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Bypass Trusts and their Inheritance Tax Treatment (IHT)
A bypass trust is a trust simply used to receive death benefits from a pension which is paid at the discretion of the pension scheme trustees. This has potentially attractive IHT benefits when compared to them being paid directly to normally the surviving spouse. We normally associate pension death benefits as being free from any IHT for the member.
However as the member will likely have nominated his spouse as the beneficiary the proceeds will just simply accumulate in the estate of the spouse. Besides IHT is only due on passing assets down a generation and not to the surviving spouse. If the death benefits are paid directly to a surviving spouse then on their death there could be a potential liability of 40%.
The bypass trust can be used to mitigate this problem. The bypass trust is setup by the member during their lifetime. This can be done by gifting a nominal sum (£10) into the trust. You would then need to make sure you have nominated the trust as your preferred beneficiary by notifying the trustees. This is usually done with a nomination or expression of wish form. It is important to note that not all schemes will allow a trust to be nominated.
The trust will include a wide range of beneficiaries, giving the trustees the power to use their discretion to make sure all dependants can receive their share.
The bypass trust will usually be a discretionary trust and therefore there are tax implications as follows:
- On creation of the trust
- 10 yearly periodic reviews
- Exit charges
As mentioned earlier if the trust is set up with a nominal sum, say £10, then this will be within the annual allowance and there will be no immediate charge to IHT. If the trust is set up with a larger investment then there is potential IHT implications depending upon whether or not the member has used up their annual exemption and also the total of their chargeable transfers made in the last 7 years. If tax is payable on set up it will be at 20% on the excess over and above the Nil rate Band.
The payment of the death benefits (whenever that may occur) will not trigger an IHT charge as these were held under trust by the pension scheme originally.
Depending on the type of pension scheme and when the trust is set up, there may be one periodic charge date (ten year anniversary of the trust) or two periodic charge dates. The two dates can be ten years from, the date the trust was established and the date member joined the pension scheme or alternatively ten years from the date the trust was established and the date the death benefits were paid into the trust.
Upon paying a distribution from the trust (note it doesn’t all have to be distributed at once) there may be an exit charge due. The rate of tax applicable will be a proportion of the rate that was applied on the last periodic charge date, based upon the number of successive quarters that have passed since. Where different dates apply to different parts of the trust, the charge will have to be applied proportionately with different rates applying to each part as the number of quarters elapsed may be different.
To summarise, by using a bypass trust, you can ensure that pension death benefits do not just simply increase the IHT your family may have to pay upon the surviving spouses death. The monies in the trust fund do not form part of the beneficiaries estate until a distribution is made. Although this could be done by way of interest free loans to the beneficiary. There may be some IHT charges whilst the money is in the trust if the value of the trust fund is above the available Nil Rate Band.
For further information and tax planning ideas, please do not hesitate to contact us on 028 9066 8700.
Chartered Financial Planner