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Legal News | 22.08.18

Trusts to receive Pension & Life Policy Death Benefits

Do you have a life policy or pension, either of which might pay out a lump sum to your surviving spouse on your death? If so, depending on the size of the joint estate, you may wish to consider ways of sheltering the lump sum from the survivor’s estate so it does not suffer the 40% inheritance tax (IHT) on their death.

In respect of pensions, before 6 April 2015 we would more routinely have suggested setting up pilot trusts (also known as, amongst other names, bypass trusts, spousal bypass trusts or asset protection trusts) to receive any such lump sum payable on death. The pilot trust would be a discretionary trust you would set up in your lifetime with a nominal sum, such as £10. This would then be shelved pending being funded further on your death by the pension lump sums. Your spouse would be a beneficiary and your letter of wishes would usually set out that you wish your trustees to treat your surviving spouse as the principal beneficiary. The fund would be ring fenced from the spouse’s own assets for IHT purposes, meaning on their death it would not form part of their estate for their own IHT calculation. The trust could then continue as a trust for the next generation, or be appointed out to the next generation and wound up.

Since 2015, however, there have been a number of changes to the options you have under a pension scheme which, as solicitors we cannot advise on, other than to say the intergenerational tax planning might now be possible within the pension itself. If so, this could be more tax efficient than a discretionary trust as discretionary trusts are taxed for income and gains on the trustees at the highest rate for individuals, being 45% for income tax and 28% for capital gains tax. Discretionary trusts also come under what is known as the ‘relevant property regime’ for IHT which means they are assessed for IHT of up to 6% every ten years. Payments out of these trusts can also attract IHT charges of up to 6%, depending on the timing of such payments out.

If your pension scheme allows you to shelter death benefits from your surviving spouse’s estate, this would be worth exploring as it may mean that the funds will not suffer the same income and gains taxes as a discretionary trust, nor will they be charged IHT in the same way.

It is therefore very important that you have a conversation with your pension adviser to ensure your pension is set up to take advantage of any intergenerational tax planning mitigation which might be available to your particular pension scheme. If you discover that your pension scheme, for whatever reason, cannot be set up in such a way as to shelter any death benefit lump sum from the surviving spouse’s estate, please do contact us to discuss further the possibility of sheltering such funds via a pilot trust.

Alternatively, if you have set up a pilot trust in the past for the purpose of receiving pension death benefits but have subsequently discovered this is not needed, it would be worth reviewing whether it would be a good idea now to wind the pilot trust up. This is advisable as, despite the fact the trust might only contain £10, its existence could be disadvantageous for a number of reasons, beyond the scope of this note.

If you have a life policy under which death benefits could be paid either to your own or your spouse’s estate on your death, this can often unnecessarily inflate either estate for IHT. You might wish to ensure those benefits remain outside either estate, but so that they can still be used as intended, by arranging for the policy itself to be placed into a suitable trust before you die.

For more information regarding inheritance tax and estate planning, speak to your usual contact at Wansbroughs on 01380 733300 or contact us at wealth@wansbroughs.com.


Posted By Our Wills, Tax, Trusts & Probate Team