Prior to the introduction of the transferable nil rate band for inheritance tax purposes between spouses and civil partners, nil rate band discretionary trusts had a very useful role to play in ensuring that one spouse’s or civil partner’s nil rate band for inheritance tax purposes was not wasted. However, since 9 October 2007 any unused portion of nil rate band has been transferable between spouses and civil partners and this has reduced the attractiveness of the nil rate band discretionary trust.
What is a discretionary trust?
A discretionary trust is one in which the trustees have `discretion’ as to how the trust income and maybe the trust capital is applied. The trustees are the legal owners of the assets. Any income received by the trusts is taxed. Trust income in excess of £1,000 is taxed at special trust tax rates. Payments made by the trust to a beneficiary carry a tax credit at the trust tax rate, currently 45%.
How do nil rate band discretionary trusts work?
Under a nil rate band discretionary trust property up to the nil rate band for inheritance tax purposes (currently £325,000) is settled in a discretionary trust. This uses up the settlor’s nil rate band. The discretionary nature of the trust provides flexibility for the trustees to provide for the beneficiaries as required, without having to specify the bequests in advance.
Are nil rate discretionary trusts still useful?
The introduction of the transferable nil rate band reduced the usefulness of nil rate discretionary trusts as they are no longer needed to shelter one spouse or civil partner’s nil rate band. Although in many cases they are now an unnecessary complication, nil rate band discretionary trusts do still have their uses and can be particularly useful in the following circumstances:
Surviving spouse remarries – where the surviving spouse remarries, a nil rate band discretionary trust may be useful where the spouse wishes to provide for children from former relationships.
Second marriage or civil partnership – a nil rate band discretionary trust can also be useful where one or both of them is the surviving spouse or civil partner of a previous marriage or civil partnership with unused nil rate bands to protect.
To reduce the surviving spouse’s assets – the assets in the trust are not taken into account by a local authority should the surviving spouse need to go into care.
Trust assets increasing at a rate greater than current nil rate band – the nil rate band has been set at the current level of £325,000 since 6 April 2009 and is frozen at this level until at least April 2021. If trust assets are likely to increase, a nil rate band discretionary trust could still be worthwhile.
To protect claims on assets – placing assets in a trust will protect them from claims by business creditors or ex-spouses or civil partners.
The trustees can within two years of death make an irrevocable and absolute appointment in favour of the surviving spouse. For IHT purposes this is treated as if left to the spouse under the Will, with the benefit of the inter-spouse exemption.
Need to know: Although nil rate band discretionary trusts have are not the planning tool they once were, in certain circumstances they can still be very useful.