Increase the amount that can pass to your family free of inheritance tax
A recent report revealed that the amount of Inheritance Tax (IHT) paid by British families has risen by more than 90% since 2010. Christopher Eriksson-Lee, Partner in Private Client explores the tax savings possible with careful planning.
All individuals have a nil rate band IHT allowance which is currently £325,000.
Since 2007 it has been possible to transfer the unused IHT allowance of a deceased spouse to the survivor. Before this scheme was introduced, married couples who left everything to each on first death wasted the IHT allowance of the first to die on the basis that everything passed to a spouse exempt beneficiary.
Transferable nil-rate band
Since 2007 it has been possible to transfer the unused IHT allowance of a deceased spouse to the survivor. Before this scheme was introduced, married couples who left everything to each other on first death wasted the IHT allowance of the first to die on the basis that everything passed to a spouse is exempt from IHT.
To get around this problem, married couples would place the nil-rate band IHT allowance of the first to die into a iscretionary trust for the benefit of a class of beneficiaries which included their spouse and children. In this way, the first to die used his or her nil-rate band which would otherwise have been lost.
When the transferable nil-rate band scheme came into effect, commentators called into question the use of nil-rate band discretionary trusts as it seemed there was little need to preserve something that could be passed on and used by the second spouse to die in due course.
However, this is not always the case, and in fact the use of nil rate band discretionary trusts is essential in overcoming the “un-transferable” nilrate band problem.
The un-transferable nil-rate band issue
The concept of the “un-transferable” nil-rate band is best addressed by way of an example:
If James died leaving everything to his wife, Susan, then James’ unused nil-rate band would transfer to Susan so that she ends up with a double nil-rate band of £650,000.
If Susan then remarries, and leaves everything to her second husband Peter, only Susan’s unused nil-rate band of £325,000 can be claimed by Peter’s executors on his death.
Only half therefore of Susan’s double nil-rate band can be passed on, and the other half, inherited from James’ estate amounting to £325,000, cannot be transferred.
This is called the un-transferable nil-rate band and represents a loss of £130,000 in a charge to IHT (ie: 40% of £325,000).
Use of multiple nil-rate bands
To prevent the above scenario arising, a nil-rate band discretionary trust can be useful. Susan can leave the unused nil-rate band IHT allowance inherited from James’ estate into a discretionary trust (naming Peter and his other descendants as beneficiaries). Susan then leaves all of the rest of her estate to Peter either outright or on a life interest trust basis and Peter then acquires Susan’s transferable nil-rate band on his death, which, as well as his own individual IHT allowance, gives Peter a double nil-rate band (£650,000).
Peter can also benefit from the nil-rate band discretionary trust in Susan’s will appointing Peter as a beneficiary, which means the wider family effectively benefit from three nil-rate bands (£975,000).
If both husband and wife are a widow and widower, four nil rate band IHT allowances (£1.3m) can potentially be used by carefully incorporating a nil rate band discretionary trust structure in their wills.
With carefully drafted trust wills, tax savings can be achieved for remarried widows and widowers.