Post-mortem tax planning: Deed of variation

The issue: Before the introduction of the transferable nil rate band (NRB) on 9 October 2007, if a husband or wife died but did not use their NRB it would normally have been lost. The failure to use the NRB could have happened by virtue of a joint ownership of property automatically passing under survivorship, or deliberately through the will of the deceased providing for the surviving spouse or civil partner. Assuming the receiving spouse or civil partner was UK-domiciled, this transfer would have been IHT free. However, it would potentially create a larger second death liability as the combined estate would only benefit from one NRB.

The solution: With good legal advice, both spouses’ or civil partners’ will(s) could have included wording to set up a discretionary NRB will trust so that, upon the first death, the value of their estate up to the NRB at the point they died would be placed in a discretionary trust. The surviving spouse or civil partner could be a potential beneficiary. Because the surviving spouse or civil partner does not inherit directly, no value adds to their estate and no PET or CLT (chargeable lifetime transfer) needs to be made.

A particularly beneficial situation can apply when a surviving spouse or civil partner remarries. This is because, on their death, the total value that can be carried forward is 100% of one residence nil rate band (RNRB), albeit this could be, for example, 30% from one spouse or civil partner and 70% from another, according to how much RNRB was not used on the death of former spouses or civil partners.

However, optimum planning would entail, on the first death, the transferable NRB being relied upon and the new spouse or civil partner undertaking a discretionary NRB trust so, effectively, two NRBs would be alienated from the estate as well as the NRB of the last person to die.

The value of a DoV: If a discretionary NRB will trust was not written into the deceased spouse or civil partner’s will during their lifetime, a well-advised surviving spouse or civil partner could, within two years of receiving from their deceased partner, undertake a DoV of what they had received, up to the value of the NRB, in favour of a discretionary trust. For IHT purposes, this variation and subsequent trust would be seen as having been created by the deceased therefore using their NRB, and once again the surviving spouse or civil partner could be included as a potential beneficiary under the trust without a gift with reservation (GWR). As a GWR only arises where an individual makes a lifetime transfer but retains a benefit in the gifted property, here the surviving spouse or civil partner is not making a lifetime transfer. This is because it is deemed as passing straight from the first spouse or civil partner to a discretionary trust.

Another planning opportunity arises when a surviving spouse or civil partner, when receiving everything from the deceased, instead transfers some or all of that inheritance into a power of appointment trust by way of a DoV. This would create an ‘immediate post-death interest’ (IPDI), from which the surviving spouse or civil partner could enjoy income, while the trustees could advance capital to other beneficiaries, affecting a PET from the surviving spouse or civil partner yet maintaining the transferable NRB from his or her former partner.

Finally, because the interspousal exemption negates the benefit of passing business relief (BR) qualifying assets to a spouse or civil partner (BR is essentially wasted), the assets could instead be transferred to another beneficiary. This would mean no IHT would be payable on the transfer as BR would negate it.

The benefits of planning: Although the transferable NRB legislation, effective 2007, initially made this planning look redundant, there can be advantages to creating a discretionary NRB will trust or, alternatively, diverting assets into a trust via a DoV.

A discretionary NRB will trust can provide three significant benefits above a transferable NRB.

1. Where the growth in value of the assets in the trust is expected to be greater than the growth in value of the NRB between the first and second death. Given the NRB reached £325,000 in 2009-2010 but is set to be frozen until 2030, any growth in the value of the assets of the NRB discretionary trust is effectively outside of the estate, rather than growing in an estate with a frozen NRB.
2. Whereas the discretionary trust route keeps growing wealth outside the surviving spouse or civil partner’s estate, it also could mean that it preserves the RNRB. This is because the RNRB tapers out on the basis of £1 for every £2 for an estate in excess of £2m, so relying on wealth transferring from the first to die to the surviving partner has a great chance of swelling the second estate rather than wealth transferring into a discretionary NRB will trust on the first death.
3. Because the transfer to the trust is not made by the surviving spouse or civil partner, the value in that trust cannot be considered as theirs by the local authority for long-term care purposes or by other creditors.

Where the same planning is instead undertaken by a DoV the first two benefits can apply, but it is possible that the surviving spouse or civil partner undertaking a DoV to a trust could be considered to have deliberately deprived the estate, particularly if soon thereafter there is a claim for long-term care funding.  

The issue: With increasing life expectancy, adult children often inherit later in life. This can mean that the deceased’s children, the most common beneficiaries, are often of an age at which they do not require the use of the inheritance. Should they choose to receive it and subsequently gift it, this would, of course, be a PET and the tax-free status of that PET would hinge on the donor living seven years beyond the date of the gift. An additional consideration is that the recipients of that PET would be able to enjoy the gift without restriction, which may not be desirable.

The solution: An alternative way to treat the inheritance would be a DoV in favour of the deceased’s grandchildren, so that a PET by the original recipient isn’t required. Albeit, as above, this does not prevent the new recipients doing as they wish with their new wealth.

One way to plan is for the original recipient to undertake a DoV into a discretionary trust. This has four possible benefits.

1. The person varying the asset to the discretionary trust can be a discretionary beneficiary of the trust, so the wealth could be appointed to them at a future date without a GWR.
2. Control can be exercised as to when benefit is passed on, and to whom.
3. The value does not sit inside the estate of the original recipient, thereby potentially reducing the threat of the RNRB tapering away.
4. Further planning can be achieved, where a discretionary trust has been established by way on a DoV or by a will, so that a discretionary beneficiary may be granted a loan rather than a direct distribution from the trust. This would mean that upon death their unprotected estate would be reduced by replenishing the loan from the trust, which sits outside their estate.