By-pass your spouse?

Typically when an individual joins a pension fund, they express their wishes for the pension fund trustees to pay the lump sum death benefit to certain named individuals. More often than not it is the individual’s spouse who is the requested beneficiary of these funds.

If the trustees exercise their discretion to transfer the funds to the surviving spouse on the member’s death, this does not normally trigger an immediate IHT charge. However, from an IHT perspective, this is not the complete picture as the surviving spouse’s taxable estate is immediately increased by that amount. As such it is necessary to consider the potential future IHT implications.

Where the surviving spouse’s other assets/ income stream is minimal they are likely to need this lump sum payment to fund their daily living requirements. In such circumstances there may be no additional IHT on second death as, in all likelihood, the cash pot received will have dramatically reduced during the surviving spouse’s lifetime.

If however, the surviving spouse is in the fortunate position where they have significant other wealth or income and therefore do not require this money to fund their day to day living, this could effectively bring the death benefit cash within the charge to IHT at 40 percent on the second death. This assumes the individual does not gift the cash during their lifetime and subject, of course to that individual’s IHT nil rate band (currently £325,000) and any remaining nil rate band of their deceased spouse.

One potential solution to this would be for the member of the pension fund to establish what is commonly known as a ‘Spousal By-Pass Trust’ such that the pension fund trustees have within their discretion the option to pass the death benefit fund directly to this Trust as opposed to the surviving spouse. As the name would suggest this enables the pension fund to by-pass the surviving spouse and ultimately pass to the next generation without adding to the IHT charge at the time of the second death.

In addition the spouse can be named as a beneficiary giving them the potential to benefit from the Trust if required during their lifetime. Providing the deed allows it the Trust can lend money to the surviving spouse. On the death of the surviving spouse, any loan outstanding would be treated as a debt or liability therefore further reducing the value of their dutiable estate and consequently reducing the IHT exposure. On second death the Trust fund can then be passed to the remaining beneficiaries or continue for the benefit of the next generation.

It should be borne in mind that the Trust itself will be subject to tax in certain circumstances and therefore it is extremely important that bespoke advice is sought.

In summary, Spousal By-Pass Trusts may be an effective way to mitigate IHT on pension benefits on second death.

Duncan R Glassey
Senior Partner – Wealthflow LLP

This article is distributed for educational purposes and should not be considered investment advice or an offer of any product for sale. This article contains the opinions of the author but not necessarily the Firm and does not represent a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but is not guaranteed. Past performance is not indicative of future results and no representation is made that the stated results will be replicated. Errors and omissions excepted.