Spousal Bypass Trusts – Pension death benefit planning

In April 2015 the taxation of pension death benefits changed dramatically.

To keep this as simple as possible, I will not detail the previous tax regime, but needless to say, the current regime is more generous in the hands of the recipient.

Currently, pension death benefits are taxed as follows:

• Lump sum benefits and income arising from death before the age of 75 are tax-free. This is providing the money is ‘designated’ to drawdown within two years of the pension provider being informed of death.
• When death occurs on or after the 75th birthday, lump sum benefits and income are taxed at the recipients’ rate of income tax.
• Beneficiary drawdown is a new part of the post-2015 pension landscape. It allows the death benefits from a pension to remain in the pension wrapper and taken as income.
• As described above, this is free of income tax if you die prior to age 75 and taxed at the recipients’ rate of income tax if you die after age 75.
• This money is not considered to form part of your estate for the purpose of inheritance tax but is considered part of the recipients’ estate once paid out from the scheme.
• Money that remains in the pension can be passed down again and not form part of the recipients’ estate.

Spousal bypass trusts were previously recommended to avoid the death benefit lump sum being paid to the spouse which would then form part of their taxable estate on death. On the face of it, the new pension landscape has largely removed the need for such trusts.

The issue, and why spousal bypass trusts can still be of use, is one of control.

If your expression of wish is for your pension scheme death benefits go to your spouse, or any other member of your bloodline, control of the fund passes to them.

As an example, should your spouse remarry or have children from a previous relationship, they could have any remaining money passed to the new spouse and or their children, meaning that the money can move outside of your bloodline.

In another example, should a child divorce, assets in a beneficiary drawdown plan in their name could be available as part of any financial settlement. This is not the case with a spousal bypass trust.

A bypass trust means that the money in the pension can be paid to a Discretionary Trust on your death.  The nominated trustees can then decide who, how and when the money from the Trust is paid.

You, by selecting the terms of the trust in your lifetime, retain the control over the funds after your death.

The problem is that payment of death benefits to a ‘non-individual’ i.e. a Trust, after age 75 will be subject to a 45% special lump sum death benefit tax charge. However, this tax charge may be reclaimable.

We also need to consider the capital gains tax charge applied to trusts which is applied at a rate of 20% for any gain over and above the trust annual allowance of £5,850.

Furthermore, that inheritance tax periodic charges may apply every ten years and exit charges may apply when distributions are made.

The use of a Spousal Bypass Trust will very much depend upon your wishes, concerns and what you want to achieve.

If your spouse does not need the money from the pension, then a simpler solution would be to nominate your children as the beneficiaries of the pension.

If, however, your spouse may need the money in the pension and you would like any remaining assets in the pension to stay in your bloodline, then a Spousal Bypass Trust with Trustees whom you trust to execute your wishes, might be an alternative, being aware of course of the additional tax implications.

You should be aware that the Trustees of the pension scheme are not legally bound to follow the wishes of your expression of wish, but they are more than likely to do so.

You could consider nominating a different percentage to different people, for example having 40% to each of your children and 20% to a Spousal bypass trust.

This approach would ensure that your children get the majority of the pension assets and should your spouse need funds upon your death, the Trustees of the Trust can decide whether that is aligned to your wishes and intentions.

If you already have a spousal bypass trust in place and wish to disregard it, you simply need to ensure that the expression of wish you have does not reflect the fact that you want the benefits paid to the Trust.

It’s important to seek professional financial and legal advice before making a decision, as this could have a significant impact on the taxes paid by your family.

If this article has spiked an interest, and you’d like to discuss pension death benefit planning in more detail, please do get in touch.