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  • Overview

    The rules governing pensions changed fundamentally on 6 April 2015. The changes now mean that anyone who has a money purchase (often called a defined contribution) pension can now pass the remaining value of their fund on death to anyone free of all tax if the individual dies before the age of 75, and on a more favourable tax basis if the individual dies after reaching that age. This is a big improvement on the old regime, where passing on lump sum death benefits could attract a 55% tax charge and any dependant’s pension was restricted to a narrow range of people.

    A lot of column inches have been devoted to the financial options that these changes create, so we have focussed on the wealth protection aspects of the new pension freedoms.

    Is there a continuing role for spousal by-pass trusts?

    Prior to the introduction of the pension reforms spousal by-pass trusts played an important role in inheritance tax planning.  A spousal by-pass trust (usually a discretionary trust with the spouse and children as the main beneficiaries) was set up in a pension scheme member’s lifetime to receive the lump sum benefits due on death, thus preventing them from falling into the spouse’s estate.  The surviving spouse could take an interest-free loan from the trust.  The downside of this was that a tax charge of 55% was applied to the fund going into the trust if death occurred after the age of 75 (it was tax free up to that age where no benefits had been drawn).

    With the introduction of the latest reforms there is a case for leaving funds within a pension wrapper, as the tax regime that will apply to such funds is more flexible.  While any withdrawals from the fund by a surviving spouse may attract a tax charge, the remaining fund will be outside the spouse’s estate.  Thus, a more tax beneficial arrangement in relation to a couple’s children can be achieved without a spousal by-pass trust.  This has lead to a number of commentators suggesting that spousal by-pass trusts no longer have a role in estate planning.

    That is, of course, not necessarily the case in situations where a pension scheme member is concerned about the possibility of their pension funds being dissipated by a spouse, a new partner, any of their children or their partners, either through profligate expenditure or as a result of a relationship breakdown.  In these circumstances a properly constituted trust is more likely to preserve the value of a pension fund for the ‘bloodline’, albeit that there is a higher tax charge levied at the outset (45% currently).

    Thus, a spousal by-pass trust remains a useful device in the estate planning tool box, where there is an overriding desire to preserve wealth for future generations.  It is also a tool that has a degree of permanence to it, in view of the constant tinkering with the pensions regime that has occurred in the last decade. 

    Nominees and successors and their role in wealth preservation

    Dependants are no longer the only persons who can benefit after the original pension fund owner has died.  Nominees and successors are two new classes of beneficiary.

    Nominees are persons the pension scheme member wishes to inherit their pension fund after their death.  They could be a combination of dependants and any other individuals the fund owner chooses.

    It may not be enough to state in a nomination form that the pension fund trustees should ‘refer to the terms of my Will’ (or something similar), as that may not override the pension fund trustees’ duty to consider dependants first.  Consequently, it has become much more important to ensure that your nomination form has been completed properly, kept up to date and reviewed in the context of your overall estate planning.  For example, in the situation of a wealthy couple where the surviving spouse will have enough assets to live on, the pension fund could be nominated to their children, giving them access to the fund earlier than would be the case if the other spouse was the nominee.  This would also ensure that the fund benefits the children even if the surviving spouse were to remarry.

    A successor, on the other hand, is someone a nominee determines should inherit any of the pension fund remaining on the nominee’s death (the nominee’s share of the fund does not fall into his or her estate).  The successor can be anyone, and neither the original pension fund owner nor the pension fund trustees have any say in the suitability of a successor.  One can imagine situations where nominees may be excluded because of the fear a pension fund owner has in relation to who a nominee could leave the fund to.

    Your best trust fund ever?

    The new pension freedoms have led one or two commentators to describe a pension fund as ‘the best trust fund ever’.  Is it?

    It is certainly a very efficient vehicle for accumulating a pot of money tax free, that can be passed through multiple generations without suffering any inheritance tax where a beneficiary dies before the age of 75 or on a lower tax basis (compared to the current rate of inheritance tax anyway) where beneficiaries draw an income from the fund and are nil or basic rate taxpayers.  It is also a good way of skipping generations and passing wealth directly to children or remoter issue.

    But what about preserving wealth for future generations, something that properly constituted trust funds are designed to achieve?  Unlike a trust fund, the beneficiaries of a pension fund are free to make their own decisions in relation to the proportion of the fund they inherit.  This means that it is quite possible that a pension fund will not last much more than one generation as nominees use the monies to fund their lifestyles.  In contrast, a trust where there is a clear expression of wishes and good trust management can ensure funds are preserved for a number of generations, particularly where more substantial sums are involved.

    So while there may be less tax to pay under the new pension regime, well constructed trust vehicles (such as the spousal by-pass trust referred to above) are likely to preserve wealth in a more enduring manner.  As ever, it is important to consider all the various options in the round, so that the best choices are made.

    As Will drafters and estate planners, we are seeing an increasing number of clients where the pension fund is their most valuable asset.  Taking professional advice on the devolution of the whole of one’s estate (including pension funds) has become more important than ever to ensure that it goes to intended beneficiaries in the most appropriate way.

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