Many people today have ‘death in service benefit’ through their employment or pension scheme which pays a lump sum should they die. They may also have life insurance policies or mortgage protection policies which will pay a lump sum on their death.
Generally, these sums are not subject to inheritance tax upon death, but they can still cause inheritance tax problems for your family in the future unless some careful planning is undertaken.
In most cases people naturally want to have peace of mind that they have taken care of their spouse should they die, and will nominate their spouse to receive the cash due under these schemes and policies. This will not result in an inheritance tax liability arising on their death if they are married or in a civil partnership. The payment however becomes part of the surviving spouse’s or civil partner’s estate. When they go on to die in the future, the payment (if it has not been spent) will form part of the spouse or civil partner’s estate and will be subject to 40% tax (depending on the other assets in their estate) at the time of their death.
A useful way to plan for this eventuality is to nominate the death in service or pension payment, or sums, which may be due from life or other policies into what is commonly called a Spousal Bypass Trust. The trust is usually discretionary in nature and will have a class of beneficiaries which will include the surviving spouse. Such a trust can be drafted very flexibly to ensure that the surviving spouse is able to benefit from the funds during their lifetime in whatever way is appropriate to their circumstances. This means that the spouse will always be properly provided for.
Trustees are appointed under the Spousal Bypass Trust and they will be responsible for the control of the trust fund. It is common for the surviving spouse to be a trustee so that they can have some control over the use of the trust funds. This provides assurance to the surviving spouse that they will not be left without any say in respect of what happens to the funds. You should also leave a letter of wishes, expressing how you would want the trust fund to be used. Whilst this is not binding on the trustees it does offer them guidance when they come to exercise their powers under the terms of the trust. The guidance given in the letter of wishes will generally be to ensure that the surviving spouse is properly provided for, before making provision for any other family member from the trust. The advantage of the trust is that, even though the spouse (or civil partner) can be both a trustee and a beneficiary of the trust, (as the trust is discretionary in nature), the assets in it will not form part of the spouse or civil partner’s estate for inheritance tax purposes upon their eventual death. This can save the 40% tax charge mentioned above.
Spousal Bypass Trusts can be set up quickly. Many pension and life assurance companies offer precedent pro forma documentation and while some of these may be sufficient, it is useful to have a solicitor go through the documentation before you sign them to ensure that they fit with your circumstances as they can be inflexible. If you do use the standard forms which are available, then it is important you are sure that they are completed accurately and the correct information is completed in the appropriate way.