Mark McLaughlin warns of a potential IHT problem when dealing with ‘nil rate band’ legacies in wills.
The inheritance tax (IHT) allowance (or 'nil rate band') (£325,000 for 2021/22) is generally available to individuals. For married couples (and civil partnerships), the transferable nil rate band (TNRB) rules broadly allow claims for unused nil rate band of a deceased spouse (or civil partner) to be transferred to the survivor.
The survivor's nil rate band can be increased by up to 100% or one additional nil rate band. Thus, a surviving spouse's nil rate band can increase to a maximum of £650,000 (n.b. ‘residence nil rate bands’ are not considered in this article).
How many?
Some individuals have wills with legacies (e.g. to a family discretionary trust) up to the amount of their available nil rate band. However, care is needed with the wording of the will.
For example, if the surviving spouse’s will leaves a sum ‘that is equal to an amount that will not give rise to an IHT charge’ to the trust, in HMRC’s view that amount will include any nil rate band transferred from the first spouse to die (see HMRC’s Inheritance Tax manual at IHTM43065).
Consequently, in the above example, if the trustees distributed trust assets to a beneficiary before the trust’s first ten-year anniversary an IHT ‘exit charge’ could result, due to how the IHT is calculated.
What does it mean?
The inclusion of the transferred nil rate band from the first death with the survivor’s own nil rate band can also cause difficulties in interpreting the survivor’s intentions in their will.
For example, in Loring v Woodland Trust [2014] EWCA Civ 1314, the deceased died on 1 September 2011. Her will included the following nil rate band clause (with the residue being left to charity):
“My trustees shall set aside out of my residuary estate assets or cash of an aggregate value equal to such sum as is at the date of my death the amount of my unused nil rate band for Inheritance Tax and to hold the same for such of the following as shall survive me….”
The net value of the deceased’s estate was £680,805. She survived her husband. Her personal representatives claimed her husband’s TNRB in full. The question was whether the effect of the above will clause was to pass £325,000 (i.e. the deceased’s nil rate band) or £650,000 (i.e. both spouse’s nil rate bands) to the beneficiaries under that clause (i.e. members of the deceased’s family). The residuary gift to charity was therefore either £355,805 or £30,805.
The charity contended that the family was only entitled to the deceased’s nil rate band of £325,000, and not her husband’s transferred nil rate band as well. This would increase the gift to the charity. The family argued the opposite, such that the legacy to them was £650,000.
The Court of Appeal concluded that the clause should be construed to mean that the legacy to the family members amounted to £650,000, being the amount of the enhanced nil rate band, and dismissed the charity’s appeal.
Practical tip
HMRC’s guidance (at tinyurl.com/HMRC-IHTM43065) includes specimen will clauses, together with comments by HMRC about which clauses are effective to pass unused nil rate band and which are not. However, best practice is for wills to be prepared by suitably qualified and experienced professionals and to avoid using ‘homemade’ wills.
