Trusts have a variety of different uses in wills. Most of these are relatively well known by will writers, however there are times where very specific facts could warrant the use of a trust. In this regular feature of the newsletter will cover situations where a trust could be recommended to a client that you might not have thought of.
This week, we will look at a situation where you may consider using a nil rate band (NRB) discretionary trust to avoid losing the residence nil rate band (RNRB).
Mr and Mrs Johnson each have assets of £1,200,000. They wish to leave their estate to each other and then to their children equally. Their estate mostly consists of their property and they only have a small amount of cash.
Mr Johnson dies in March 2020 and Mrs Johnson dies a few months later in May 2020.
What’s the problem?
Due to the value of their estates, distributing all of their estate to each other may not be completely advisable.
Where the value of an estate is more than the taper threshold, which is currently £2,000,000, the amount of RNRB available is tapered by £1 for every £2 that the estate is over the taper threshold.
On the first death of Mr and Mrs Johnson, the estate is below the taper threshold. However on second death when the estates have been combined, the value of the estate is over the taper threshold, meaning that the full benefit of the RNRB will not be obtained. An estate of £2,400,000 is currently £400,000 over the taper threshold meaning that £200,000 of the RNRB will be lost. This would mean that Mrs Johnson’s available RNRB on her death would be:
|£175,000 x 2||£350,000|
|Reduced by £200,000||£150,000|
Mrs Johnson’s estate would therefore be taxed as follows:
|Mrs Johnson’s Estate||£2,400,000|
|Minus 2x NRB (£650,000)||£1,750,000|
|Minus available RNRB (£150,000)||£1,600,000|
|Taxed at 40%||£640,000|
Mr and Mrs Johnson could consider the use of an NRB discretionary trust in their wills and leave the remainder of the estate to the spouse outright. Anything that passes to the NRB discretionary trust would be outside of the surviving spouse’s estate. Allowing the value of the NRB to pass outside of the spouse’s estate will ensure that the value of the combined estate on second death will be below the taper threshold and allow them to benefit from the full value of the RNRB.
On Mr Johnson’s death, his estate would be distributed as follows:
|Mr Johnson’s estate||£1,200,000|
|NRB to trust||£325,000|
|Remainder to Mrs Johnson||£875,000|
|Mrs Johnson’s total estate after inheritance||£2,075,000|
This would mean that Mr Johnson’s NRB would be used on his death and would not be available to be transferred. Unused RNRB would however be available. Mrs Johnson’s estate is now only above the taper threshold by £75,000, meaning only £37,500 of the RNRB will be lost. The available RNRB will be:
|Reduced by £37,500||£312,500|
Mrs Johnson’s estate will be taxed as follows:
|Mrs Johnson’s Estate||£2,075,000|
|Minus 1x NRB (£325,000)||£1,750,000|
|Minus available RNRB (£312,500)||£1,437,500|
|Taxed at 40%||£575,000|
|Tax saved by using the trust||£65,000|
A separate letter of wishes should also be drafted to guide the trustees, stating that the spouse should be treated as the main beneficiary of the trust for the rest of their life and afterwards the trust assets can pass to their children.
Mr and Mrs Johnson could also have considered putting more than the NRB into a discretionary trust on first death to ensure that the full RNRB is available on second death. However, this should be weighed against the fact that this would cause an IHT liability on first death and the trust would incur anniversary and exit charges.
If you would like any further advice on this, please don’t hesitate to contact us at [email protected].