Passing the Buck

When I first mentioned a spousal bypass trust (SBT) to my wife, she thought I was trying to write her out of my will! Of course, this was not the case – in basic terms, an SBT simply transfers funds that would typically go to your spouse into a trust which they, and others, can benefit from.

Say I have 4x death-in-service benefits from my job and I earn £150,000 per year. If I die, my wife (or whichever beneficiary I nominate) would receive £600,000. This would immediately increase their IHT estate above the nil-rate band and increase the potential inheritance tax (IHT) exposure on their death.

Instead, I could create a discretionary trust for the benefit of my spouse (together with children, wider family, friends, etc.) and nominate the trust to receive the benefits. Then, if I die and a payment is made, the trust receives the £600,000 and it is not included in anyone’s IHT estate.

Flexibility and Protection

The discretionary nature of an SBT also provides more flexibility for making loans and distributions to a wider group of beneficiaries and may offer legal protection from (for example) the bankruptcy or divorce of a beneficiary.

The flexibility of a discretionary trust might also provide comfort around the risks of children receiving substantial amounts while they are young, vulnerable beneficiaries, or the impact of a spouse remarrying.

Pension Planning

Historically, SBTs were popular to receive death benefits from pension pots for the same reason (i.e., to avoid inflating the beneficiaries’ IHT estate). Following the ‘pension freedoms’ in 2015, they became less popular as unused pension pots could be passed down free of IHT; however, based on current plans, pension pots will become included in the IHT estate again from April 2027. Does this mean that SBTs could become more popular once again?

Under current proposals, unused pension benefits will be included in the deceased’s IHT estate. If the pension pays death benefits to a surviving spouse or civil partner, there should be no IHT due (under current proposals – although the value received will increase the spouse’s estate). A payment to a SBT would, however, not be exempt (even if the spouse could benefit) making the use of an SBT unattractive.

However, if there is no surviving spouse, then an SBT could be useful for the IHT planning of the (non-spouse) beneficiaries. It would allow the death benefits to pass to a trust for, say, children or grandchildren, which they could benefit from without inflating their estate.

Trust Tax

On the face of it, the benefits of SBTs sound compelling. Do not forget, the trust will be in the relevant property regime, so it will have to pay IHT every 10 years (at a maximum 6%).

In addition, the income tax implications of pension death benefits must be considered. This depends on whether the individual was under or over 75 when they died, and how much of their lump sum and death benefits allowance (previously the lifetime allowance) is available.

The trustees of an SBT will be liable to income tax, but it may be possible for beneficiaries to obtain a credit or even a refund of this tax, depending on their circumstances.

Watch this Space

It’s difficult to plan in a changing environment, but SBTs could become a useful planning tool once again, subject to navigating the various tax and legal elements of trusts and pensions.

Practical Tip

Consider whether an SBT may be useful for you and your finances, alongside your will and other IHT planning. It’s also worth checking that your nominations to pension, death in service, and life assurance policies are in place and up to date, as these are sometimes overlooked.