More often than not, most people have death-in-service benefits through their employment or death benefits via their pension scheme. These benefits are generally given to the surviving spouse or partner so are not treated as assets of the deceased’s estate. However, this often creates simply a delay to the inheritance tax charge which will subsequently occur on the death of the surviving spouse when the assets are passed to the next generation.
For example, on the death of the first spouse, the death-in service pays a lump sum to the survivor. Once the benefits of the policy have been paid to the survivor, they become an asset of the partners estate. Therefore, when the survivor dies, their estate is subject to IHT at 40% of the value of the estate in excess of the IHT nil rate band threshold.
This tax issue can be mitigated by sending the benefit into a special trust. The Spousal Bypass Trusts avoid death benefits passing directly to a spouse and so they will not form part of the spouse’s estate. The trust can include the spouse as a potential beneficiary in case he or she needs to access the capital. The trust can also be drafted with power to loan monies to the survivor and as a result the survivor will have the full use of funds to invest or spend or live off the income as they see fit.
Many pension and life insurance companies offer precedent trust documents. Whilst some of these contain the necessary powers to make loans, not all standard form trusts have the necessary powers and are limited in their usefulness. Alternatively, a ‘made-to-measure’ trust can be created incorporating the appropriate powers which are tailored to personal circumstances.
What formalities are required?
These trusts can be set up promptly and are typically, but not necessarily, done at the same time as a testator drafts their will. The Trusts are discretionary in nature and, as with any Estate Planning, it is important that the client is in good health when the Trust is drawn up. The trust will be subject to exit and periodic charges as is common with discretionary trusts.
What is the impact of a Spousal Bypass Trust?
Without spousal bypass
| Jack dies and leaves his estate to his wife, Alison | £ 500,000 |
| Lump sum death benefit paid to Alison | £ 600,000 |
| Alisons own estate | £ 400,000 |
| Total Estate | £ 1,500,000 |
| Less nil rate band (x2 to include Jacks unused allowance) | £ 650,000 |
| Net taxable estate | £ 850,000 |
| Inheritance Tax payable at 40% | £ 340,000 |
With spousal bypass
| Jack dies and leaves his estate to his wife, Alison | £ 500,000 |
| Alisons own estate | £ 400,000 |
| Total Estate | £ 900,000 |
| Lump sum death benefits £600,000 paid to bypass trust within 2 years. Turst makes £200,000 loan to Alison | £ 200,000 |
| Gross Estate | £ 1,100,000 |
| Less loan due back to trust | £ 200,000 |
| Less nil rate band (x2 to include Jacks unused allowance) | £ 650,000 |
| Taxable estate | £ 250,000 |
| Inheritance Tax payable at 40% | £ 100,000 |
Need further information? Email enquiries@btwc.co.uk and we’ll be happy to help.