Before the recent pension changes were announced, it made
sense, for Inheritance Tax (IHT) planning
purposes, to request that any death benefits payable from a money purchase
private pension on the pension scheme member’s death were paid into a separate
trust (a ‘bypass trust’), usually for the benefit of the member’s spouse and
family. Structuring matters in this way
would prevent what could sometimes be significant sums from being paid direct
to the surviving spouse, with the potential for any unspent funds to be taxed at
40% IHT on the surviving spouse’s death.
On the other hand, by using the trust route, the spouse could still
enjoy full access to the pension funds via loans made from the trust, which
have the potential to be deductible for IHT purposes on the survivor’s death.
Another attraction of this arrangement was that the trust
could have a class of beneficiaries, with no restriction on who appeared in the
class. Unborn grandchildren could be
included, for example. In contrast,
under the old pension plan rules, death benefits paid as drawdown income could
only be paid to a narrowly drawn list of the pension member’s dependants, not
including adult children over 23. But
under the new pension rules, the member (or subsequent beneficiary) can specify
anyone to receive flexi-access death benefit pension income – they no longer
need to be a dependant. And the fact
that they have the ability to draw down on those funds does not mean the funds are
in their estate for IHT purposes on death.
Does this mean that pension death benefit trusts can be
consigned to history? Not necessarily, I
think. It will depend upon each member’s
attitude to those important factors of tax and control.
First let’s look at the tax factor. This will depend on the age at which the
pension scheme member died. If under age
75, a lump sum payment (to a bypass trust or an individual) will be tax free. So will flexi-access income drawdown – if
taken. If the member died aged 75 or
over, the lump sum would be taxed at 45% in 2015/16. Flexi-access income drawdown will be taxed at
the recipient’s rate of Income Tax. It
certainly looks more attractive to pay a lump sum to a bypass trust if the
member dies before age 75.
If a lump sum is paid to the bypass trust, the funds then
representing the pension death benefits will be subject to the usual tax regime
applicable to trust income, capital gains and periodic charges to Inheritance
Tax. With trustees paying Income Tax at
45% on some income, this regime is none too friendly but can be managed with a
careful investment policy. None of these
issues apply if funds remain within a flexi-access account as until drawn they
will continue to accrue in the tax free wrapper that applies to pension schemes.
Now let’s look at the asset control factor. People concerned about asset protection and
control may be less keen on flexi-access pensions. This is because a named drawdown beneficiary
could remove the entire pension fund supporting their income stream and spend
it as desired. The fund would also be
exposed to claims on the beneficiary’s wealth from divorcing spouses,
ex-cohabitees or creditors of a failed business. The current nominated beneficiary can also
direct whom the pension fund passes to on their death. In contrast, the income stream from a bypass
trust of pension death benefits can be given to one beneficiary, say the
surviving spouse of a second marriage for their lifetime, and then reallocated
after that spouse’s death to the children of the deceased’s first marriage. The surviving spouse’s will cannot control
what happens to the bypass trust funds on the survivor’s death.
At the end of the day, in order to maintain IHT freedom,
the question of who receives flexi-access death benefits at any given time is
at the discretion of the pension scheme administrator. If families want to retain control of the
matter within the family unit, getting death benefits paid to a bypass trust,
coupled with well chosen, trusted family trustees, may be the preferred option.
Some pension members might like to keep their options open
by creating a bypass trust with a nominal sum now and lodging a letter of
wishes with their pension administrators requesting that they be guided by the
pension member’s executors as to whether to transfer death benefits to the
trust. As is often the way with estate
planning, there is no ‘one size fits all’ approach and pension members will
require bespoke advice.
Helena is indebted
to John Woolley of Technical Connection for his input into this blog.
