What is a Nil Rate Band Discretionary Trust? 

A Nil Rate Band Discretionary Trust (NRBDT) is a type of Trust that may be included in a Will. It allows assets up to the available Nil Rate Band to be placed into a Trust when someone dies. The Trustees then decide how and when those assets are used for the beneficiaries.

Nil Rate Band Discretionary Trusts were once commonly used by married couples and civil partners for Inheritance Tax planning. Changes to Inheritance Tax rules mean they are less commonly needed for this purpose today. However, many older Wills still contain them, and they can still be useful in certain circumstances.

 

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What is the Nil Rate Band?

The Nil Rate Band (NRB) is an Inheritance Tax allowance that allows you to pass on part of your estate without paying Inheritance Tax. The current allowance is £325,000.

Broadly, this means that the first £325,000 of a person's taxable estate can fall within the Nil Rate Band before Inheritance Tax becomes payable. Other exemptions and allowances may also apply. For married couples and civil partners, any unused percentage of the Nil Rate Band can normally be transferred to the surviving spouse or civil partner's estate.

There is also a Residence Nil Rate Band (RNRB), which may provide an additional allowance when a qualifying home passes to direct descendants, such as children or grandchildren. 

 

What is a Discretionary Trust? 

A Discretionary Trust gives the Trustees flexibility in how they use the assets held within it. Depending on the terms of the Will, Trustees may be able to decide:

• Which beneficiaries receive money or assets
• How much each beneficiary receives
• When payments are made
• Whether money is paid as a lump sum or in stages
• Whether conditions should apply to a payment

Unlike a beneficiary who has been left a fixed gift, someone named as a potential beneficiary of a Discretionary Trust does not necessarily have an automatic right to receive anything. The Trustees must make a decision in line with the terms of the Trust and consider the interests of its beneficiaries.

 

How does a Nil Rate Band Discretionary Trust work?

When someone with an NRBDT in their Will dies, assets up to the amount specified by the Will can pass into the Trust. The Will itself normally contains the terms of the Trust and sets out who the Trustees and potential beneficiaries are.

The Trustees then decide what should happen to the Trust assets. Depending on the wording of the Will and the family's circumstances, they may decide to retain and manage the assets within the Trust or distribute some or all of them to the beneficiaries.

The flexibility is one of the main features of an NRBDT.        

 

Why were Nil Rate Band Discretionary Trusts commonly used?

Before October 2007, a person's unused Nil Rate Band could not generally be transferred to their surviving spouse or civil partner. As a result, married couples and civil partners sometimes included an NRBDT in their Wills to make use of the first person's Nil Rate Band when they died. 

The rules changed in 2007, allowing any unused percentage of one spouse or civil partner's NRB to usually be transferred to the survivor's estate. As a result, an NRBDT is no longer necessary solely to preserve the first person's Nil Rate Band in many estates.

However, that does not mean an NRBDT in an existing Will should simply be ignored.

 

Why might an NRBDT still be useful? 

An NRBDT can provide flexibility beyond Inheritance Tax planning.

For example, it can give Trustees greater flexibility when providing for beneficiaries with different financial needs. It can also be useful where someone wants assets to remain available to a surviving spouse while helping to protect them for children or other beneficiaries in the future. This could be particularly relevant for blended families, where someone has children from a previous relationship.

A Discretionary Trust can also give Trustees greater flexibility to respond to circumstances that may not have been anticipated when the Will was written. 

 

What is a Letter of Wishes?

A Letter of Wishes may accompany a Will containing a Discretionary Trust.

It can explain how the person who made the Will hoped the Trustees would use their powers. For example, it might explain which beneficiaries they particularly wanted to support or the circumstances in which money should be distributed. However, a Letter of Wishes is generally not legally binding.

The Trustees must consider the terms of the Trust itself and use their own judgement when making decisions.

 

Can Trustees decide not to pay a beneficiary?

Potentially, yes.

The defining feature of a Discretionary Trust is that the Trustees have discretion over distribution, subject to the wording of the Trust. Being named as one of several potential beneficiaries doesn't necessarily guarantee an inheritance from the Trust. Trustees must exercise their powers properly and consider the interests of the beneficiaries as a whole.

 

What happens if an old Will contains an NRBDT?

Finding an NRBDT in a Will does not necessarily mean the Trust must continue exactly as originally anticipated. Tax legislation and family circumstances may have changed significantly since the Will was written. Depending on its terms, the Trustees may have several options for dealing with the Trust.

For example, they may be able to retain the assets within the Trust or appoint assets out to beneficiaries.

Trustees should understand the legal and tax consequences before making a decision. Once assets have been distributed, reversing that decision may not be straightforward.

 

Does a Nil Rate Band Discretionary Trust pay tax?

Potentially.

Most Discretionary Trusts fall within the Inheritance Tax-relevant property regime. This means Inheritance Tax (IHT) charges can potentially arise on ten-year anniversaries and when assets leave the Trust. Income generated by the Trust may also be subject to Income Tax. If Trustees sell or transfer assets that have increased in value, Capital Gains Tax may also need to be considered. 

Trust taxation can be complicated, so Trustees may wish to seek professional tax or legal advice before making distributions or changing how Trust assets are held.

 

What are the responsibilities of the Trustees?

Becoming a Trustee brings legal and administrative responsibilities. Trustees may need to:

• Understand and follow the terms of the Will
• Identify and protect Trust assets
• Consider the needs of all beneficiaries
• Keep clear financial records
• Manage investments or property
• Complete relevant tax reporting
• Register the Trust with HMRC where required
• Make and document decisions about distribution

Trustees should not simply make decisions based on what benefits one beneficiary, such as the surviving spouse. They need to consider their responsibilities towards everyone covered by the Trust.

 

Do you need professional help with an NRBDT?

Nil Rate Band Discretionary Trusts can be difficult to understand, particularly when they appear in a Will written many years ago. 

Changes to IHT legislation may mean that the original reason for creating the Trust is no longer as relevant. However, there may be other reasons why keeping the Trust is appropriate. Getting professional advice can help Trustees understand the choices available to them, their legal responsibilities, and the potential tax consequences before deciding what to do.

 

Final thoughts

A Nil Rate Band Discretionary Trust gives Trustees flexibility over how assets are managed and distributed after someone dies.

Although NRBDTs are less commonly used purely for Inheritance Tax planning today, they still appear in many Wills and can continue to serve other purposes. If you are an Executor or Trustee dealing with an NRBDT, it is important to understand the wording of the Will and consider the legal and tax implications before taking action.