Mark McLaughlin and Toby Harris highlight practical issues following the introduction of the Inheritance Tax transferable nil rate band
How should practitioners advise?
Inheritance Tax (IHT) planning for many married couples and civil partnerships was simplified by provisions introduced in Finance Act 2008 (see IHTA 1984, ss 8A–8C), which allow a claim for all or part of an unused nil rate band on the death of a spouse or civil partner to be transferred to a surviving spouse or civil partner who dies on or after 9 October 2007.
Previously, the thinking behind utilising the nil rate band on the first death was to leave it to chargeable beneficiaries. Following the transferable nil rate band provisions, in many cases the emphasis will be on not using the nil rate band on the first death, in the hope that the transferable band will be larger on the second death, when it will really be needed. However, some individuals will prefer to ‘bank’ the nil rate band, rather than rely on its availability on the survivor’s death.
Discretionary trusts in existing wills
Suppose that husband and wife (or civil partners) are both still alive and had previously made wills that incorporate nil rate band discretionary trusts. What should they do? If they feel uncomfortable with the relative complexity of trusts in their wills, they could consider making new wills, although codicils to their existing wills may well be sufficient to dispense with the nil rate band legacy.
Alternatively, there is scope (under IHTA 1984, s 144) for the trustees of a relevant property trust to appoint funds or assets to beneficiaries within two years of the death. To avoid the difficulty suffered in Frankland v IRC  STC 1450, trustees should not normally take any action until three months have elapsed from the date of death. Between the fourth and the twenty-fourth month, however, a distribution from the discretionary trust will take effect as if it had been a gift under the terms of the will and not a distribution from the relevant property trust.
Therefore, there is no need to change the will. On the death of the first to die of husband and wife, the trustees simply wait at least three months and appoint the whole of the nil rate band to the surviving spouse (note there is no need to wait three months if the effect of the deed of appointment is to create an immediate post-death interest, only if the interest created is an absolute one). If the will of the surviving spouse is drafted in common form, the provision as to the nil rate band will not apply on the second death because it has been excluded where the surviving spouse is not married at the date of death. In this scenario, therefore, all that is needed is a deed of appointment by the trustees of the nil rate band set up by the will of the first spouse to die.
However, nil rate band trusts may still be useful in certain circumstances. They will be appropriate where the surviving spouse already has an additional nil rate band available (ie for remarried spouses, following the death of a spouse), and for other reasons which are not related to IHT. Possible reasons include the following:
- where future care costs are a concern; or
- for asset protection purposes (eg in the event of financial or marriage failure); or
- where it is likely that the survivor may remarry; or
- if the value of an asset is likely to increase faster than increases in the nil rate band, or if the asset qualifies for business or agricultural property relief.
Following death of a spouse
In certain situations, it is quite conceivable that four nil rate bands may be available. This could happen if, for example, a co-habiting couple who had each been married before left their respective estates to chargeable legatees such as adult children (or to the survivor), in order to utilise both their own nil rate band and the transferred nil rate band of their deceased spouse. However, following marriage their overall IHT position could dramatically worsen.
Example – Marriage or co-habitation?
Doris, widowed with one daughter, had inherited from her husband all his modest estate. Her part of London had become fashionable and their former council house was now worth £425,000. She had worked on the checkout at a very successful supermarket and had always taken up any employee share offers, so she now had a holding worth £100,000.
Eric, a jobbing builder until his retirement, had also inherited all of his late wife’s estate and intended to leave everything, amounting to £600,000 in value, to their two sons.
Eric and Doris met on a long journey on a coach holiday in Tuscany. They decided to set up home together, letting Eric’s house, and consulted their friend, a tax adviser, about getting married and leaving their estates to each other. Their friend was as discouraging as Dr Johnson had been to the young man in Streatham. It was not that, for Eric and Doris, second marriage would be the triumph of hope over experience; far from it. However, leaving their estates to each other would not only result in the nil rate band of either Eric or Doris being wasted on the first death, but also the unused nil rate band of the spouse from their first marriage. Marrying each other may well create a further unused nil rate band on the first of Eric or Doris to die, but it could not be transferred to the survivor, whose maximum nil rate band entitlement had already been reached. The deceased spouse’s additional nil rate band entitlement from their first marriage could not be transferred either.
In this example, if Eric and Doris did marry, consideration could be given to including a legacy to chargeable beneficiaries (eg to adult children or a discretionary will trust) on the first death, sufficient to use the deceased’s nil rate band plus the transferred nil rate band from that person’s first marriage.
Mark McLaughlin CTA (Fellow) ATT TEP and Toby Harris LLB CTA TEP are co-authors of Ray & McLaughlin’s Practical IHT Planning (8th Edition), from which the above article is adapted.
This article first appeared in Busy Practitioner (January / February 2009), which is published by Tottel Publishing.