New main residence nil rate band may require a change of approach

The government’s decision to introduce a new main residence nil rate band allowing homeowners to pass on their property or some of its value to the next generation without paying inheritance tax will require a change of approach on the use of ‘discretionary trusts’.

With effect from April 2017, the government is gradually introducing a main residence nil rate band which will eventually be worth an additional £175,000 per person by 2020/21. Its introduction allows married couples and civil partners to pass on assets worth up to £1 million including the main residence to their direct descendants, without paying any UK inheritance tax.
While the move is welcome news in that it will make it possible for many people to leave more of their assets to their descendants free from any inheritance tax, some could miss out on this opportunity due to the inclusion of a ‘discretionary trust’ clause in their will.

Private Client Advice

To avoid being caught out in this way, private clients should be advised to review their wills to ensure they are not using ‘discretionary trusts’ in a way that could disadvantage them from an IHT planning perspective. Historically, many married couples chose to include a clause allowing the creation of a discretionary trust for their children or grandchildren upon first death to use their IHT nil rate band, otherwise it was lost. However, when the law changed in 2007 allowing married couples and civil partners to transfer their IHT nil rate band allowance to the surviving spouse or partner, this clause was rendered redundant in most cases.

Whilst a simple amendment is usually sufficient to solve the problem and allow couples to pass on more of their wealth tax-free, it is important to take advice, as depending on the personal objectives of the individuals concerned, a ‘discretionary trust’ may still be the best option. An estate can also lose the main residence nil rate band if the value of their assets are worth more than £2million in total, so again a discretionary trust may remain a viable option in those circumstances.

Advice for the Private Client Adviser

For the adviser, the introduction of the new family home allowance is a classic door opener; another opportunity to remind clients about the need to review their IHT planning regularly. This is especially important in an area like inheritance planning due to the natural reluctance that many people have to discussing the subject. Now there is a positive reason to do so.

Other trusts are unlikely to raise similar inheritance tax implications. For example, ‘bare trusts’ will not be excluded from the new allowance as long as they are held for direct descendants. In addition, ‘Interest in Possession (IIP) trusts, which could be created on first death , should also not be excluded from the main residence nil rate band. An IIP trust gives a right to receive income from the trust to the life tenant (usually the surviving spouse) but ensures the trust capital passes to the residuary beneficiaries (usually the children); this is a helpful structure to protect your legacy in cases when the surviving spouse remarries.

Of course, when considering making any alteration to someone’s will, it is important that advisers fully understand their clients’ wishes. Only once their position is understood and protected, should the adviser suggest ways to reduce their IHT liability. Taking action now, however, could bring significant benefits for clients and their families as well as helping to remove any hassle for executors when the time comes.

For further information, please contact Craig Hughes on chughes@menzies.co.uk