The announcements made in September 2014 regarding the changes to the way death benefits are dealt with has raised the much-debated question, should I leave my death benefits to a trust, directly to my beneficiaries or, where possible, to a beneficiaries’ drawdown?
Previously, the compelling answer was to leave it in a trust in many circumstances, but with the new legislation, it is definitely something that needs more consideration.
Trusts have always been a common option for receipt of death benefits within a pension scheme, particularly where benefits were uncrystallised. In such circumstances benefits were usually paid to the trust free from inheritance tax (IHT), which would be the same as if it had been paid directly to a beneficiary. Although a payment directly to a beneficiary would become part of their estate, so subject to IHT on their death. This would not be the case if funds were paid into a trust, as the trust could distribute funds to a wide variety of beneficiaries.
Trusts were less popular when the benefits had been crystallised because of the 55 per cent tax charge on crystallised lump-sum death benefits. In these circumstances it was often more tax efficient, where possible, to leave income to a dependent within the pension scheme. The income was, however, likely to be restricted and taxed at the recipient’s marginal rate. On the beneficiary’s death any residual fund would then be paid out as a lump sum less the 55 per cent tax charge.
Trusts are subject to periodic charges every 10 years or on distribution of assets, but this was generally significantly less than any IHT that would be payable otherwise.
The new legislation introduces two major changes in the treatment of pension death benefits: the first is the removal of the 55 per cent tax charge on lump sums paid from crystallised funds; the second is the ability to name any beneficiary to receive income from the fund, rather than it being limited to a dependent of the original member.
The removal of the requirement for income only to be paid to a dependent opens up a greater number of options for nominations. In addition, on second death there is no requirement for the residual fund to be paid out. The capital can remain within the pension scheme and be passed onto a new beneficiary of the person receiving the income at that time of death.
This move means that money can pass down or across generations without being subject to IHT charges and, in cases where the death of the person receiving the income is before age 75, it isn’t subject to income tax or any pensions death tax upon distribution to the deceased’s survivors. It is still possible for the beneficiary to take the option of a lump sum, again tax-free if pre-age 75, or for a bypass trust to be nominated to receive the subsequent death benefit.
If a person rather than a trust takes the fund as a lump sum, there may be no tax on the original distribution to that person but there will be tax charges on any income and gains arising on these funds once in the hands of the beneficiary. This would not be the case should the funds be left within the scheme to invest.
