Do you have clients for whom you have set up trusts linked to death benefits from pensions?
Are you aware of recent changes in the law which mean the arrangements you have set up may no longer be appropriate for those clients?
Firstly I should explain that I am not talking here about death benefits from a defined benefit scheme. The changes in law do not affect such schemes and if the advice to set up a trust to receive the death benefits was sound when you gave it then it is probably still sound. These changes only apply to defined contribution schemes.
Secondly what I am about to show you has absolutely no reflection on the original advice you gave. You probably advised your client to set up a spousal bypass trust. At the time I am quite sure this was the right thing for your client to do. As well as avoiding potential inheritance tax on second death, by putting the death benefits in trust you were helping your client protect this money for future generations rather than allowing it to be unnecessarily depleted through divorce, local authority charges for nursing home care, bankruptcy, etc. You should be congratulated for advising the client to set this structure up. Many financial advisers would have missed this opportunity.
So, what has now changed which means paying death benefits into a trust may not be a good idea?
I am sure you are familiar with the “flexi-access drawdown” rules for defined contribution pensions, and in particular how these new rules impact on death benefits. In summary, the death benefit rules for clients aged under 75 are:
The pension value can be passed to anyone without a tax charge. If it is passed to an individual it is passed as a pension. This means the beneficiaries can take as much or as little of the pension value as they like, when they like, and there will be no tax charge at all.
“Anyone” includes trusts. So the value of the pension can be paid into a spousal bypass trust.
If the value is paid into a trust, though, it will go into the trust as cash, not as a pension. Any capital growth within the trust over and above the trust annual exemption (currently £5,550) will be taxed at 28%. Any income over £1,000 will be taxed at 45% (or 37.5% if it is from dividends), and if it is up to £1,000 will be taxed at individual rates. Also, depending on the amount of money in the trust, there may be inheritance tax charges – periodic charges every 10 years and an exit charge if the beneficiaries take the money out.
If there was quite a lot of money in the pension, and if you are expecting reasonable growth, that is quite a lot of tax to pay!
You may be able to reduce some of those tax bills by appointing income to the beneficiaries. But unless the beneficiaries have little or no other taxable income and the income is under the personal allowance there will still be some tax for them to pay.
So do not simply focus on the fact that the money is tax free when it is first received. Look at the overall tax picture.
If, however, the death benefits are paid to an individual, for example directly to the spouse, those benefits are still treated as a pension, with all the tax benefits of a pension arrangement. The individual actually has the best of both worlds. Any money drawn from the pension is tax free, regardless of the tax position of that individual, but any growth and any income produced in the remaining pension is free of capital gains and income tax. There are also no periodic or exit charges for inheritance tax.
My experience has been that although most advisers are familiar with all the above, many have not taken the next logical step and thought about whether it is best for cash to go into a trust or the pension to go to the spouse or other beneficiaries. The potential ultimate tax difference between the two can be enormous!
If you had the choice, which would you prefer?
Money in a trust, subject to tax on any investment returns (as well as possibly some inheritance tax too)?
Money you can leave to grow completely tax free but still have access to whenever you like?
I imagine you probably chose the second option. And if you found someone had accepted the first option on your behalf without giving you any choice in the matter, how would you feel? Slightly annoyed perhaps? Or maybe quite angry? If that person was a professional who should have taken a lot more care to ensure you didn’t pay tax unnecessarily, what might you do? Complain and insist on some hefty compensation maybe?
That is the position any of your clients with death benefit trusts will be in unless you at least sit down with them and explain to them their options under the new rules. This includes clients who may have been set up with those trusts by someone else. Their beneficiaries will probably take pot shots at anyone in sight, and that includes you!
There may, of course, be very good reasons for the money to go into trust and be subject to tax on growth rather than to go to the spouse and be completely tax free. If, for example, the spouse is in a nursing home I am quite sure the remaining family members will be very happy for the money to go into trust.
The answer, therefore, is that your clients need flexibility. A way for the pension to pass to the spouse under normal circumstances but into a trust if the circumstances warrant. This pretty much comes down to the way the “Nomination of Beneficiary” form is worded, and the in depth understanding of the issues by the professional trustee you use with the pension death benefit trust. Ideally you would want to use the services of a solicitor very familiar with these issues.
As with so many changes in law in our profession, this one could be both a threat and an opportunity for you.
If you already have the right professional connections you should get round as quickly as possible to all your clients who have pension death benefit trusts associated with defined contribution pensions. If you do not have such professional connections, then you had better find them quick so you can ensure all those clients get proper advice on their options.
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