
What do I do with my death in service benefit?
In today’s sophisticated financial market, most people have death-in-service
benefits through their employment or death benefits via their pension
scheme. These benefits are
generally given to the surviving spouse or partner so are not treated as
assets of the deceased’s estate.
But there is a massive potential Inheritance Tax (IHT) problem which
can destroy 40% of their value.
Generally speaking most people nominate their death benefit to be paid
directly to their spouse or partner which is fine - as far as most advice
goes. 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 the partners estate.
Subsequently, when the survivor dies 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 sending the death-in-service benefit or
pension death benefit into a special 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 benefit from the trust and receive cash or
other benefits. 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
further reducing the value of the estate for IHT purposes.
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, though care must be taken to ensure that critical illness, cash value or other lifetime benefits don't accidentally go into the Pilot / Spousal By Pass Trust.
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 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.
Whilst a
discretionary trust, or any type of trust, has its own taxation regime upon
which advice is required, in many cases it is certainly worth looking into
this type of arrangement.
How else
would I use a spousal by-pass trust?
Although
these trust are mainly used to receive death in service benefits they can be
created now to receive assets passed into them by Will such as business or
agricultural property and if you have a substantial estate you may wish to
consider multiple spousal by-pass trusts simply to increase the availability
of the nil rate bands across the trusts.
What
formalities are required?
These
trusts can be set up quickly and are typically, but not necessarily, done at
the same time as a testator drafts his Will.
They are normally discretionary and are created with a trust fund of
as little as £10.
What is the effect?
No
spousal bypass
|
John dies and leaves his estate to his wife, Jane |
£500,000 |
|
Lump sum death benefit paid to Jane |
£600,000 |
|
Jane’s own estate |
£400,000 |
|
Total estate |
£1,500,000 |
|
Less nil rate band (x2 to include John’s unused allowance) |
£624,000 |
|
Net taxable estate |
£876,000 |
|
Inheritance Tax payable at 40% |
£350,400 |
With
spousal bypass
|
John dies and leaves his estate to his wife, Jane |
£500,000 |
|
Jane’s own estate |
£400,000 |
|
Total estate |
£900,000 |
|
(Lump sum death benefits of £600,000 paid to 2 bypass trusts within two
years. Trust makes
£200,000 loan to Jane) |
£200,000 |
|
Gross Estate |
£1,100,000 |
|
Less loan due back to trust |
£200,000 |
|
Less nil rate band (x2 to include John’s unused) |
£624,000 |
|
Taxable
estate |
£276,000 |
|
IHT @ 40% |
£110,400 |
(NB The
bypass trust will be subject to its own IHT regime: a charge every 10 years
of 6% and an exit charge but it will be substantially less than the
difference between £350,400 and £110,400 even if it is kept intact).
…………………………… a by-pass worth having!
Information for Financial advisers
Allied Professional Will Writers Ltd
2 Hankham Street Hankham Pevensey BN24 5BG
0845 166 8873