For married couples and civil partners, you should consider leaving assets up to the value of the nil rate band (£325,000 in 12/13) directly to your children on the first death.
This transfer of assets would be free of tax as it would fall within the deceased’s nil rate band. Of course a second nil rate band would still be available to set against the survivor’s estate.
Using two nil rate bands in this way means that £650,000 in tax year 2012/13 can be removed from the joint estate free of Inheritance Tax.
If your joint estate is less than that you probably do not have an Inheritance Tax problem.
A downside to this approach is that the surviving spouse will then lose access to the income and the capital of those assets passed to the children on the first death. To overcome this issue, yet still make use of the first nil rate band, you can consider a nil rate band discretionary will trust.
The discretionary trust only begins on first death as the will simply instructs this action at that point.
The surviving spouse would be a trustee who could also benefit under the terms of the discretionary trust. In other words, the deceased has left an amount to a discretionary trust that the spouse can continue to have access from although not exclusively.
The discretionary trust should also be set up with the power for the surviving spouse to have access to loans on an interest free basis.
The trustees could make interest-free loans repayable on demand to the surviving spouse and he/she could spend the money as income. This would mean that on the surviving spouses death, the outstanding loan would be regarded as forming a debt on their taxable estate and therefore further reduce the IHT liability at that time. This is a way of using three nil rate bands and ensuring estates of £936,000 do not pay any Inheritance Tax.
Phizackerley case
Be mindful of the decision of the Special Commissioners for Tax in the Phizackerley case and how it affects nil rate band planning. Many believed it negatively affected it but this is not true:
Julie Hutchison, Estate Planning Specialist at Standard Life Assurance Limited, commented on the decision of the Special Commissioners for Tax in the Phizackerley case, reported 14 February 2007.
“I regularly attend professional conferences on IHT and trust planning. For several years now a risk point about nil-rate band Will Trusts has been raised at some of these events, normally ending with the comment “but HMRC has not yet taken the point in a case as yet.” News of the Phizackerley case therefore does not come as a surprise – many people will consider that it was just a matter of time before a case arose with an unfortunate order of events and order of deaths for Section 103 Finance Act 1986 to apply.
What it comes down to is this simplified example: A and B are spouses. A is the wealthier spouse and A gives some assets to B to help to equalise their estates for tax purposes. B later dies and B’s will contains a nil-rate band Will Trust. That trust includes the surviving spouse A as a potential beneficiary along with the children, which is entirely normal. The trustees have full discretion over who benefits and when, and decide to make funds available to A. The trustees don’t simply distribute some assets to A: instead they lend them to A, perhaps on an interest-free basis repayable on A’s death. Section 103 Finance Act 1986 is relevant here since that loan might not be deductible on A’s death, since the funds have essentially gone round in a circle, emanating from A in the first place and ending up back in A’s hands by virtue of the loan.
Any suggestion that the Phizackerley case is evidence that nil-rate band Will Trusts do not work is wide of the mark. The trusts themselves are not the issue. The issue is rather this: in what way are funds made available to the surviving spouse from the trust? If the funds are made available by way of loan, simply take care to check first whether the “circle of transfer” point applies before deciding whether to make a loan or an outright distribution. Much depends on which spouse dies first. Had Dr rather than Mrs Phizackerley died first, this issue would not have arisen.
This point is relevant in any trust where the trustees are considering making a loan to a beneficiary rather than an outright distribution. In particular it affects nil-rate band Will Trusts where assets are lent to the surviving spouse (sometimes called an “IOU” situation) rather than distributed outright, which is a route particularly favoured when dealing with the family home.”
Those involved in advising families on IHT and estate planning can take away two points from this case:
- Pause and reflect before proceeding to equalise the estates of spouses;
- Pause and reflect before advising trustees to make a loan to a beneficiary, to check if the “circular” point set out above applies
Tax and legislation are liable to change. This information is based on Standard Life’s current understanding of law and HM Revenue & Customs practice in the UK.
