Plan now to save up to 40% more of death benefits

Year Published: 2012

If you have death in service benefits through your employment or death benefits through your pension, you will probably have completed a nomination form to direct the money to your spouse or partner. These funds will be paid directly to the nominated beneficiary and are therefore never part of your estate and so not liable for Inheritance Tax.

However, while the nomination used in this way works very well to ensure the proceeds of the payment are not taxed as part of your estate, you should give some thought to what will happen when your spouse or partner dies, as there could be a potential Inheritance Tax problem on their death.

If, on your death, your spouse or partner receives a lump sum from a death benefit, the money then becomes part of their estate. Subsequently, when the survivor dies, their estate will have been swelled by the value of the potentially large lump sum and therefore a large Inheritance Tax liability can arise, reducing the value of your estate to pass on to your beneficiaries, usually your children.

The solution

This tax problem can be avoided by your nominating the lump sum from a death in service benefit or pension death benefit into a trust (often called a Spousal Bypass Trust). The trust is not part of the survivor’s estate on their death and therefore not subject to Inheritance Tax assessment. However, the spouse can be a beneficiary of the trust and receive funds.

Even more beneficially the trust can be drafted with power to loan monies to the survivor. As a result the survivor can have full use of the funds to invest, spend or live off the income as they see fit. However, as a loan has been made, a liability has been created that can be paid out of the survivor’s estate on their death thereby reducing the value of the estate for Inheritance Tax purposes.

By using the Spousal Bypass Trust, not only can the survivor have the full benefit of the monies payable but an Inheritance Tax saving can be made at the same time.

The advantages of using a Spousal Bypass Trust

They are very flexible trusts, often used to benefit the whole family, save tax and preserve family wealth. Particular benefits include:

• The assets in the trust do not belong to any particular beneficiary, so the funds are not subject to Inheritance Tax when one beneficiary dies.

• While Spousal Bypass trusts which exceed the Nil Rate Band (the amount that can pass free of Inheritance Tax and is currently worth £325,000) are not particularly tax-efficient, it is possible, and often better, to set up more than one trust to ensure that each one is limited to the Nil Rate Band.

• The surviving spouse can be a trustee and therefore control how the funds are used.

• You can decide how the trust operates, who will benefit and at what age.

• The funds, while they are in the trust, may be protected from divorce claims, creditors, second marriages and financial abuse of or by the beneficiaries.

• They are not limited to death in service benefits and pension benefits; they can be used in conjunction with any form of life insurance.

If you require any further information please contact Helen Kelly from our Trusts team on 01625 442 147.

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