Why set up a trust to accept pension death benefits?

Prior to April 2015, one of the main reason why a trust was set up to receive the payment of lump sum death benefits was so that they did not become part of the inheritance tax assessable estate of the intended beneficiaries.

However, new legislation introduced in April 2015 meant that, in the vast majority of cases, the benefits are able to pass down through generations free of inheritance tax if they remain in the pension wrapper and hence the expression of wish form is most popular approach for dealing with pension death benefits.

As such many have said that bypass trusts are no longer required. However, there are many reasons why someone might decide to set up a trust to receive a lump sum death benefit payment from their pension scheme.

These may include the following:

  • Asset Protection
    A trust can help to protect assets in the event of a beneficiary’s divorce or bankruptcy and it will also ensure that death benefits aren’t included in anylocal authority assessment for long term care provisionfor a beneficiary.
  • Tax Planning
    It’s a way of keeping the lump sum out of the desired beneficiary’s estate whilst still allowing them to benefit from it. It may also be possible to grant loans to a beneficiary which may be an allowable deductible for IHT on the beneficiary’s death.
  • Flexibility
    It can give greater flexibility to distribute the lump sum in stages, or to multiple beneficiaries, as circumstances dictate.
  • Control
    It allows the individual to appoint their own trustees, who arefamiliar with their personal circumstances, to decide how the lump sum should be distributed – rather than leaving this in the hands of an insurance company, their employer or individuals who are complete strangers to them.Trusts can be used to hold assets for the benefit of children or other beneficiaries who can’t manage their own affairs (such as the mentally incapacitated).

It is important to understand thelegal structureand rules of the pension scheme involved as this will determine whether a trust can be set up to accept lump sum death benefits.

The type of trust established to hold lump sum death benefits from a pension scheme is generally referred to as a Bypass Trust. It is a discretionary trust and enables the death benefits to be held in trust for the deceased member’s widow(er), civil partner or otherbeneficiarieswithout forming part of the beneficiaries’ estates.

Pension death benefits are usually exempt fromIHT, provided they are paid out at the discretion of the pension scheme administrator/trustees. If those assets are then held in trust, the trustees can pay out capital and income to the beneficiaries – or, if the trust provisions allow, grant them loans which will normally be a debt on their estate for IHT.

A Bypass Trust is subject to therelevant property regime, meaning that the trust will be subject to the 10 yearly periodic chargesand proportionate exit chargeson capital leaving the trust. The timing andcalculationof any charges largely depend on the structure of the pension scheme(s) involved. It is this potential tax liability that can put people off using a bypass trust, however, this does need to weighed up against the benefits that can be attained by setting up the trust in the first place.

The payment of lump sum death benefits into a Bypass Trust are tax free where the scheme member dies before age 75 and benefits are within the lifetime allowance. Where the scheme member dies at 75 or older the death benefits will be subject to a 45% special lump sum tax charge.

However, when an individual beneficiary receives a payment from a bypass trust from funds that have been subject to the 45% special lump sum tax charge, the individual will receive a 45% tax credit. The intention of the tax credit is to put the individual in the same position as it they had received the payment directly from the pension scheme.This means any individual whose marginal rate of tax is less than 45% can claim a tax refund.

Whichever route is used to cascade wealth through the generations, expression of wish or bypass trust, the options should be thoroughly discussed.

If a client’s main objective is to be able to influence the ultimate destination of the accumulated money a bypass trust is a useful planning tool.