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Nil Rate Band Discretionary Trusts – are they still useful?

October 30, 2023

Every individual is entitled to pass up to £325,000 inheritance tax free. This amount is known as the nil rate band.

Prior to 2007 nil rate bands were not capable of being transferred between spouses. Gifts to spouses were and remain exempt from inheritance tax. This meant that often spouses were advised to incorporate a nil rate band discretionary trust into their Wills otherwise the benefit of the nil rate band would be lost on the first death.

A nil rate band discretionary trust on the death of the first spouse would take £325,000 out of the estate and the beneficiaries would often be the spouse and their children. This meant that if the spouse needed the money, they could access it. This also could also mean that any children could inherit up to £325,000 inheritance tax free.

In 2007 the nil rate band of each spouse became transferrable and therefore it was no longer the case that it would be wasted if all was left to spouse. This means that if your Will has a nil rate band discretionary trust incorporated on the first spouse’s death and the nil rate band sum is paid out to any children, the nil rate band is used up. Therefore, instead of the second spouse being able to pass up to £650,000 inheritance tax free, they could only pass up to £325,000. If a nil rate band trust is in your Will, your estate could still wind up the trust and pay the funds absolutely to your surviving spouse, but this must be done within 2 years of your death. Therefore, from an inheritance tax perspective it may be more effective to remove a nil rate band discretionary trust from your Will.

There may, however, be certain situations where this type of trust would still be useful given your personal circumstances.

Vulnerable beneficiaries

If a beneficiary is unable to manage their financial affairs on their own or you are concerned that unwise financial decisions may be made, then it may be worth considering a nil rate band discretionary trust. The trust will have trustees who will control the release of any funds. This type of trust may also protect a beneficiary from losing their entitlement to any benefits that they are receiving.

Family dynamics

If you have children from a previous marriage, you may be concerned whether they will inherit from your estate if you die before your spouse. By putting the nil rate band into a discretionary trust, it would be up to the trustees to take into account the surviving spouse’s needs and balance them with your wish for your children to inherit. However due to the discretionary nature of the trust it is not guaranteed how much, if anything, your children would inherit.

Potential tax benefit – residence nil rate band

If your estate is above £2m then the residence nil rate band inheritance tax exemption may be lost. Depending on the value of your estate you may benefit from putting the nil rate band amount into a nil rate band discretionary trust in order to reduce the estate on the second spouse’s death below the £2m threshold. This would allow for the residence nil rate band exemption if the other conditions for the relief are met.

This area of law is complex, and your individual circumstances will determine whether a nil rate band discretionary trust is right for you. If you would like to speak to a Wills and Probate Solicitor, please call either our Solihull office on 0121 705 7571 or our Dorridge office on 01564 779393.

Sophia Kenna
Trainee Solicitor – Wills & Probate Department

This article is for general information purposes only. It does not constitute technical, financial, legal advice or any other type of professional advice and is no substitute for specific advice based on your individual circumstances. We do not accept responsibility or liability for any actions taken based on the information in this article. For more information, please click here.