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The nil rate band is a very important part of IHT planning because you can make sure it is only used to cover assets that are not already shielded from IHT by reliefs for business/agricultural property or exemptions allowed for spouses, civil partners, charities, political parties, etc. Therefore, the nil rate band is maximised by not wasting it on assets that will be free of IHT anyway.

Until 9th October 2007, your nil rate band died with you if it was not used to cover assets in your estate. For this reason, many married couples would structure their wills so that certain assets, such as their half of the marital home, would not pass directly to their spouse but go into a trust and eventually pass to their children. The surviving spouse would continue to enjoy a life interest in the assets belonging to the trust, perhaps in return for a notional rent, whilst the trust would obtain the benefit of the deceased’s nil rate band and pass assets to the children free of IHT upon the death of the surviving spouse. For this to work, it was usually necessary in the case of jointly held property, such as the marital home, for the spouses to change their status from joint tenants to tenants in common, so that they both owned 50% each (or some other proportion) rather than both owning the property in joint names with no particular share belonging to either of them. Nil rate band trusts were the mainstay of effective IHT planning for most people.

In late 2007 inheritance tax became something of a political football with the Conservatives proposing a £1 million threshold. In response, the Labour government changed the IHT rules so that spouses (and civil partners) could inherit the nil rate band of their deceased partner (or part thereof) if it was not fully used on their death, provided the surviving spouse (or civil partner) died on or after 9th October 2007. Nil rate band trusts have therefore become less relevant to IHT planning and in some cases can actually have a detrimental effect, for example in times of falling property prices. Where this is the case, it may be advisable to reverse the previous arrangements and draft a new will.

However, it would be wrong to assume that nil rate band trusts are now totally redundant. In many cases they are still highly relevant, for both tax and non-tax reasons. The most obvious example is when the IHT threshold does not keep pace with property prices. The transferable nil rate band is based on the tax year in which the surviving spouse (or civil partner) dies, so it goes up in line with the current IHT threshold, but if house prices go up much faster than this it would be more tax efficient for large estates to use a nil rate band trust to hold the share of the marital home belonging to the first spouse (or civil partner), as subsequent increases in the value of the property would be shielded from IHT.

Second marriages after the death of the original spouse are another good reason for using a nil rate band trust. The maximum transferrable nil rate band is 100% of the IHT threshold that exists in the year during which the surviving spouse dies, so if the new spouse dies first and his/her nil rate band is totally unused, any part of the nil rate band for the original spouse that would have been transferrable will be lost, or to put it another way, any unused part of the nil rate band for the original spouse may be transferred to the surviving spouse but, even if this is less than the current IHT threshold, only the difference can be transferred from the nil rate band of the new spouse. The same applies to civil partnerships where the surviving partner enters into a new civil partnership after the death of the original partner.

Of course, another issue with second marriages is protecting the inheritance of the descendants of the original spouse. If he/she leaves everything to the surviving spouse, who then re-marries and dies before the new spouse, the children of the original spouse (or any other intended future beneficiaries) may lose their inheritance if everything is left to a person who is not related to them. Therefore, if you expect your spouse to re-marry after your death, it can make sense to leave part of your estate in a nil rate band trust so that your children will eventually inherit free of IHT. The surviving spouse can still retain a life interest in the estate, such as residence of the family home, but your children will be able to inherit without having to rely on the will of the surviving spouse, or even worse, on the intestacy laws.

If your spouse is not domiciled in the UK, he/she will only be entitled to an IHT exemption of £55,000 (a figure that has been frozen since 1974!). In that situation, it is likely that your spouse will need your nil rate band in order to eliminate (or at least minimise) the IHT burden on your estate, so it is less likely that a nil rate band trust would be appropriate. Again, the same goes for civil partnerships. There may well be other good reasons for having a nil rate band trust that are unrelated to tax. For example, you may want to protect your estate from any future creditors or ex-spouses if the people intended to be the eventual beneficiaries, such as your children, are likely to be divorced or go bankrupt before your spouse dies. It is important that the assets are placed in a trust rather than left directly to the children or other beneficiaries, as trust property will not actually belong to them until the surviving spouse dies. Also, it will avoid your spouse having to pay rent to your children in order to continue residing in the matrimonial home, as he/she can be given a life interest in the trust property.

It should also be noted that assets in a trust will not be taken into account for means testing if your spouse eventually needs to go into a nursing home. However, their own property may well be subject to such means testing, including their share of the matrimonial home, and in that situation it may well be wise to convert the property into more liquid assets, for example by entering into an equity release scheme, and using the money to make gifts under the lifetime exemptions (although care needs to be taken with gifts out of normal income as the proceeds would be regarded as capital rather than income).

Acumen Tax Solutions
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For information of users: Although every care has been taken in compiling this material, it only provides an overview and does not take the place of an individual consultation. We strongly advise all users to consult the detailed legislation or seek professional advice. Therefore no responsibility for loss occasioned by any person acting or refraining from action as a result of this material can be accepted by the authors or this firm.

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