of 40%.
To avoid the need continually to revise the amount of charitable donations written in a Will, a clause with an appropriately worded formula can be included in a Will to ensure that it will always meet the 10% test.
Nil Rate Band Discretionary Trust (NRBDT) Wills
Prior to 9 October 2007 (the date the transferable nil rate band was implemented), IHT planning for married couples was straightforward. If spouses left everything to each other then, on the death of the first spouse, there would be no IHT payable due to the spouse exemption, but IHT could arise in the estate of the surviving spouse because assets above the nil rate band would be subject to IHT. As such, the nil rate band was wasted because an IHT exempt amount was being left to an IHT exempt beneficiary (the surviving spouse).
In order to avoid the nil rate band being wasted, the first spouse to die could leave assets to the value of the nil rate band to taxable (that is, non-exempt) beneficiaries, such as their children. Then, on the death of the surviving spouse, the value of their estate would be lower, and if it were within the nil rate band it would be free of IHT. Whilst making use of the first spouse’s nil rate band in this way resulted in an IHT saving, it could also result in the surviving spouse’s financial needs not being met. The way to make use of the nil rate band on the death of the first spouse whilst still allowing the surviving spouse access to the assets in the estate was a nil rate band discretionary trust Will (NRBDT Will).
With an NRBDT Will, assets to the value of the nil rate band would be left to the trustees to administer for a widely defined group of beneficiaries which would typically include any surviving spouse, children and grandchildren. A discretionary trust is one where no beneficiary has a right to income or capital from the trust fund. Instead, as the name suggests, the trustees have the discretion to decide how much income or capital (if any) to pay to each of the beneficiaries but without the value of the trust fund forming part of their estate for IHT purposes. Whilst it is possible to guide the trustees on how to exercise their discretion by preparing a Letter of Wishes, the ultimate decision on how (or even whether or not) to exercise their discretion rests with the trustees. Trustees must act unanimously, and so just one trustee may have the ability to prevent payments from the trust fund even if all the other trustees agree. Choice of trustees is therefore crucial.
Since 9 October 2007 (the date the transferable nil rate band was implemented), IHT planning for married couples has become less straightforward. Now, a surviving spouse can “inherit” the unused percentage of their deceased spouse’s nil rate band, potentially doubling the surviving spouse’s nil rate band. When the first spouse dies (whether before or after 9 October 2007), any unused percentage of their nil rate band is claimed by the personal representatives in the estate of the surviving spouse. The unused percentage of the first spouse’s nil rate band is applied to the nil rate band amount in force as at the date of the surviving spouse’s death.
The transferable nil rate band means that NRBDT Wills may not be required. However, there are disadvantages with Wills which simply leave everything to the surviving spouse:
Administrative reasons
The personal representatives in the estate of the surviving spouse make a transfer claim to the tax office which involves ascertaining the unused nil rate band of the first spouse to die. Suitable records may not exist, to include details of joint assets at the time of the first death, and details of lifetime gifts which may reduce the nil rate band available at the time of the first death. There is then a risk of being unable to make, or correctly state, the transfer claim to the tax office.
Political reasons
The nil rate band could be frozen, reduced or scrapped. The transferable nil rate band could be withdrawn.
Having a NRBDT Will is therefore still of benefit, and in particular in the following situations:
Highly appreciating assets
If the value of assets in the estate of the first spouse to die were to grow at more than the rate of increase in the nil rate band then IHT may be payable on the death of the surviving spouse. A NRBDT can take any growth in the value of the assets outside of the estate of the surviving spouse.
Care fees planning
If the surviving spouse receives long term care, a NRBDT protects assets from care home fees given that the trust assets cannot be taken into account in a financial assessment.
Those who have been married more than once or if the surviving spouse remarries
The surviving spouse is free to change their Will so as to leave their estate to beneficiaries who the first spouse to die may not have wanted to benefit, for example to children from a previous marriage. Similarly, if the surviving spouse were to remarry then any Will is automatically cancelled. A NRBDT provides some measure of protection for the beneficiaries chosen by the first spouse to die because the trust assets cannot be transferred away from those beneficiaries.
If beneficiaries are bankrupt or divorce or receive means-tested benefits
The surviving spouse, or the ultimate beneficiaries of the estate, may be bankrupt or divorce or receive means-tested benefits. A NRBDT can provide a measure of protection because the trust assets do not belong to the beneficiaries and so could not be taken into account in bankruptcy proceedings or any claim for means-tested benefits, and may similarly be disregarded in divorce proceedings.
Loss of mental capacity
If the surviving spouse were to lose the mental capacity to manage their financial affairs, a NRBDT provides a fund from which the trustees can meet their financial needs until the Deputyship application to the Court of Protection is concluded, or any Power of Attorney can be used.
Further IHT planning opportunities
A NRBDT can provide the opportunity to take further IHT planning measures, following the death of the first spouse, for those couples who have assets of more than twice the nil rate band. If, for example, the trustees were to lend the nil nilrate band amount to the surviving spouse who then gives that sum away, the gift will fall outside of their taxable estate if they live for seven years, yet the loan to the trustees remains outstanding and so is deducted from their taxable estate on death, so long as it is actually repaid.
Securing Business Property Relief (BPR) and / or Agricultural Property Relief (APR)
If the first spouse to die has assets which qualify for BPR or APR, the relief will be lost if those assets are left to the surviving spouse and subsequently sold, since the previously IHT-free assets will be taxable cash in the estate of the surviving spouse. Any assets which may qualify for BPR or APR should therefore be given to a separate discretionary trust in the Will (sometimes referred to as a “Business Trust Fund”) of which the surviving spouse is one of the potential beneficiaries. The trustees then have the following options:
- If the tax office determines that the assets qualify for BPR or APR, the trustees can choose to continue with the trust, whether the assets held in trust are retained or sold
- If the tax office determines that the assets qualify for BPR or APR, the trustees can sell those assets to the surviving spouse. If the surviving spouse then owns those assets for two years, BPR or APR will be available on the surviving spouse’s death. At the same time, the cash held within the trust would fall outside of the surviving spouse’s taxable estate. This is often known as “double dipping”
- If the tax office determines that the assets do not qualify for BPR or APR, the trustees can “appoint” (that is, transfer) those assets to the surviving spouse before the second anniversary of the deceased spouse’s death, and the “gift” will be read back into the deceased’s spouse’s Will and so the spouse exemption will apply to it
Wills: Options
A NRBDT provides the flexibility to decide what to do on the death of the first spouse. If there are already NRBDT Wills in place then there is no need to change these just because of the introduction of the transferable nil rate band. If there are not currently NRBDT Wills in place then these ought to be signed. When the first spouse dies there are two options:
- Bring the NRBDT to an end
If, on the death of the first spouse, it is decided that the NRBDT is not useful then the trustees can bring the trust to an end by distributing all of the trust assets within two years of the date of death. The Will of the first spouse to die is then construed as if the distributions from the NRBDT were in fact gifts contained in the Will. It is therefore possible to “opt in” to the transferable nil rate band regime.
- Continue with the NRBDT
For one or more of the reasons set out above.
Potential issues with NRBDT Wills
If a couple has assets worth more than double the nil rate band, each spouse should hold assets of at least the nil rate band. If a couple has assets worth less than double the nil rate band, neither spouse should hold assets of more than the nil rate band. A jointly owned property is generally held as Joint Tenants so that, on the death of the first spouse, the property passes automatically to the surviving spouse regardless of the content of any Will. The Joint Tenancy should therefore be split so that the property is owned as Tenants-in-Common in equal shares, and each spouse can then leave their share of the property to the NRBDT in the Will. Jointly held cash and investments should similarly be split.
The NRBDT is subject to the taxation rules applicable to trusts – including IHT anniversary and exit charges – which may be less advantageous than the rates for personal taxation.
The surviving spouse does not own the NRBDT assets outright. A discretionary trust is one where no beneficiary has a right to income or capital from the trust fund. Instead, the trustees have the discretion to decide how much income or capital (if any) to pay to each of the beneficiaries. Whilst it is possible to guide the trustees on how to exercise their discretion by preparing a Letter of Wishes, the ultimate decision on how (or even whether or not) to exercise their discretion rests with the trustees. Trustees must act unanimously, and so just one trustee may have the ability to prevent payments from the trust fund even if all the other trustees agree. Choice of trustees is therefore crucial.
If the surviving spouse has rent-free occupation of a property part-owned by the NRBDT, the tax office may say that this is an “interest in possession”. This would result in that part of the property owned by the NRBDT being added to the estate of the surviving spouse, and defeat the object of the NRBDT. Alternatively, the tax office may rely on the fact that any increase in the value of that part of the property owned by the NRBDT would be subject to Capital Gains Tax (CGT) even though the property is the surviving spouse’s main residence.
For these reasons, the NRBDT should be implemented using one of the following methods:
- The Debt Scheme; or
- The Charge Scheme; or
- Appointment from the NRBDT to an Interest in Possession (IIP) trust.
The Debt Scheme
With the Debt Scheme, the Will of the first spouse to die establishes a NRBDT and then the residue of the estate passes to the surviving spouse outright. All the assets in the estate, including any property, are transferred to the surviving spouse who in return gives an IOU to the trustees for an amount equal to the nil rate band. The IOU owed to the trust is deductible from the taxable estate of the surviving spouse on their death, so long as it is actually repaid.
The surviving spouse may have given chargeable consideration for the transfer of the property, meaning Stamp Duty Land Tax is payable. There are also circumstances where the tax office disregard the IOU as an artificial debt. So, the Charge Scheme is preferable to the Debt Scheme.
The Charge Scheme
With the Charge Scheme, instead of the assets in the estate being transferred to the surviving spouse in return for an IOU, the executors in the estate can offer the IOU to the NRBDT trustees which results in a charge (that is, a mortgage) being put on the property in favour of the NRBDT trustees for an amount equal to the nil rate band. The property is then transferred to the surviving spouse subject to that charge which reduces the value of the property held in the estate of the surviving spouse, so long as the charge is actually repaid.
The surviving spouse does not provide any chargeable consideration for the transfer of the property, but receives it subject to the charge, and so no Stamp Duty Land Tax is payable. Further, the surviving spouse does not incur the debt owed to the NRBDT trustees, and so there is no artificial debt (unless the debt exceeds the value of the property).
If the surviving spouse moves house then the charge is secured on the new property by the surviving spouse, and so an artificial debt may arise. The solution is in the drafting of the Will which still establishes a NRBDT, but then provides for the residue of the estate to be held in trust for the lifetime of the surviving spouse. This is commonly known as an interest in possession trust or life interest trust, but is technically known as an “Immediate Post-Death Interest” (IPDI) trust.
The executors put a charge on the property for an amount equal to the nil rate band in favour of the NRBDT trustees, and then transfer the property to the IPDI trustees (who are typically the executors). The IPDI trust fund forms part of the surviving spouse’s taxable estate on death, but the value of this is reduced by the charge, so long as it is actually repaid. If the surviving spouse wants to move house, the sale and purchase, and securing of the charge on the new property, is conducted by the IPDI trustees, so there is no artificial debt.
To use the Debt or Charge Schemes, the Will appoints separate executors and NRBDT trustees so that the offer by the executors to the NRBDT trustees of an IOU (rather than actual assets), and acceptance of that offer, is not seen as artificial. The executors and NRBDT trustees should not be exactly the same people. The surviving spouse should not be an executor, but can be an NRBDT trustee. It is advisable to have independent executors given that the executors decide whether or not to offer the IOU to the NRBDT trustees.
Appointment from the NRBDT to an Interest in Possession (IIP) trust
An alternative to the Debt or Charge Schemes is to “appoint” (that is, transfer) the NRBDT to an IIP trust for the surviving spouse. An IIP trust is one where the beneficiary (known as the life tenant) has no right to the trust capital, but instead has an immediate right to the trust income (after tax and expenses) as it arises, or to enjoy or occupy any trust property (whether or not it produces income) without the trustees having to make any further decision to confer such a right. On the death of the life tenant, the trust capital passes to other beneficiaries (known as the remaindermen). The IIP trustees are given a “power of appointment” which allows them to pass trust capital to any of the beneficiaries (whether the life tenant, the remaindermen, or otherwise).
Historically, with all IIP trusts, on the death of the life tenant, the trust assets formed part of the life tenant’s estate and were subject to IHT. This was in contrast to discretionary trusts which were taxed under the “relevant property regime” and so, on the death of any beneficiary, the trust assets did not form part of the beneficiary’s estate and were not subject to IHT. As such, an appointment from a NRBDT to an IIP trust would have been disastrous for IHT purposes.
Now, however, almost all new Will trusts are taxed under the relevant property regime for IHT purposes and so, on the death of any beneficiary, the trust assets do not form part of the beneficiary’s estate and are not subject to IHT. One exception to this general rule is an IPDI trust – such as IIP trust for a surviving spouse which arises immediately after the death of the deceased spouse – which is not taxed under the relevant property regime for IHT purposes and so, on the death of the life tenant, the trust assets form part of the life tenant’s estate and are subject to IHT.
To appoint the NRBDT to an IIP trust within two years of the date of death of the deceased spouse would have the effect of the new trust being “read back” into the Will of the deceased spouse so that it would become an IPDI. The trust assets would then form part of the surviving spouse’s estate and be subject to IHT as though the surviving spouse owned the capital of the IPDI trust fund outright. If, however, the appointment from the NRBDT to the IIP trust occurs more than two years after the date of death of the deceased spouse then the new trust will not be “read back” into the Will of the deceased spouse. The trust assets would not then form part of the surviving spouse’s estate and so would not be subject to IHT; but at the same time the trust assets will be part of the surviving spouse’s assets for CGT purposes and the principal private residence relief can be claimed on a future sale of the property. This helps avoid CGT on any increase in the value of the property from the second anniversary of the deceased spouse’s death to the date of death of the surviving spouse (or earlier sale of the property).
The NRBDT trustees should not confer rights of occupation – actually or notionally – on the surviving spouse within two years of the date of death of the deceased spouse, and so:
- The Title Deeds to the property should not be amended during this period to show the part ownership by the NRBDT, which helps with the argument that the executors have not concluded the administration of the deceased spouse’s estate, and so the NRBDT trustees could not have granted anyone rights in the property; and / or
- The surviving spouse could pay rent (or “compensation”) to the NRBDT trustees for residing in that part of the property owned by the NRBDT for the period from the date of death of the deceased spouse up to the date of the appointment from the NRBDT to the IIP trust. Any such rent / compensation will be subject to income tax.
There may be a charge to CGT from the date of death of the deceased spouse up to the date of the appointment from the NRBDT to the IIP trust if the property has increased in value.
In spite of these points, the rules which restrict the deduction of liabilities mean that an appointment from the NRBDT to an IIP trust is preferable to the Debt or Charge Schemes.
Pilot Trusts
Historically, to avoid IHT anniversary and exit charges on any part of an individual’s estate which was to be held in trust post-death, the individual could set up a number of trusts (known as “Pilot Trusts”) during their lifetime, and divide that part of the estate to be held in trust between the Pilot Trusts given that each trust had its own nil rate band.
However, from 6 April 2015, the same-day addition (SDA) rules will prevent settlors from obtaining IHT advantages by increasing the value of assets in more than one trust on the same day. The exceptions are where the trusts were created before 10 December 2014 and the settlor makes no additions on or after that date; or where the settlor makes additions by Will on his death before 6 April 2016 without changing his Will on or after 10 December 2014.
