2007 was a milestone year in inheritance Tax (IHT) planning for married couples with the introduction of the ‘transferable nil rate band’. Not only did that sound the death knell (almost) for the nil-rate-band-discretionary-will-trust but the traditional use of a deed of variation did an about face.

Before 2007, just as now, any assets left on death to a surviving husband or wife were tax free (the ‘spouse exemption’).

Otherwise, the first £325,000 (the ‘nil rate band’) of value left other than to a spouse or charity was tax free and the balance was charged to IHT at 40%.

So, from a purely tax perspective, it made sense for, say, a husband, to leave £325,000 to the children and the rest to his wife.

When the wife died, in due course, her own nil rate band would come into play and a further £325,000 (making a total of £650,000 overall) would have been left to the children tax free before the balance was charged at 40%.

If, on the other hand, the husband had left his entire estate to his wife, the value of his nil rate band would have been lost and (assuming no inflation), the ultimate tax bill would be £130,000 more (£325,000 @40%).

The problem was that most married couples simply couldn’t leave £325,000 to the children and the rest to the survivor for fear of leaving the survivor hard up.

Big fanfare. Enter the ‘nil rate band discretionary trust’. The individual wills of husband and wife provided that, on the first death, the first £325,000 would be held on discretionary trusts of which the survivor would be a potential beneficiary. The balance would be left to the survivor outright, spouse exempt.

Leaving the nil rate band on discretionary trusts made full use of the nil rate band while still allowing the survivor access to the money as beneficiary. The fact that the survivor would be one of the executors/trustees, and there would be a letter of wishes left with the will expressing the wish that the survivor be treated as principally entitled to the assets in the trust during their lifetime, meant that any concerns of the survivor seeing part of the inheritance in trust were assuaged. Many such trusts permitted (and expected) the trust assets to be loaned interest free to the survivor so that he or she had power to enjoy them for all practical purposes, free of any trustee interference.

Then, as now, the bulk of most couple’s wealth was tied up in the family home. So, where the home was (usually) held as joint tenants (so that it would have passed automatically to the survivor on the first death, the joint tenancy was ‘severed’ and converted to a tenancy in common. With a tenancy in common, the half share of the deceased passes under the will, so that part of the value of the deceased’s half share could be applied in satisfying the nil rate band gift into trust.

Where, say, a husband died with a will leaving everything to the wife, all, and especially the nil rate band was not, necessarily, lost. The wife was entitled by (second fanfare) deed of variation within two years of death to redirect the nil rate band to the children (if such were affordable) or to a nil rate band discretionary trust of which she were a beneficiary. The effect of a deed of variation is that the effective gift by the survivor is treated for IHT and CGT purposes as if it had been contained in the deceased’s will. (If need be the deed of variation could also retrospectively sever the joint tenancy of the family home).

The perceived wisdom prior to 2007 was that it was better to have a nil rate band discretionary trust in the will than rely on a deed of variation. The need for the survivor to be alert to the possibility of, and to have mental capacity to enter into, a deed of variation was avoided, along with additional legal fees and the application of the ‘settlor –interested’ income tax rule.

Then, in October 2007, the then Chancellor Alistair Darling announced to everyone’s surprise (well, mine anyway) that the time had come to put an end to the need for married couples to go to such convoluted lengths to make use of their simple and lawful entitlement to a nil rate band.

From then on, the first of a married couple to die could simply leave their whole estate to the survivor and the benefit of their nil rate band ( or such part of it as was unused) would be applied against the survivor’s estate (in addition to the survivor’s own nil rate band) when they subsequently died.

The change produced two immediate results

  1. A realisation that, in some cases, it was not only safe but actually better, from a tax perspective, to leave everything to the surviving wife/husband on the first death; and
  2. A big worry for those couples who had nil-rate-band-discretionary-trust wills as to whether they needed to rush to their solicitor to get the wills changed.

Where, say, a widow finds herself in a financial position where her late husband could safely have left his nil rate band to their children, better to leave his nil rate band intact, accept his whole estate and make a gift, herself, to the children. Once she survives the gift by 7 years, it’ll fall out of account for IHT purposes, her husband’s nil rate band would remain preserved, and her own nil rate band will have ‘revived’.

Where someone dies with an old-style nil rate band discretionary trust will, there’s not a problem in practice. In the same way as a deed of variation, an appointment of the nil rate band out of a Will Trust to the widow(er) within two years of death is read back to the will which is then read, for tax purposes, as if the whole estate had simply been left to the survivor.

So, with married couples simply able sensibly to leave their estates to each other, with no tax need to use the nil rate band on the first death, does there remain any role in IHT planning for either the nil rate band discretionary trust or the deed of variation?

Nil Rate Band Discretionary Trusts…

With the generation that has experienced the country’s highest levels of divorce also enjoying increased longevity, the number of second marriages among ‘older’ people is rising. Many of the parties to those marriages will have children from a previous relationship.

In order to balance the needs and expectations of both the new spouse and the existing children, many will leave their nil rate band to their children (if the size of the estate and their financial obligation to their new spouse both permit). The nil rate band might, instead, be left on discretionary trusts, not because there’s a desire to include the new spouse in the class of potential beneficiaries, but for ‘family’ reasons if the children are spendthrift, or where there’s a risk of one of them becoming, say, bankrupt - or simply to facilitate the tax efficient movement of wealth down the generations.

2. Where the estate contains assets likely to increase substantially in value, best drop them in a discretionary trust. The widow(er) can enjoy the assets as a beneficiary of the trust but the increase in value will be outside their estate and will escape IHT on their subsequent death.

As these assets are likely identified on, rather than before, the death of the first of the couple to pass away, assets are generally redirected to a trust by deed of variation.

It’s worth mentioning at this point, that it’s common practice for assets qualifying for 100% Business Property or Agricultural Relief from IHT to be dropped into a discretionary Will Trust. This crystallises the relief on the first death and ring-fences the assets against IHT should the business/farm be sold, or the reliefs be repealed, before the death of the survivor.

Deeds of Variation…

… continue to allow, say, a parent, to redirect an inheritance to their own children to ‘skip a generation’ for IHT purposes so that the value isn’t charged to IHT, again, on the parent’s death. A redirection by deed of variation is more tax efficient than making a gift out of one’s other resources, because there’s no requirement to survive by seven years to save IHT.

But remember, while a gift by deed of variation is treated as having been made by the deceased for tax purposes, it’s still, in reality, a gift for all other legal and practical purposes. For example, the redirection of an inheritance to one’s children by deed of variation, or to a trust for oneself, might still be a gift liable to be set aside if made, say, with intention of putting the gifted assets beyond the reach of creditors.