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Why should I put my death in service benefits in trust?
In today’s sophisticated financial market, most people have death-in-service benefits through their employment or death benefits via their pension scheme. These benefits are generally given to the surviving spouse or partner, so are not treated as assets of the deceased’s estate . But there is a massive potential Inheritance Tax (IHT) problem which can destroy 40% of their value.
Generally speaking most people nominate their death benefit to be paid directly to their spouse or partner which is fine - as far as most advice goes. As a result, because the benefit is not treated as an asset of the estate, on the first death there is no liability to IHT. However, IHT liability arises on the second death. For example, on the death of the first spouse, the death-in-service pays a lump sum to the survivor. This is outside the estate for tax purposes. Once the benefits of the policy have been paid to the survivor they become an asset of the partners estate. Subsequently, when the survivor dies their estate (which would include any death-in-service benefit monies) is subject to IHT at 40% on the value of the estate in excess of the IHT threshold.
This tax problem can be avoided by sending the death-in-service benefit or pension death benefit into a special trust. The trust is held outside the survivor’s estate; (and therefore not subject to IHT on the survivor's death). However the survivor can benefit from the trust and receive cash or other benefits. Even more beneficially the trust can be drafted with power to loan monies to the survivor. As a result the survivor will have the full use of the funds to invest or spend, or live off the income as they see fit. However, as a loan has been made from the trust a liability has been created which can be paid out of the survivor's estate on their death thereby further reducing the value of the estate for IHT purposes. Whilst a discretionary trust, or any type of trust, has its own taxation regime upon which advice is required, in many cases it is certainly worth looking into this type of arrangement.
What formalities are required?
These trusts can be set up quickly and are typically, but not necessarily, done at the same time as a testator drafts his Will. They are normally discretionary and are created with a trust fund of as little as £10.
What is the effect?
NO DEATH IN SERVICE TRUST
John dies and leaves his estate to his wife, Jane £500,000
Lump sum death benefit paid to Jane £600,000
Jane’s own estate £400,000
Total estate £1,500,000
Less nil rate band (x2 to include John’s unused allowance) £650,000
Net taxable estate £850,000
Inheritance Tax payable at 40% £340,000
WITH DEATH IN SERVICE TRUST
John dies and leaves his estate to his wife, Jane £500,000
Jane’s own estate £400,000
Total estate £900,000
(Lump sum death benefits of £600,000 paid to £600,000
death in service trust. Trust makes £600,000 loan to Jane)
Gross Estate £1,500,000
Less loan due back to trust £600,000
Less nil rate band (x2 to include John’s unused allowance) £650,000
Net taxable estate £250,000
Inheritance Tax payable at 40% £100,000
SAVINGS BY USING TRUST £240,000 |
