Tony Mudd, divisional director for tax and technical support at St James’s Place, responds to last week’s article that pensions freedoms will drive more to investment trusts, warning that while trusts do have a place in estate planning, the issues are more complex than suggested.
The piece refers to a ‘spousal bypass trust’ and the changes introduced post April having little, if any, effect on ‘death in service’ benefits. This, by definition, should go into a trust for all the reasons that are well understood and were touched upon.
Whether you should use a trust for pension accrued benefits payable on death is a much more complex issue following last month’s pension reforms. Helpfully the decision to use a trust does not need to be made, nor should it be made until the member’s death, at which point, at least some of the factors that will influence the decision will be known.
However, the issues are fundamentally different.
There are a number of advantages of retaining the funds within a pension, and several different advantages of using a trust.
Advantages of retaining funds within the pension:
• any funds, lump sum or drawdown, paid from a pension where the member is below aged 75, will be free of inheritance tax, income tax and capital gains tax, for as long as the funds are not exhausted, or, the nominated beneficiary remains alive;
• any monies taken, either lump sum or drawdown, where the member died after the age of 75 (setting aside the 45 per cent income tax charge in 2015/16) will only be subject to the beneficiary’s marginal rate of income tax. Monies paid into a trust will be subject to 45 per cent tax, although this is yet to be confirmed;
• beneficiaries of the pension funds will be able to nominate successor beneficiaries. The taxation of which will depend on the original beneficiaries age on their death; and
• funds retained in the pension fund have no practical time limit attached to them, subject to point one below, plus, they will not be subject to IHT periodic and exit charges.
Advantages of using a trust:
• any tax liability on payments out of the pension funds into a trust will depend on the age at which the member or last beneficiary died. If the member or last beneficiary died under the age of 75, payments out will be tax free. A payment to a trust would be tax free and not exposed to future tax charges based on the age of a beneficiary at death or a future change in legislation;
• any funds held within the trust should not generally be considered as the financial resources of any beneficiary. This would protect the funds and potential recipients from claims by creditors, spouses on divorce, or local authorities in respect of long-term care. This differs from a pension fund held for a nominated individual, where the funds would be counted as part of his/her financial resources; and
• the trustees could grant interest free loans to a beneficiary to further reduce the beneficiary’s taxable estate, to the extent of any outstanding loan on their death. Similar loans would not be available from a pension fund.