Nil Rate Band Discretionary Trusts (NRBDTs) were commonly used before the introduction of the Transferable Nil Rate Band (TNRB) on 9 October 2007. Before its introduction, if spouses gave all their assets to each other outright the Nil Rate Band (NRB) was often wasted. The spouse would inherit everything tax free from their spouse, but the unused NRB would be lost.
Inheriting outright would often cause them an IHT liability on their death as they would now own assets worth more than their individual NRB.
Spouses would instead include a NRBDT in their wills to ensure that they could take advantage of both NRBs.
What are Nil Rate Band Discretionary Trusts (NRBDTs)?
NRBDTs are simply a discretionary trust that takes assets up to the value of the NRB. Discretionary Trusts are relevant property trusts and therefore their own legal entity for IHT purposes. The assets held in the trust are seen as owned by the trust and not by the trust’s beneficiaries, and therefore are not part of the beneficiaries’ taxable estates.
The trust would commonly name the surviving spouse and others (usually children and remoter descendants) as potential beneficiaries of the trust. The trustees would then allow the surviving spouse access to capital, often by the way of a loan that is repaid on the survivor’s death and could also provide for a child’s education and welfare.
A letter of wishes would be drafted alongside the will to guide the trustees on how they should act, usually stating that the spouse should be treated as the main beneficiary and that assets would then be distributed to children on the spouse’s death.
Whilst the introduction of the TNRB has led to a decrease in the use of Nil Rate Band Discretionary Trusts, there still are two main scenarios when a NRBDT will be of use to clients and also some less common uses.
Unmarried Couples and Nil Rate Band Discretionary Trusts
Unmarried couples do not benefit from either the spousal exemption, the TRNB or transferable Residential Nil Rate Band (RNRB). The estates of an unmarried couple leaving everything to each other would therefore be considered for IHT on both first death and second death and without the benefit of two NRBs on second death. This could lead to an unnecessarily high IHT charge on second death.
The solution would be to use a NRBDT. Any assets passing to the trust would remain outside of the partner’s estate for IHT purposes, but they could continue to benefit from those assets.
The advantage of using a NRBDT here is best shown by way of example:
John and Jane are a married couple owning £300,000 each. They have no joint children, but John has children from a previous relationship.
John dies first, leaving his estate to her outright. On his death no IHT is due thanks to the spousal exemption and his unused NRB (and RNRB) are available to transfer to Jane. On Jane’s death, she passes her estate of now £600,000 to John’s children. As her estate benefits from her own NRB, and John’s unused NRB, no IHT would be payable on her death. Whilst her estate does not need RNRB, stepchildren are classed as direct descendants for the purpose of RNRB.
Imagine this same scenario, but John and Jane were not married. On John’s death, no IHT would be payable as his estate is below the NRB. On Jane’s death however, her estate will only benefit from her own NRB. This would mean that £275,000 out of her £600,000 estate would be taxable at 40%. Her estate would also not qualify for RNRB, as her late partner’s children would not come under the definition of direct descendants for RNRB purposes.
If John and Jane had used NRB Discretionary Trusts, on John’s death no IHT would be payable as his estate is below the NRB. All his assets would pass to the trust. On Jane’s death, she will only own £300,000 worth of assets. As this is below the NRB, it will pass IHT free to John’s children.
Remarried Widows and Nil Rate Band Discretionary Trusts
S8A IHTA 1984 provides that a person may only benefit from a single additional NRB. This could leave a remarried widow in a difficult IHT position. They may have an available NRB from their late spouse. Should they leave their entire estate to their new spouse, or alternatively should the new spouse die and leave everything to the widow, only one additional NRB can be claimed on second death, wasting the possible third.
The solution would be for both to leave assets equal to one NRB into a NRBDT, with the remaining passing outright to the survivor. This means that should the widow die first, one of their NRBs can be used towards the assets passing to the NRBDT, with the other available to be claimed by the survivor on second death. Should the new spouse die first their NRB can be used towards the assets passing into the trust, allowing the widow to claim their own NRB plus the NRB from their first spouse.
Reducing Anniversary and Exit Charges
If a married couple intend to place the estate into a discretionary trust on second death and have assets over the value of the NRB, they could also consider placing assets into a NRBDT on first death.
If their combined estates are over the value of one NRB, if the whole combined estates were placed into one discretionary trust on second death, this would mean that anniversary and exit charges would apply to the discretionary trust.
By placing assets into a NRBDT on second death, this ensures there will be two trusts in existence at second death. They would each have their own NRB and this could have the effect of reducing or completely eliminating the potential anniversary of exit charges of the trusts.
This would however mean that the transferable NRB would not be available to the surviving spouse.
RNRB – Taper Threshold
For a married couple who individually have assets below the RNRB taper threshold (which is currently £2 million) but combined have assets above the taper threshold, there may be a benefit to using a NRBDT on first death.
In these circumstances if the spouses benefit each other outright with the whole estate this would place the surviving spouse’s taxable estate over the taper threshold and the RNRB available on second death would begin to be reduced.
Anything that passes into the NRBDT would be outside of the surviving spouse’s taxable estate. Having the value of the NRB pass outside of the surviving spouse’s estate could keep them below the taper threshold or perhaps ensure that they benefit from more of the RNRB than they would have if the estate had passed to the survivor outright.
All references in this article to spouses, married couples and marriage also includes civil partners and civil partnerships.