Nil rate band planning

Summary

Through lifetime and testamentary planning, individuals can (often substantially) reduce their inheritance tax (IHT) liability – with the help of financial advice.

Facts and analysis

Since it was announced in the Pre-Budget Report of 9 October 2007, a spouse or civil partner who dies on or after that date has been able to claim the unused proportion of the nil rate band of a spouse or civil partner who died earlier (ie. even if that spouse or civil partner died before 9 October 2007). For example, W dies today and H (W’s spouse) died in May 2002. Only 25% of H’s nil rate band was used at death, so W’s nil rate band can be increased by 75% (the unused proportion of H’s nil rate band) of the nil rate band at the time of W’s death.

For civil partnerships the earlier death must have occurred on or after 5 December 2005.

For many, this has taken away the need to carry out nil rate band planning on first death, although such planning is, of course, still effective. Also, there may be times when it is desirable to use the nil rate band when the first spouse or civil partner dies. For example, if the value of the assets in question is likely to increase by more than the nil rate band in the future.

The nil rate band will remain frozen at £325,000 until 2021.

Transfer of the unused nil rate band:

For the unused nil rate band to be transferred, a claim must be made, using Form IHT 402, not later than 24 months from the end of the month in which the second spouse died.

Form IHT 402 (which is a schedule to form IHT 400) should be sent to HMRC by the personal representatives, preferably at the same time as they send in the form IHT 400. The claim form must be supported by the following documents:

• A copy of the grant of representation on the estate of the first spouse to die.
• Death certificate.
• A copy of the first spouse’s Will, if there was one.
• A copy of any deed of variation.
• Marriage or civil partnership certificate for the couple.

It would also be useful to keep in place any valuation(s) of assets that pass under a Will or intestacy, other than to the surviving spouse or civil partner, and the value of any other assets that also passed on the death of the first spouse or civil partner, for example jointly owned assets, assets held in trust and gifts made in the 7 years prior to death.

When might a first death transfer within the deceased's nil rate band be appropriate?

Despite the undoubted attraction of the transferable nil rate band, for many couples there will be situations where a “first death” use of the nil rate band may still be the preferred “way to go”.

Obvious examples include the following:

• As discussed above, where the assets under consideration are expected to increase at a faster rate than the nil rate band. In this case, all other things being equal, it would make IHT sense to move them out of the couples’ ownership as soon as possible.
• Where the expected survivor of the couple who would inherit has, from the death of a spouse from a previous marriage, already “inherited” a 100% multiplier to their nil rate band through the receipt of the entire estate of that deceased spouse. To leave everything to such a spouse would then result in the loss of the nil rate band of the first to die.
• Where there is concern over the eventual destination of the assets left to the surviving spouse. This has long been a concern of married couples and a key “non-tax” reason why Will trusts are used. Typically, the surviving spouse would be left a life interest (right to income) in the Will of the first to die. The Will would then specify the eventual destination of the capital – typically to the couple’s children. A power of appointment or discretion may be granted to the trustees.

If this type of trust is used it will still be treated for IHT as a transfer to the surviving spouse and thus result in the nil rate band of the first to die being effectively transferred to the surviving spouse resulting in the increase of the nil rate band available on the death of the surviving spouse. However, this type of transfer will also “pre-designate” the eventual destination of the capital so that it will not be capable of being “diverted” by the surviving spouse. The trust terms would, typically, give wide powers to the trustees to advance or lend capital to the spouse if required.

A further alternative would be to use a discretionary Will trust under which the surviving spouse would be a potential beneficiary. This would use the nil rate band of the first to die ie. it would not be transferred. The normal “discretionary trust” IHT implications would need to be considered.

Using the nil rate band during lifetime

Use of the nil rate band is not confined to planning through the Will. If lifetime planning is to take place then, to be effective, it needs to avoid the gift with reservation and pre-owned assets tax provisions.

This is a very relevant issue for the many who cannot gift without retaining some degree of access to and/or control over the asset in question.

Discounted Gift Trusts can help here by facilitating a “discounted” lifetime transfer – say within the nil rate band - while providing access to a regular flow of payments for the donor.

Loan Trusts do not usually involve any gift but do enable the lender to retain access to the original capital lent.

For those who can afford to give up access to the funds/assets under consideration then an outright gift or gift into trust during lifetime can be made within the donor’s nil rate band. After seven years the gift can be ignored for IHT purposes and the nil rate band “used” in making the gift will be restored.

With any lifetime gifting, it may be necessary to consider the capital gains tax implications. This is not, of course, relevant when there is a gift or use of cash.

Next steps

Along with the available reliefs and exemptions from inheritance tax the nil rate band is one of the most powerful and widely used provisions of the IHT legislative code. Used properly it can deliver IHT savings of £130,000. And these savings can be secured every seven years if the nil rate band is used to make lifetime gifts on a regular (seven year cycle) basis.

And through the use of appropriate trusts the donor can continue (usually via the trustees) to influence some control over who benefits from the gift, how and when. As stated above, Discounted Gift Trusts can even deliver a continued flow of regular payments to the donor.

As well as these possibilities to use the nil rate band during lifetime, there are also the (probably even more widely used) possibilities of using any unused nil rate band on death. For most this will be the whole nil rate band at the time.

As indicated in the Facts and Analysis the two main ways of using the nil rate band on death are:

• through the use of the transferable nil rate band and
• through the use of “first death” outright or trust-based dispositions to other than the deceased’s surviving spouse or civil partner.

The nil rate band thus offers financial advisers the means of helping their clients to carry out effective IHT planning during lifetime and/or on death through outright and/or trust-based gifts.

An awareness of “testamentary” and trust-based nil rate band planning will also facilitate informed overall advice being given by advisers and the means of liaising with other professionals to effect an overall estate planning solution. And to the extent that an IHT liability remains, there is always the opportunity to put forward the means of meeting the liability through appropriate life cover in trust.

Important information

This information has not been approved for use with customers and is based on Aviva's interpretation of current law and legislation and our understanding of HM Revenue and Customs (HMRC) practice as at  6 April 2021. It is provided for general information purposes only and should not be relied upon in place of legal or other professional advice. Both the law and HMRC practice will change from time to time and our interpretation may be subject to challenge by HMRC or other regulatory body. Aviva cannot act as legal advisor for you or your clients. You should always seek appropriate legal or other professional advice.