Hardly a week goes by without me being involved in the age-old debate about the need (or not) for spousal bypass trusts to receive pension scheme death benefits.
I thought this would have ceased, or at least reduced, following the pension freedoms in 2015.
The tax-efficient options now available to cascade benefits down the generations within pension wrappers initially led many to believe trusts’ days were numbered. This has not been the case. Indeed, it has just caused more confusion for clients and their families.
One clear reason to still have a bypass trust is to receive the death
in service benefits paid as part of the pension scheme. This is usually a significant amount, which would immediately give the receiving spouse an inheritance tax problem even if they did not have one before.
The trust does not avoid the lifetime allowance test, but it can avoid IHT on second death should the receiving spouse die while still in possession of the funds.
Bypass trusts cannot be dismissed as unnecessary when thinking about pensions more broadly either, particularly considering the complex world we live in.
Unusual family structures or financially unstable beneficiaries means more control over, what can be, very large funds is needed.
A classic example is a family with children from different relationships, where the funds need to be left to the current partner in the first instance, but the pension member wants to be sure the children from the first relationship do not miss out if there is anything left.
The issue with leaving funds in drawdown on death is that there is no scope for the original member to direct the funds on second death. The decision is entirely down to the beneficiary at the time.
Nominations are often changed at age 75, from the trust to the beneficiaries direct. This is mainly due to the 45 per cent tax charge on the payment of benefits to a trust after the age of 75, whereas a direct beneficiary will only pay tax under PAYE on the money taken out of the fund. This could be a lump sum, regular or ad hoc income.
That said, this should not be the over-arching reason to change the nomination because there is a tax credit given to the beneficiaries when payments are made. The whole picture still needs to be considered and, for those who still worry about what will happen to the funds on second death, the trust could still be appropriate.
So, all in all, as with everything pensions, it is a personal decision to be made. The pros and cons of each option should be weighed up. However, do not forget that, in most cases, if there is a chance a trust is required, it needs to be in place before death, even if it is not eventually used.
Claire Trott is head of pensions strategy at St James’s Place Group