In the ever-increasing taxable world we live in, the concept of a spousal bypass trust has much to recommend it and is something that should be considered as a key part of retirement planning.
The spousal bypass trust should be of interest as many employees have death-in-service benefits through their normal employment terms and conditions, or indeed death benefits which are payable under their pension arrangements.
In the normal course of events, such death benefits would be paid to the surviving spouse on the member's death and would therefore not be treated as part of the deceased's estate. However, for the uninitiated this could lead to a potential inheritance tax (IHT) charge of 40%.
When the death benefits are paid over to the surviving spouse, there is no liability to IHT on that first death. But in the event of the surviving spouse's death, an IHT liability does arise as the death benefits would form part of the deceased spouse's estate.
This, therefore, would be subject to IHT at 40% on the value of the estate in excess of the IHT threshold. (Everyone's estate is exempt from IHT up to a certain threshold: £325,000 in 2011-12. This threshold is also called the nil-rate band.)
This 40% tax charge can be avoided by directing the payment of the death-in-service benefit into a spousal bypass trust. As the trust is held outside of the survivor's estate, it would not be subject to IHT on the survivor's death.
Benefits of spousal bypass
There are many advantages to spousal bypass trusts. The first, as mentioned above, is that there will be no IHT payable on the payment of the death-in-service benefit into the spousal bypass trust.
The second advantage is that spousal bypass trusts are not limited to death-in-service benefits. They can be used together with various lump sum death benefits payable from different pension arrangements and any form of life insurance. This, therefore, can be considered for use in conjunction with a wide variety of retirement planning vehicles.
The third plus point is that the Trust Deed establishing the spousal bypass trust can include powers to loan monies to the beneficiaries including the surviving spouse. On the death of the surviving spouse, the loan would be treated as a debt or liability on his or her estate, therefore reducing the value of the estate and the IHT due on the second death.
The fourth benefit is that the trust can be used to shelter funds for prodigal relatives, support a handicapped person or provide a shelter until uncertain circumstances (such as insolvency or divorce) resolve.
The fifth is that the surviving spouse or partner can be a trustee and thus control how the funds of the spousal bypass trust are used, while at the same time having access and achieving the IHT savings set out above.
Finally, a spousal bypass trust can be officially established with a nominal sum of as little as £10, which is placed into the trust fund.
The trust and tax
As a form of discretionary trust, a spousal bypass trust will still be subject to its own IHT regime. But careful planning and management can reduce or minimise the following tax charges: a ten-yearly charge of 6% on the value of the trust which exceeds the prevailing nil rate IHT band, and a 6% exit charge.
However, while the member is alive, the sole asset in the trust (the future right to the death benefit) has only nominal value and will therefore not exceed the nil-rate band, meaning that no liability will arise from the ten-year charge.
Additionally, if a ten-year anniversary falls within two years after the member's death, there will be no charge for that anniversary. The ten-year periods will continue to run as normal.
A spousal bypass trust can be set up quickly, efficiently and with minimal cost. Please speak to your financial adviser to discuss your own personal circumstances and the advantages a spousal bypass trust may afford to you or your spouse.
Like all retirement, estate and tax planning suitable legal and financial advice ought to be taken to understand the whole tax position and family circumstances.
Mairi Black is an associate (pensions) at Biggart Baillie
Categories: Estate planning