IHT-Solutions

The nil-rate band discretionary loan Trust

For practitioners, the nil rate band discretionary loan trust Will is ordinarily the most appropriate means of setting up the affairs of a married couple or civil partners in order to make a potential tax saving of up to £114,000 (£120,000 from April 6th 2007).

The problem as indicated by this post's title is that this type of Will is complex and there is some difficulty in explaining to the lay person the mechanism by which this type of Will should work, after allowing for potential government intervention in the scheme.

In conjunction, with Amy Muncer, a newly qualified solicitor within my department, we have prepared a fact sheet for our clients which aims to simplify the nil rate band discretionary loan trust Will scheme so far as possible. Hopefully, we have achieved our aim but any constructive criticism will be taken on board.

The fact sheet reads as follows:-

Wills including Nil Rate band Discretionary loan Trusts

This type of will is usually suitable for a married couple or civil partners whose estate is valued over the nil rate band (this is currently £285,000 but will be rising to £300,000 in April 2007) regardless of whether or not the money is tied up in their home.

Currently anything that you pass to your spouse or civil partner under your will is exempt from inheritance tax. This means that if you have set up a will whereby everything goes to your surviving spouse* no inheritance tax will be payable on the first death, but one nil rate band exemption will be wasted. On the second death the value of the estate passing to your residuary beneficiaries (i.e. your children) will be much higher. Inheritance tax of 40% will have to be paid on the value of the estate over the nil rate band.

By setting up your will to include a nil rate band discretionary trust you can make full use of both of your nil rate bands and potentially save up to £120,000 in inheritance tax from April 2007.

How will a will including a Nil Rate Band Discretionary Trust Work?

The will works as follows:-

• You sever the tenancy of your home so that you hold the property as tenants in common so that your share of the property does not pass to your spouse* automatically by survivorship.

• A legacy of the value of the nil rate band will be left under each of your wills to a discretionary trust. The remainder of your estate will be left to your surviving spouse.

• The trustees of the trust can be the surviving spouse* and at least one other. The other trustees may be the persons that you wish to benefit from your residuary estate (for example your children) or an independent third party such as your solicitor.

• The potential beneficiaries of the trust will be the surviving spouse* together with any other persons that you wish to benefit from your residuary estate.

• On the first death, if the surviving spouse* has sufficient funds available these may be paid into the trust up to the value of the nil rate band. This may not be the case if the money is tied up in the matrimonial home. Instead the trustees can accept up to half the value of the matrimonial home. This is secured by a simple IOU from the surviving spouse* or an equitable charge over the property in favour of the trustees.

• No inheritance will be payable on the first death as the value of the half share of the house paid to the trust ( by way of the charge or IOU) comes within the nil rate band, and the remainder of the estate passes to the surviving spouse*, therefore attracting the spouse exemption.
• On the second death the property will pass fully to the residuary beneficiaries but inheritance tax will not be payable on the half that has already been passed to the discretionary trust (albeit secured by equitable charge or IOU)

• The discretionary trust that is set up on the first death will need to be reviewed annually so that it is seen as a properly constituted trust by the Inland Revenue, but other than this little work is generally involved by the trustees.

Benefits of this type of will:-

~ You are able to make full use of both nil rate bands therefore making a potential inheritance tax saving of up to £120,000!
~ You can avoid inheritance tax without having to sell the matrimonial property on the death of the first spouse.*
~ Although the residuary beneficiaries have an interest in the trust they do not actually own a share of the matrimonial property outright so they are not able to enforce a sale.
~ Whilst within the trust, the property is not actually seen to be part of the residuary beneficiary’s assets which should avoid any claims over the property by divorcing spouses or bankruptcy.
~ The surviving spouse* may move homes during the trust period.
~ Gifts can be made to other beneficiaries of the trust during the trust period if agreed.

* All references to a spouse include a civil partner

The reducing value of the IHT annual allowance

Whilst there is much rightful comment about the fact that the nil-rate band allowance for inheritance tax has not kept abreast of house price inflation, there has been little discussion of another important IHT allowance.

This is the £3000 annual exemption allowed to each individual on an annual basis as measured by the tax year. In addition, each individual can count back one tax year to make a gift of £6000, if the allowance has not been used in the previous tax year.

If a married couple both utilise this allowance religiously, there is the opportunity to make between them, for instance, tax free gifts of £60,000 over a 10 year period which could potentially save £24,000 of inheritance tax.

There is one fact about the £3000 annual allowance that most of us forget, however. This is the fact that this annual allowance has been fixed at £3000 since the tax year 1981/1982. I have checked the retail prices index and note this accounts in real terms to over £8100 today.

As such, if the annual allowance could be raised in line with inflation to say a round annual £8000, this would allow a married couple to make tax free gifts over a 10 year period of £160,000 giving a potential tax saving of £64,000.

In the circumstances, it appears clear to me that an upward adjustment of the annual allowance now would both be a fair reflection of increased price inflation and a further opportunity for those who are most prudent to take simple inheritance tax saving measures.

Perhaps, this is one idea the Treasury may take on board to sweeten the IHT pill.

Why a Will Works

There are many reasons to make a Will, not least because a well-drafted Will allows gifts to be made either directly or by way of a suitable Trust that could currently save up to £114,000.00 of inheritance tax.

Over and above inheritance tax factors, of course, the making of a Will grants you the opportunity in one document to put a number of matters relating to your affairs in order by way of what can be seen as additional benefits.

For instance:-

* The Will enables you to appoint a named person or persons who you trust to be your executors and trustees to administer your estate and any trusts created by the terms of your Will.

* The Will allows specific gifts to be made eg. personal jewellery.

* The Will allows guardians to be appointed for infant children.

* The Will allows funeral directions to be given, if applicable.

* The Will allows you clearly to set out how the net balance of your estate ( the residuary) is to be distributed.

Without a Will, these matters are dictated by the law and, in particular, the laws of intestacy and in many cases this may result in a result far from that intended.

As just one example, the intestacy laws do not currently recognise unmarried couples. As such, an unmarried partner would have no right to any part of the deceaced partners' assets under law and could only possibly recover any assets by recourse to the Courts.

Alternatively, in the case of a married couple with children, the surviving spouse is only currently entitled to the first £125,000 of the deceased spouse's sole assets plus a life interest (an income) from the remaining half.

The potential difficulties arising are legion.

So, my New Year advice is to make or update your Will with a Solicitor specialising in this area of work to both save inheritance tax where possible and to ensure your affairs are in order.