Barry Foster takes a look at trust planning and discusses what we need to think about and consider when making these type of decisions…
The information contained in this page is for professional Financial Adviser use only.
The Residence Nil Rate Band (RNRB) will be introduced on 6th April and no doubt you have read plenty of articles and technical briefings on how and when the RNRB will apply. In this, the second of three articles, we will meet Boris and Michael and consider the use of trusts via a will and interaction with the RNRB.
As you will know, the RNRB only applies in respect of transfers on death and this can include bequests to certain types of trust. Legacies to the following types of trust can qualify for the RNRB to apply:
- Bare trust for a lineal descendant
- IPDI trust for a lineal descendant
- Disabled person's trust for a lineal descendant
- 18-to-25 trust
- Bereaved minor's trust (BMT)
Legacies to discretionary trusts, for example will not qualify.
When dealing with the administration of an estate (or when assisting the family, the executors and trustees of a deceased client) you are likely to come across trusts created via the deceased’s will. Often there will be a discretionary trust but you may also often find a qualifying interest in possession trust where an Immediate Post Death Interest (IPDI) has been created. In the following case study we consider why it is important to look at the wider financial situation of a couple when discussing the RNRB implications of an IPDI.
Boris and Michael are in a civil partnership and have children
Unfortunately, the level of trust in their relationship has broken down in recent times!
They are considering re-writing their wills as they are now reluctant to leave all of their assets to the survivor but they do still want to ensure financial security of the survivor when it comes to the family home that they share.
They would like to protect their assets tax efficiently on death, and they are also keen to protect their legacies to their children.
They own their home as tenants in common but have always kept their other finances separate and private from each other. Their home is valued at £800,000.
Unfortunately, Boris dies in June 2017 and his will provides that most of his estate is distributed equally between all of his children. However, he leaves his share of the family home on trust for Michael for life and then their adopted children on Michael’s death.
The transfer of Boris’ share of the house on trust for Michael creates an IPDI. As such the transfer is IHT exempt because the value of this type of trust is included in the life tenant (Michael’s) estate. This means that Boris has not used his RNRB on his death but, by virtue of the exempt transfer to Michael, it is preserved to be transferred to Michael.
What was Boris hoping to achieve by this planning:
- To protect Michael’s continued and unchallenged residency in the house
- To restrict Michael’s access to the capital value of the property so as to…
- To protect the value of the house for their children.
- To protect the RNRB so that Michael’s executors can claim 100% uplift when he eventually dies.
There is a problem!
Boris did not know how wealthy Michael was! When Michael dies in May 2020 his privately owned assets are valued at £2,000,000, however the value of the IPDI trust is included in the total value of Michael’s estate.
Assuming no growth in the value of the house there is a settled property component to Michael’s estate of £400,000. The total value of his estate is therefore £2,400,000.
What is the impact on RNRB?
Michael’s executors can offset his own Nil Rate Band (NRB) against the value of his estate but there is no Transferable NRB from Boris as he had used his NRB on his death (the legacies to his children).
This was understood and accepted but Michael was expecting to have 100% uplift on his RNRB as a result of Boris’ IPDI planning and in, September 2020 this would mean an additional £175,000 RNRB.
However, the problem is that Michael’s estate is over £2,000,000 the RNRB is tapered away:
- £400,000 excess over £2,000,000 results in £200,000 tapering of the RNRB.
Not only has Boris’ planning failed to provide Michael with 100% uplift to the RNRB it has actually caused Michael’s own RNRB to be tapered from £175,000 to £150,000!
What might Boris have done differently?
He could have considered having his share of the house transferred to a discretionary trust on his death, with Michael as a potential beneficiary and a letter of wishes to the trustees (who could include Michael) indicating that he would like them not to object to Michael continuing to reside in the property for life.
As Boris’ interest in the property does not pass to a direct descendant on death via the discretionary trust he will not have used his RNRB and it would therefore be possible for Michael to have a 100% uplift to his RNRB. Michael’s estate would not include the value of Boris’ share of the property so should avoid tapering of the RNRB.
There is still a problem, however, as the discretionary trust would attract IHT (as it would not be an exempt transfer to a registered legal partner). The IHT payable on Boris’ death would exceed the IHT at stake should he use opt for the IPDI solution!
It is possible therefore that the IPDI was the most suitable and appropriate solution after all but failure to identify (and document!) that Michael may suffer tapering of the RNRB might lead to a complaint from Michael’s beneficiaries that other options were not adequately considered.
What other options?
Subject to being in a position to make lifetime transfers, both Boris and Michael could have considered lifetime gifts. The gifts would not only be outside of the estate immediately (significant for calculating the value of their net estates for the purposes of tapering of the RNRB) but would also be out of account for IHT purposes should they survive the gifts by seven years.
Assuming they do not survive the gifts by seven years their gifts would still be on account for IHT but they would be out of the estate. For example, if Michael had made lifetime gifts of £400,000 after Boris’ death his estate would not exceed £2m and there would be no tapering of the RNRB. Although the amount subject to IHT on Michael’s death would still be £2,400,000 (£400,000 lifetime gift and the £2m estate) Michael would have his NRB and 2 X RNRB which would reduce the IHT bill.
Trust planning options
Michael may not be in a position, or willing to give away £400,000 on Boris’ death simply to reduce the IHT liability on his death.
Being able to retain the right to an ongoing income from the funds via a Discounted Gift Trust may provide a suitable solution. The chargeable lifetime transfer would take the funds out of Michael’s estate immediately, a discount may apply in respect of the transfer should he die within seven years and, depending upon the level of discount, Michael may be able to transfer £400,000 to the trust without incurring an entry charge as would be the case with a discretionary gift trust.
In the next article we meet David and Georgina who have individual estates below the £2million threshold for tapering of the RNRB but currently plan to leave everything to the survivor on first death. On second death the survivor’s estate will be in excess of the £2 million threshold and tapering will apply. We will consider some options available to them.
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The information contained in this page is for professional Financial Adviser use only. If you are a private investor, please visit the Private Investor section or contact your Financial Adviser for more information.