A Monthly Publication

 By Robin Sainty

As most people are aware, the lump sum death benefit from a UK registered pension scheme can be paid free of Inheritance Tax. This can be a significant benefit, given that the accrued fund is often a very significant amount. However, for some couples, particularly those who have both enjoyed high levels of income, accumulated significant assets and made separate pension provision this can actually create a greater problem for the recipient and his or her family further down the line. This is because the recipient will usually hold the death benefit in the form of capital, which will increase the Inheritance Tax liability on their subsequent death.

Inheritance Tax is, quite rightly, very unpopular because it effectively penalises those who have managed their money effectively and tried to pass some of their assets to their children. Such actions are not only the preserve of the super rich, and an increasing number of working class families are caught up in the trap. The situation has been exacerbated in recent years with a high level of property inflation resulting in the family home itself often taking up a disproportionate percentage of the Inheritance Tax allowance, i.e. the threshold below which Inheritance Tax is not payable (currently £325,000 for 2009/10)

An increasingly common solution to the problem outlined in my first paragraph is what are known as spousal bypass trusts. This is a form of trust that can be set up by the pension scheme member during their lifetime with the intention of receiving the death benefits from the pension plan which will then be distributed by the trustees (who would be chosen and appointed by the member) after the members death. Usually the member will provide the trustees with a written expression of wishes setting out whom he or she wishes to benefit.

Usually the intention of such a trust is to facilitate inheritance Tax planning by passing the death benefits directly to the children via the trust, so bypassing the spouse, in order that that the death benefits are not aggregated with the surviving spouse’s taxable income on their subsequent death, but such a structure can also be useful where there are dependent children, in which case having trustees to oversee the investment and management of the death benefits on their behalf would obviously be sensible.

Of course, one common problem with trust arrangements such as this is the financial need of the surviving spouse. Obviously, as I have mentioned earlier, such an arrangement would have little attraction unless both spouses have significant assets individually, but clearly circumstances and needs can change over time, so an important feature of these trusts is a facility whereby the trustees can appoint capital from the trust to the surviving spouse during his or her lifetime. The best way to structure this is to document the payments as interest free loans repayable on demand. Provided that this capital is spent during the recipients lifetime (the exercise is pointless if this is not the case) there is no increase in the survivor’s taxable estate, and, in fact, on the survivors eventual death the loans will form debts on the survivor’s estate which represent allowable deductions for Inheritance Tax purposes, which will reduce the final tax bill.

There are two main forms of spousal bypass trust, but both effectively create a situation where the pension scheme administrator or trustees pass the death benefits to the personal trustees appointed by the trust creator rather than directly to the nominated beneficiaries, and the personal trustees then appoint benefits in line with the trust creator’s wishes, giving much greater flexibility for tax planning,

Given the space available to me, and the complexity of the subject matter, all I can achieve here is a fairly simplistic overview of the concept and potential benefits of a spousal bypass trust, and clearly professional advice should be sought before making any decisions in this area. However, hopefully the foregoing comments will be of interest and in the event that any of you wish to discuss this or any other financial planning matter in more detail please feel free to contact me on 01553 776398 or e-mail me at CLOAKING