Mark McLaughlin, CTA (Fellow), ATT (Fellow), TEP, offers some useful inheritance tax planning points, as well as guiding you through the pitfalls surrounding the transferable inheritance tax nil rate band.
The inheritance tax (IHT) transferable nil rate band (TNRB) provisions broadly allow a claim for all or part of unused IHT allowance (or ‘nil rate band’) on the death of a spouse (or civil partner) to be transferred to the survivor (ss8A-8C, Inheritance Tax Act 1984 (IHTA 1984); all references are to IHTA 1984).
The TNRB facility can help prevent the nil rate band of the first spouse to die being left unused and therefore wasted. A common reason why the nil rate band is likely to be unused on the first death is that a deceased spouse leaves their entire estate to the surviving spouse. However, the spouse exemption is subject to potential restriction if the recipient spouse is not domiciled in the UK (see s18(2)).
The residence nil rate band (ss8D-8M) can contribute to an effective IHT threshold of £1m per married couple or civil partnership (ie, £325,000 plus £175,000 per individual), if available. Unused residence nil rate band is transferable to a surviving spouse or civil partner upon a successful claim being made. However, this article focuses on the ‘standard’ TNRB.
The TNRB applies on the death of the surviving spouse (or civil partner). Hence the survivor should not try to set extra nil rate band against a chargeable lifetime transfer (eg, a gift to a discretionary trust). The deceased’s nil rate band is not available on that occasion.
Should the surviving spouse die within seven years of a chargeable lifetime transfer, an extra nil rate band might then be available to reduce any additional IHT on the lifetime gift. However, the TNRB facility does not provide an opportunity to claim a refund of any lifetime IHT paid.
Previous marriages, etc
If a surviving spouse was married more than once and their deceased spouses did not use up their nil rate bands on death, the survivor’s estate can generally make a claim in respect of each previous spouse. However, the nil rate band of the surviving spouse’s estate can only be increased by 100%, or one additional nil rate band (s8A(6)(b)).
In some cases, the deceased spouse may have been married before, but a claim for the TNRB was not made because the deceased’s estate was covered by their own nil rate band.
Helpfully, there is a provision to deal with such circumstances. It allows those entitled to make a claim on the death of the surviving spouse to also make a claim in respect of their deceased spouse if appropriate, provided the IHT position in respect of the first person to die is unaffected (s8B(2)).
Example 1: Earlier deaths
Charles died on 1 May 2021. He had been married to Bernice for nearly 20 years, until her death in December 2019. Bernice was previously married to Arnold, who died in June 1996. Arnold left his modest estate to Bernice.
In her will, Bernice left her entire estate of £227,500 to a discretionary trust for the children and grandchildren from her marriage to Arnold. Her TNRB was therefore £97,500 (ie, 30% of £325,000). As her estate was below the nil rate band, there was no need for a claim to transfer unused nil rate band from Arnold’s death.
On Charles’ death, his personal representatives can claim not only Bernice’s unused nil rate band (30%), but also Arnold’s (100%), subject to an overriding limit of 100% or one additional nil rate band (£325,000).
Married or single?
In some cases, an unmarried couple may have up to four nil rate bands available between them. For example, both individuals might have been married and widowed previously, and a TNRB may be available from their deceased spouse. By remaining unmarried and leaving their estates to chargeable legatees (eg, each other), it may be possible to utilise their own nil rate band, plus the transferred nil rate band of their deceased spouse (ie, £650,000 each).
However, suppose the couple decided to get married?
Example 2: Tie the knot – or not?
Dennis, a widower aged 80 with three adult offspring, inherited his wife’s estate on her death in November 2012. Dennis has an estate worth £800,000.
Erica, a widow aged 78 with two adult children, inherited her late husband’s estate in March 2014. Her own estate amounts to £700,000.
The long-term friendship of Dennis and Erica blossomed into love. In January 2018, they decided to live together. They are now considering marriage and having wills drafted to leave everything to each other.
However, this would result in the nil rate band of either Dennis or Erica being potentially wasted on the first of them to die; the same would apply to the nil rate band of the spouse from their first marriage. This is because the surviving spouse’s maximum TNRB entitlement had already been reached from their first spouse.
If Dennis and Erica did get married, they could consider leaving legacies to chargeable beneficiaries (eg, their children) on the first death, sufficient to use the deceased’s nil rate band plus the TNRB from that individual’s first marriage.
It is not uncommon for the deceased’s will to create a nil rate band discretionary trust (NRBDT). For example, in the case of wills pre-dating the introduction of the TNRB provisions, if each spouse or civil partner owned sufficient assets to constitute their nil rate band, their estates could be sheltered from IHT up to an amount equal to the nil rate band; this was often achieved by legacies to a NRBDT for family members.
Some care is needed concerning wills referring to legacies by reference to the nil rate band, particularly for surviving spouses with the benefit of an additional nil rate band transferred from the first spouse to die.
For example, if the will of a surviving spouse or civil partner leaves a sum ‘that is equal to an amount that will not give rise to an IHT charge’ to a family discretionary trust, in HMRC’s view that wording provides for an amount including transferred nil rate band (see HMRC’s Inheritance Tax Manual at IHTM43065). When calculating an IHT ‘exit charge’ of the discretionary trust before its first 10-year anniversary, if the historic value of the trust is greater than the single nil rate band applicable when the property leaves the trust, there will be a positive rate of tax (under s68(1)), and an IHT liability generally arises on the exit.
The inclusion of the transferred nil rate band from the first death with the survivor’s own nil rate band can also cause difficulties when trying to interpret the survivor’s intentions in their will, such as where a charity is a residuary beneficiary (eg, see Loring v Woodland Trust  EWHC 4400 (Ch)). Careful drafting is needed.
The IHT rule on survivorship clauses (s92) provides that where (under the terms of a will or otherwise) property is held for someone (‘A’) on condition that they survive another person (‘B’) for a period of not more than six months, and B becomes entitled to the property because it transpires that the six month survivorship condition was not satisfied by A, the IHT position is the same as if B had been entitled to the property in the first place.
Caution is needed with survivorship clauses, especially where the deceased spouse has a large estate, but the surviving spouse has very little. The result of assets not passing to the survivor could be that chargeable value passes to the next generation on the first death that exceeded the nil rate band, which, had it been channeled through the estate of the surviving spouse, might have benefited from that survivor’s unused nil rate band.
About the author
Mark McLaughlin, CTA (Fellow), ATT (Fellow), TEP is a co-author of Inheritance Tax 2021/22 and Ray and McLaughlin’s Practical IHT Planning (Bloomsbury Professional)