Spousal By-Pass Trust - A Useful Inheritance Tax Planning Tool

Many people nowadays have death in service benefit lump sums that will be payable following their death, through their employment or pension scheme. 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 so 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 By-Pass 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 By-Pass 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 wish expressing how you would want the trust fund 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 By-Pass Trusts can be set up quickly. Many pension and life assurance companies do offer precedent pro forma documentation and while some of these may be sufficient it is useful to have a solicitor look over them 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 that you are sure that they are completed accurately and the correct information is completed in the appropriate way.

Far better than using the standard proforma documents, is to have a bespoke Trust created for you. DWF LLP Private Client Team offer the opportunity to draw up such a Trust incorporating all the necessary powers to ensure that it will work accurately and suit your particular circumstances. By creating one Trust, all of the death benefits can be held in one "pot", rather than the number of small "pots" that would be created by using standard documents. In addition, many standard company trusts are time limited which can make them inappropriate and therefore we recommend that you do take legal advice when considering setting up a Spousal By-Pass Trust. Such trusts also have their own tax regime which you should be aware of before setting them up and we are able to provide details of this.

The Trust can be set up with a nominal sum from as little as £10.

There are also other planning opportunities which can be considered through the use of Spousal By-Pass Trusts and one of our experienced team would be happy to have a further discussion on this point with you.

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