Spousal By-pass Trusts

In today’s sophisticated financial market, many people have death-in-service benefits through their employment or death benefits via their pension scheme. These benefits are generally not considered an estate asset and are regarded as free from inheritance tax (IHT). However, even though these death benefits are not treated as estate assets, there is a potential IHT problem.

Most people nominate their death benefit to be paid directly to their spouse or partner. As a result, because the benefit is not treated as an asset of the estate, on the first death there is no liability to IHT. However, IHT liability arises on the second death. For example, on the death of the first spouse, the death-in-service pays a lump sum to the survivor. This is outside the estate for tax purposes. Once the benefits of the policy have been paid to the survivor they become an asset of their estate. Subsequently, when the survivor passes away their estate (which would include any death-in-service benefit monies) is subject to IHT at 40% on the value of the estate in excess of the IHT threshold.

This tax problem can be avoided by nominating the death-in-service benefit or pension death benefit into a trust. The trust is held outside the survivor’s estate; (and therefore not subject to IHT on the survivor's death) however the survivor 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 will have the full use of the funds to invest or spend, or live off the income as they see fit. However, as a loan has been made from the trust a liability has been created which can be paid out of the survivor's estate on their death thereby reducing the value of their estate for IHT purposes.

By using a spousal by-pass trust, not only can the survivor have the full benefit of the monies payable but an IHT saving can be made at the same time!

Spousal by-pass trusts are not limited to death in service benefits and pension benefits. They can be used in conjunction with any form of life insurance. Therefore anyone with any type of term life insurance or mortgage protection insurance should consider placing the benefit of the policies into such a trust. The surviving spouse can still be a trustee and therefore control how the funds are used. This way considerable IHT savings can be made.

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. If you decide to use these standard forms, do make sure that they are completed correctly as putting the wrong name in the wrong box can cost you literally tens of thousands of pounds in IHT.

Alternatively we can draw up a "made to measure" trust for you incorporating the appropriate powers tailored to your own personal circumstances.