Introduction

A will is essential in order to ensure that wealth is left in a way that meets the testator’s objectives and best suits the inheriting family and/or friends of the individual concerned. Failure to execute an appropriate will can cause additional expense for the surviving family and friends, and so it is generally preferable for a will to be professionally drafted. 

Inheritance Tax (IHT) may need to be considered when drafting a will to assist in preserving family wealth for future generations. This note considers the IHT position on death, taking into account clauses commonly included in wills. It is most suitable for UK domiciled individuals. Additional points need to be considered by non-UK domiciled individuals. Different considerations may also apply if agricultural or business assets are held. Information on these matters is available separately.

Throughout this note, references to a spouse should be taken to include references to a registered civil partner.

Use of the nil rate band

Every individual is entitled to a nil rate band which can be set against their estate. 40% IHT is payable to the extent the value of the estate exceeds the available nil rate band, unless IHT reliefs or exemptions are available. Notably, UK domiciled spouses are able to leave an unlimited value of assets to each other IHT-free, albeit IHT may arise on the second death. 

The nil rate band is frozen at £325,000 until 5 April 2028. On death, the nil rate band is offset against lifetime gifts when calculating the IHT due on those gifts, before being offset against the value of the assets the individual owned on death.  

If a married individual does not use their entire nil rate band on death, the remaining percentage can be transferred to their surviving spouse for use on their eventual death.

Part of the nil rate bands available to a couple will be wasted if one of the spouses has insufficient assets to utilise the nil rate band(s) available on their death. With this in mind, it is essential that the terms of any will in place are checked, as many wills contain a survivorship clause such that a spouse will not inherit if their death occurs within a short period of the first death. A 30 day period is common. The interaction of this clause with the transferable nil rate band rules may mean that the surviving spouse cannot utilise the entire nil rate band available on their death. An example illustrating this point is below. 

Example

• Mr and Mrs Smith, a married couple, have wills that leave everything to each other and include a 30 day survivorship clause. Both nil rate bands are fully available as no gifts have been made in the last seven years. The residence nil rate band (see below) is not available to them. 

• Mr Smith has assets of £570,000 in his own name and Mrs Smith has assets of £80,000 in her own name.  

• Mr Smith dies and this is followed by Mrs Smith’s death within the next 30 days, so no assets pass to Mrs Smith.

The IHT payable by Mr Smith’s estate is as follows: 

Value of estate                £570,000

Less: nil rate band         (£325,000)

Chargeable                      £245,000

IHT @ 40%                         £98,000

Mrs Smith’s estate is worth less than the nil rate band so no IHT is due on her death. Her unused nil rate band is £245,000. 

IHT liability (no survivorship clause)

If there were no survivorship clause, all of Mr Smith’s assets would have passed to Mrs Smith on his death. The value of her estate on her death would be £650,000 (£570,000 plus £80,000). Mr Smith did not use any of his nil rate band (as the spouse exemption was available), so Mrs Smith is entitled to both her nil rate band and his unused nil rate band, totalling £650,000. As a result, no IHT is payable by the couple’s estates, compared to £98,000 when a survivorship clause was in place. 

Whilst it may be unlikely that both deaths would occur so close together, the potential for this to happen should be considered.  

Residence nil rate band

An additional nil rate band applies where an individual leaves their residence to a direct descendant, such as a child or grandchild. The residence nil rate band has been £175,000 since 6 April 2020 and is frozen until 5 April 2028. 

Individuals can leave up to £500,000 to their descendants without an IHT liability, taking into account both the £175,000 residence nil rate band and standard £325,000 nil rate band. 

The available residence nil rate band is tapered for estates that are worth more than £2million on death. £1 of residence nil rate band is removed for each £2 of the value of the estate over £2million, which means that, presently, the £175,000 residence nil rate band is reduced to nil for estates worth £2,350,000 or more. 

The residence nil rate band is transferable between spouses, in the same way as the standard nil rate band. It should be borne in mind that, if the second spouse inherits the assets of the first spouse, the available residence nil rate band may be reduced for the estate of the second spouse if the inheritance increases the value of their estate such that tapering applies. 

A form of downsizing relief is available where a previous main residence is or was sold on or after 8 July 2015. The rules are complex, and advice should be taken if this may be relevant. 

Providing for your spouse

Apart from concerns about using the nil rate band efficiently, it is important to ensure that a will makes adequate provision for the testator’s family and in particular for any surviving spouse. Several options are available including outright gifts and creating a settlements on death under the terms of a will. 

If a settlement is being considered, then whilst this could include the creation of a discretionary trust, a more attractive solution in many cases is an Immediate Post Death Interest (IPDI) trust. Here the gift will qualify for the spouse exemption, so that in most cases there will be no IHT to pay on the death of the first spouse. The surviving spouse must be entitled to receive the income arising under the trust. The value of the assets in the trust will be within the surviving spouse’s estate, and so IHT may arise on their death. Further detail on the tax position of IPDI trusts is included below.

Settlements for minor children

Parents and grandparents often wish to provide for their children or grandchildren by way of a trust set up by their will. The most popular choices of trusts currently available to parents and grandparents are set out below. 

Choices for grandparents

The choice of will trusts for grandparents is limited to the options below. 

Bare trusts

The trustees of bare trusts hold the income and capital absolutely for the beneficiary. A minor beneficiary will become absolutely entitled to the trust capital and any accrued income at age 18. Ongoing income and gains are taxed on the beneficiaries, so their personal allowances and capital gains tax annual exemptions can be used against this income and gains. No ongoing IHT charges will be payable and the property held on trust for the beneficiary will be within their estate for IHT purposes. 

Discretionary trusts

A discretionary trust is a trust under which a class of beneficiaries may potentially benefit, but no beneficiary has a fixed entitlement to income or capital. It is therefore a very flexible arrangement. Trustees will need to pay income tax and capital gains tax at the highest rates of tax on most income and gains they make. The property held on trust will not be within any of the beneficiaries’ estates, though IHT charges may arise every ten years and/or on distribution of assets from the trust (though there is an exception from this where assets are distributed from the trust within two years of the testator’s death – see the section on discretionary will trusts below). 

Immediate Post-Death Interest (IPDI) trusts

An IPDI is a trust created by will under which a beneficiary has the right to receive the income of the trust. The beneficiary will pay income tax on the income to which he or she is entitled at their marginal income tax rate. The trustees will pay 20% capital gains tax on most capital gains they make, however a 28% rate applies to the disposal of residential property and carried interest in private equity structures. IPDI trusts are not subject to the ten year and exit IHT charges that apply to most other types of trust. However, the trust property is treated as forming part of the beneficiary’s estate for IHT purposes and could be subject to IHT on their death.

Further choices for parents

The choice is wider for parents and in addition to the three trusts above includes the trusts below. 

Trusts for Bereaved Minors (TBM)

These are usually established on the death of a parent while the child is under 18. The child must become entitled to the income and capital of the trust at age 18. Until then the child could have a right to receive trust income, though this is not required. The trust income can only be applied for the maintenance or benefit of the child. The income and capital gains tax position while the beneficiary is a minor will be as set out for discretionary trusts above, though if the beneficiary is entitled to receive trust income the tax analysis would instead be as set out for IPDIs above. 

TBMs are not subject to IHT ten year and exit charges, so trust assets can be distributed absolutely to the beneficiary without a charge to IHT. Once distributed, the trust property forms part of the child’s estate for IHT purposes.

18-to-25 trusts

These are similar to TBMs except the beneficiary need not become absolutely entitled to the trust income and capital until age 25. However this extra protection comes at an IHT cost. IHT exit charges apply between ages 18 and 25, such that a distribution at age 25 will attract a maximum IHT charge of 4.2% of the value of the trust’s assets.

The income tax, capital gains tax and IHT treatment of each of the above options varies significantly. If you wish to provide for your children or grandchildren in your will it is important that you discuss your circumstances in detail with your Deloitte contact and legal adviser, to ensure that the strategy put in place is suitable. 

Discretionary will trusts

Some individuals may not wish to commit to a set distribution of assets in their will, instead retaining flexibility over how their assets will be distributed. 

If assets are left to a discretionary trust but are distributed by the trustees within two years of death, the distributions are effectively treated for IHT purposes as though the will had provided for outright gifts to be made to the recipient(s) of the trust distributions. This can therefore provide extra flexibility where the individual is not yet certain to whom he or she would like to leave assets. The income tax and capital gains tax positions where assets are distributed by trustees in these circumstances may vary from the positions which would have applied had outright bequests been made. 

Trust register 

Individuals who are considering setting up a trust should be aware of HMRC’s trust register. Most UK trusts and some non-UK trusts must register with HMRC. Information held on the register is generally available to members of the public with a “legitimate interest” in the information, or in some cases more broadly where the trust has a controlling interest in a non-UK, non-EEA entity. Exemptions from disclosure can apply where beneficiaries are minors, lack capacity (as defined) or where HMRC consider that disclosing information would present a risk of harm to people associated with the trust. 

Some non-taxable trusts do not need to register with HMRC, including trusts that are created under a will and wound up within two years of death. 

Bequests to charity

Many individuals consider including a bequest to charity in their wills. Gifts to qualifying charities are exempt from IHT. Furthermore if at least 10% of the individual’s net estate is left to charity, the IHT rate for the remainder of the estate is reduced to 36%. A separate briefing note is available on request.