Death benefit nominations indicate to the pension administrators/trustees who you would like to benefit from your pension in the event of your death. In many situations, this way of passing pension benefits on is entirely suitable, however where there are more complex situations it may be useful to deploy the use of a Bypass Trust which provides an enhanced level of control and flexibility over the distribution of your pension on death, whilst maintaining some important tax advantages associated with pension death benefits.

Bypass Trusts can be useful in several scenarios, the major ones being:

Where the pension member has a complicated family situation:

When you nominate someone to be a beneficiary of your pension, on your death (subject to the pension’s approval) they would have an outright entitlement to the death benefits and, on their subsequent death, would be able to nominate whoever they chose, even if this would not have been in line with the original member’s wishes.

Scenario: Oliver is married to Jill, who has children from a previous marriage. If Oliver nominates Jill to receive his pension death benefits, she could in turn leave them to her children which may not have been Oliver’s original intention. If a Bypass Trust were used, Oliver could tell the trustees that Jill is to be allowed access to trust monies during her lifetime and that, on her death, any remaining capital was to be distributed in line with Oliver’s further wishes.

 Where there are young or vulnerable beneficiaries:

It may be that you want to leave your pension death benefits to someone who may not be in an appropriate position to receive full access to the benefits. This could be due to factors such as age, health and lifestyle.

Scenario: Charlie is recently widowed, making him the sole parent of his daughter who has autism and does not understand the value of money. He would like to leave his pension to her in the event of his death, however if he were to simply make a death benefit nomination in her name, she would have an immediate entitlement to all the pension monies and Charlie is concerned that she would give the monies away and/or spend them irresponsibly. If a Bypass Trust were used, Charlie could instruct the trustees to pay his daughter a monthly allowance from the trust, in addition to lump sum payments as and when required, at the discretion of the trustees.

Where the use of loans to beneficiaries is important in their financial planning:

If the intended beneficiary already has a substantial estate, drawing further funds from an inherited pension would increase their estate further, leading to a potentially higher Inheritance Tax charge on second death.

Scenario: Elliot and Rebecca were a wealthy married couple and on Elliot’s death, Rebecca received all of his estate in addition to his pension. The value of Rebecca’s estate is now at such a level that it is c.£200,000 over her available Inheritance Tax allowances and Rebecca’s executors will therefore have to pay Inheritance Tax on this amount in the event of her death. If Elliot had set up a Bypass Trust for his pension, the trust could loan Rebecca £200,000 (plus contingency for growth in the value of her assets) which she could spend however she wishes and, on her death, her estate would be reduced by the outstanding loan amount. If the loan was fully spent, the net position would likely bring her estate within her available allowances meaning there would be no Inheritance Tax to pay on Rebecca’s death.

 Bypass Trusts also have special tax rules to bring them broadly in line with normal pension death benefit taxation:

The similarities to pensions are as follows:

• There is no inheritance tax to pay on death up to April 2027, when pensions will be brought within the scope of Inheritance Tax.
• The pension benefits pass free of income tax into the trust if the member dies before age 75 (subject to them having sufficient lump sum and death benefit allowances).

However, there are some significant differences:

• Lump sums paid into bypass trusts after age 75, or before age 75 where there is not sufficient lump sum and death benefit allowance, or cases where the lump sum is paid more than two years after the member died, will be taxed at 45%, which can be used to offset any tax due by the beneficiaries on any payments from the trust.
• Periodic and exit charges apply in the same way they do for a normal discretionary trust.
• Income and capital gains within the trust are subject to income tax and capital gains tax in the normal way for a discretionary trust.
• The administration and cost associated with maintaining a trust, including the requirement to register the trust with HMRC’s Trust Registration Service and maintaining an up-to-date register.

There is clearly a place for Bypass Trusts in the arena of financial planning, however it would only be suitable where an enhanced level of control and flexibility is needed that cannot be satisfied by making normal death benefit nominations.

If you are interested or considering Bypass Trusts we’re here to help.

Contact us on 0330 320 9280, email info@cravenstreetwealth.com or complete our online enquiry form for practical advice tailored to your own circumstances and needs.

 

The content of this article is for information only and does not constitute formal financial advice. This material is for general information only and does not constitute investment, tax, legal or other forms of advice.

References to legislation and tax is based on our understanding of United Kingdom law and HM Revenue & Customs practice at the date of publication. These may be subject to change in the future. Tax rates and reliefs may be altered. The value of tax reliefs to the investor depends on their financial circumstances. No guarantees are given regarding the effectiveness of any arrangements entered into on the basis of these comments.

You should not rely on this information to make, or refrain from making any decisions. Always obtain independent, professional advice for your own particular situation.

Craven Street Financial Planning Limited is authorised and regulated by the Financial Conduct Authority (FCA). The FCA does not regulate tax advice.