Having control of your pension death benefits from the great beyond

While you physically won't be able to control your pension death benefits post mortem, you can put plans in place during your lifetime to have a form of 'control' over how these are distributed.

The simplest way to achieve this is to complete an expression of wish for the trustees of the scheme to be aware of your wishes. There are intricacies involved with this as it's essential to find out what discretion the scheme has to take account of your wishes. But on the whole this is viewed as the easiest option.

But the 'control' that a client had by using the expression of wishes disappears once dependants/nominees' drawdown is set up. It then becomes the pot of the dependant/nominee. Assuming that they don't take the benefits as a lump sum and stay in the pension environment, it is then their wishes that may be taken into account by the trustees after their death.

In today's society with the increase of 'fractured' families, this may mean although you'd hope that the recipient of your pension pot would take your wishes into account, they're not compelled to do this. If your spouse remarries, they may nominate their new spouse, and on your spouse's death the new spouse may inherit the pot and pass this on to their own children, ignoring your  bloodline.

Since pension freedoms were introduced, a lump sum death benefit paid from a pension scheme is taxed based on the age of the member when they die, with 75 being the 'knife edge'. Prior to age 75, it's generally paid with no deduction of tax (subject to available lifetime allowance) where it's paid within two years of the scheme becoming aware of the member's death.

Post-75, this used to be paid after the deduction of a 45 per cent tax charge. However, this changed on 6 April 2016 and lump sums are now taxed at the recipient's marginal rate. But this change only applies when the payment is made to an individual; payments to non-individuals (such as a trust) are still subject to this 45 per cent tax charge.

So for clients who are thinking about setting up a spousal bypass trust (SBT), the 45 per cent will be deducted.

This 45 per cent tax charge seemed an expensive price to pay for the use of an SBT as a destination for post-75 death benefits. Some thought it might be best to bypass the SBT when 75 was reached and cascade the funds within the pension.

However, section 206 of the Finance Act 2004 was altered as of 6 April 2016. Therefore, this 45 per cent may not be totally lost to the ultimate beneficiaries of the trust. In the context of a bypass trust, a payment of lump sum death benefit to the trust, which is then paid to a beneficiary, is treated as income of that beneficiary, net of a reclaimable 45 per cent tax credit.

So what does this mean in theory?

This gives a member a degree of control over the ultimate destination of the monies accrued in a pension (as the trustees of the member's trust will control the destination of what was the pension fund money). This is not offered by pensions freedoms, where the member's dependant or nominee will then nominate a successor via their expression of wish form.

The money will no longer be in a pension wrapper, though, and the deduction of the 45 per cent tax will limit any profit/loss from the pension fund because less will be invested and potentially not be as tax efficient.

Whichever route is taken should be thoroughly discussed with existing and new clients alike as both routes can cascade wealth down the generations. But if a client's main objective is to be able to influence the ultimate destination of the accumulated money over the wrapper that it's held in, is an SBT the more attractive option?

If the 'cost of control' has lessened, there may be no need to bypass the SBT post-75.

Further information on the use of bypass trusts can be found in our Technical Centre at the following links:

http://www.pruadviser.co.uk/content/knowledge/technical-centre/iht_pensions/

http://www.pruadviser.co.uk/content/knowledge/technical-centre/pensions_iht_planning/

How will the admin work on this?

Pension Schemes Newsletter 77 detailed that the pension scheme will have to inform the trustees of the gross value of the lump sum death benefit and the tax that has been deducted. The scheme administrators have to provide this within 30 days of making the payment to the trustees.

Further to this, when the trustees then make a payment to a beneficiary from all (or part) of the lump sum death benefit received, they have to inform the beneficiary what proportionate gross value of the lump sum and tax paid from the pension scheme has been made to them. They must also provide this to the beneficiary within 30 days.

To reclaim any tax that may be due, the beneficiary will have to put this in their self-assessment tax return, which may lead to a refund in tax. If the individual doesn't normally complete a tax return, they can claim a refund using form R40.

But how will this work in practice?

If we assume that a member has died post-75 and a lump sum death benefit payment of £45,000 is to be made to an individual with £50,000 adjusted net income, before any lump sum death benefits are paid the tax position of the individual is as follows:

Income Band Tax Rate Tax Due
£11,000 0% £0
£32,000 20% £6,400
£7,000 40% £2,800
Total £9,200

Ignoring the initial emergency tax that will be paid, the income will be taxed as below:

Income Band Tax Rate Tax Due
£11,000 0% £0
£32,000 20% £6,400
£7,000 40% £2,800
£45,000 40% £18,000
Total £27,200

Therefore in this instance the recipient of the lump sum has had to pay £18,000 more in tax, so the net benefit is £27,000.

If the lump sum were directed towards a trust, the initial tax would be simple:

Income Band Tax Rate Tax Due
£45,000 45% £20,250
Total £20,250

As per the above, the scheme would pay out £24,750 to the trust and the scheme administrators have 30 days to inform the trustees that there was a £45,000 gross value of the lump sum death benefit and that £20,250 tax had been paid.

If the trustees immediately paid £24,750 to a beneficiary, this is paid with a tax credit of £20,250, so the total payment assessed against income tax is £45,000. At higher-rate tax, the liability on this would be deemed to be £18,000. As the tax credit is worth £20,250, there is actually an additional £2,250 that can be used to offset tax paid by the individual. This effectively adds a further £2,250 to the net position of the £24,750, which, as per the money going to an individual, gives the beneficiary a £27,000 net benefit.

Conclusion

While the change in legislation can be shown to equalise the position on this tax, trustees will have to keep a careful eye on the legislation as HMRC is vague in its definition of 'payment' to the beneficiary. Further clarity will be needed as to what is meant by this as, if a trust purchases a bond and assigns a segment to a beneficiary, this is classed as capital and not income. However, usually where the legislation does not match the intention of the law this is (eventually) corrected.

Further analysis of this and how the funds will be treated when there is growth in the trust, along with the periodic and exit charges, will follow in a later article.

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