What are the benefits of using a trust? Most of us can look forward to many years of retirement and use pensions as a tax-efficient way of saving for life after work, so it’s important to be aware of what happens to a pension fund on death. Changes to tax rules and the pension freedoms mean a pension fund can be left to loved ones on death, normally free of inheritance tax.
Careful thought needs to be given to who should inherit a pension fund. In broad terms, if death occurs before age 75, normally a pension fund can be passed on tax-free. If death occurs on or after the 75th birthday, a pension fund becomes taxable in the hands of beneficiaries, at their marginal rates of income tax. If a pension plan offers the full flexibilities of the “pension freedoms”, the pension fund can stay in the pot and be passed on to others on subsequent death, affording tax planning. However, if the pension freedoms don’t apply to the plan, the only options might be to use the fund to purchase an annuity or to pay out the entire fund as a lump sum, as a result, the fund is no longer held in a pension wrapper which can have unintended consequences.
Regardless of whether the pension freedoms are available or not, when family circumstances are complex, involve multiple marriages, young people and/or a substantial pension fund, it might be better to use a trust. On death, the pension fund is paid as lump sum death benefit to a trust.
THE BENEFITS OF USING A TRUST TO PROVIDE FOR A SPOUSE
If the pension fund is paid out as a lump sum to a spouse, on their subsequent death, any remaining funds will form part of their estate and could be subject to inheritance tax. On remarriage and subsequent death, the inherited pension fund might end up with a completely different family. The benefits of using a trust are that it can still provide for a spouse during their lifetime as well as ensuring the residual fund is kept in the family on death. Where the full range of options permitted under pension freedoms is available, the option of taking the death benefits via flexi-access drawdown ensures ongoing inheritance protection as well as other advantages.
PROVISION FOR CHILDREN/GRANDCHILDREN UNDER 18
Divorced or separated parents naturally want to pass their pension on to their children, but not give the ex-spouse control of the child’s pension fund as they will have parental control of the child’s finances. Setting up a trust means the trustees are responsible for the funds in the trust.
CONTROL OVER THE WAY BENEFITS ARE TAKEN
How would you feel about giving a financially inexperienced beneficiary access to a large sum of money? A trust means that access to funds can be restricted and avoids the situation of an 18 years old taking a large fund in cash.
CARE HOME FEES
If a spouse has inherited a pension that is in drawdown, even if no funds are withdrawn, once they reach state pension age the income that could be purchased with the fund is taken into consideration by the local authority when assessing assets and income (before state pension age, only actual withdrawals are taken into account). If the pension money had been paid to a trust instead, it can’t be considered whilst it remains within the trust – however trustees can help to pay for the care if needed. Any income/capital paid from the trust to the beneficiary can be taken into account for means testing.
The benefits of using a trust and the key advantages and tax treatment of trusts are outlined in the newsletter and for the sake of brevity aren’t repeated here. From an income tax point of view, the tax treatment on monies entering the trust are broadly the same as stated in paragraph 2. You should seek financial planning and legal advice to put your pension death benefits into trust.