Tony Mudd: The role of spousal bypass trusts post-pension freedoms

Tony Mudd

Much has been written about so-called spousal bypass trusts since the implementation of pension freedoms. The general consensus appears to be their use with pension death benefits is, at best, questionable.

But while the issues around this are complex, it is not a view I share. There are tax and non-tax arguments on both sides but the original purpose of such structures appears to have been missed in the debate.

Indeed, SBTs were primarily introduced as recipient structures for death in service benefits and the changes to pensions introduced last April have no impact here. As a result, death in service benefits (to be differentiated and indeed separated from death benefits from accumulated pension funds) should go into SBTs in all circumstances. The arguments for this are well established and do not need to be repeated by me.

Spousal bypass trusts and inheritance tax

On the reasonable assumption any death in service benefits payable into an SBT will remain in the trust, there is, of course, the issue of inheritance tax: specifically, charges on the 10-year anniversary or exit charges between these anniversaries. The level of charge and when it is applied is determined on when the trust commenced and special IHT rules apply when property moves between different trusts.

In this case, when property moves from one discretionary trust (the pension scheme) to another (the SBT) for tax purposes, that property will be treated as continuing to be comprised in the original trust. In other words, when an individual joins a pension scheme constituted under trust, that individual is treated as creating a trust of their pension benefits, including any death benefits paid.

Should the member die and death benefits be paid out of the pensions scheme trust to an SBT, the relevant date for establishing the anniversary for the purposes of periodic and exit charges on the SBT is the date the member joined their pension scheme.

Would IHT be reduced if death benefits from a trust-based pension were paid to several SBTs, each with their own nil-rate band? Where all the death benefits originate from one trust-based pension scheme, the answer is no.

As HM Revenue & Customs takes the view that, for tax purposes, the trust of an individual’s pension benefits was created on the date the member joined the pension scheme, no subsequent splitting of those benefits, through any number of SBTs, will create different/separate trusts. On this basis, only one nil-rate band will be available. Other pension combinations will exist, introducing different results, however.

Where an individual has several trust-based pension schemes, the number of SBTs used does not affect the IHT position of the SBT. This is because the property derived from each pension scheme will be treated as a separate trust for IHT purposes, irrespective of whether the pension scheme is transferred on the member’s death into one or more SBTs.

Each trust will have its own 10-year anniversary fixed by preference to the date the member joined each scheme. Where a single SBT is used the assets inside will need to be apportioned for valuation purposes to determine any periodic and exit charges. For this reason, there may be a practical advantage to using an SBT for each pension scheme.

Where a scheme member transfers his pension benefits from one trust-based scheme to another, the benefits in the receiving scheme are treated as being held in a trust that began when the member joined the original scheme. If there were no funds in the scheme at the time of transfer and no further contributions, there is only one trust.

However, where there have been a number of transfers to a trust-based pension scheme, any subsequent payment into an SBT for IHT purposes will be deemed to be as many trusts within the SBT as original pension scheme, each with its own nil-rate band and benefits apportioned to each trust in accordance with the proportions originally transferred in.

Contract-based pension schemes

It is also possible to establish contract-based pension schemes and where this is the case the position is different. According to HMRC, for the purposes of establishing the original commencement date, the rules applying to trust-based pension schemes do not apply to contract-based pension schemes.

Therefore, a member in a contract-based scheme, including one that has received transfers from previous trust-based schemes, is able to create multiple trusts and, therefore, multiple nil-rate bands by the member establishing several SBTs.

Perpetuity periods

Finally, it is worth remembering there is an established principle that property should not be held in trust for an unreasonable period of time preventing beneficiaries from receiving capital or income. This is known as the perpetuity period and for SBTs depends on the date on which the member first joined the pension scheme.

If the member joined the scheme before 5 April 2010 the perpetuity period will be 21 years from the date of the member’s death. However, if the member joined the scheme on or after 6 April 2010 the perpetuity period is 125 years from the date the member joined.

Tony Mudd is divisional director of tax and technical support at St James Place