BY-PASS TRUSTS AND THE FINANCE BILL 2015

Charterbridge

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BY-PASS TRUSTS AND THE FINANCE BILL 2015

ALTERNATIVE INVESTMENTS – FROM INTELLIGENT PARTNERSHIP

 

Synopsis: The Finance Bill 2015 confirms that with effect from 6 April 2016, lump sum death benefits paid to an individual will be taxed as income of that beneficiary.  It also confirms that where a lump sum death benefit is paid to a trust (other than a bare trust) after 5 April 2016  following the death of the member at age 75 or over there will continue to be a 45% tax charge (the SLSDBC – the special lump sum death benefit charge) . This charge will therefore apply to payments to most By Pass Trusts. However, where benefits are later paid out of the trust to a beneficiary, the beneficiary may get some credit for the 45% tax charge that applied when the trustees initially received the payment of death benefits from the pension fund.

 

Date posted: Tuesday, July 28, 2015

 

Since the introduction of flexi-access pensions on 6 April 2015, people have queried whether a By-Pass Trust can still serve a purpose as a recipient of death benefits on the death of a member.  This question has arisen following the introduction of flexi-access drawdown for death benefits and the claim that wealth can ‘cascade down the generations’ without forming part of a beneficiary’s estate. In other words there is no need for a lump sum death benefit to leave the pension funds following the death of the member. Where the member dies aged 75 or over, one can see the basis of this argument being strengthened as thee will then be a 45% special lump sum benefit charge (SLSDBC). On the other hand, there would be no such charge if the member died under age 75 and so from a tax standpoint, the position is neutral.

Of course, having the benefits held inside a trust will be the only way of retaining some control over who benefits from the money representing the pension fund, to what extent they benefit and when they benefit. A by-pass trust vests the power to make these decisions in the trustees whereas if funds are left in the pension fund with beneficiaries designated by the scheme administrator (usually taking account of the expression of wish of the deceased member/previous beneficiary) the designated beneficiary(ies) at any point in time  would have complete control to take the  benefits at any time.

Despite the ‘control’ benefit of the by-pass trust the special lump sum death benefit charge of 45% that applies to payments to trusts is likely to prove a major impediment to the use of a by-pass trust where the member dies over age 75

On the other hand, if funds are left in the pension fund following death, drawdown income would only be taxed when drawn by the beneficiary – and then at the beneficiary’s personal rate of income tax.

Decisions on how lump sum death benefit payments are made may however require some re-thinking.. Whilst the Summer Finance Bill 2015 confirms that the 45% tax charge will still be payable by the Scheme Administrator in future on payments to trusts, it also states that when payments are made out of the trust:

1.  the amount received by the beneficiary (together with an attributable amount of the tax charged on the lump sum) will be taxed as income of the beneficiary, and

2. but the attributed tax may be deducted from the beneficiary’s tax bill at the end of the tax year in which they received the benefit.

Example:

Harry dies age 77.  The value of his pension plan is £100,000.  The Scheme Administrator want to pay a lump sum to a by-pass trust.  They therefore pay a tax bill of £45,000 leaving £55,000 payable to the trust.

1 year later the trust fund is still worth £55,000 and £25,000 is distributed to Ebenezer – Harry’s son.

Ebenezer is treated for tax purposes as receiving £25,000 + £20,454 (the tax at 45% that would leave a net sum of (£25,000)  =   £45,454

He will be assessed on an amount of £45,454 as income in the year of receipt as a higher rate taxpayer, his liability on this sum would be £18,181. However, he will have a “tax credit” of £20,454 representing the attributed proportion of the 45% paid by the scheme administrator on the initial payment to the trust.  As he can set this against his total tax liability for the year which would “neutralise his liability of £18,181 on the payment and provide a further tax credit against other income of £2,273.

What this means is that where a tax bill of 45% arises on a payment to a by-pass trust, when a subsequent payment is made out of the trust to a beneficiary, the tax paid can effectively be reclaimed to the extent that the charge exceeds the tax liability of the beneficiary at their tax rate. So unless the beneficiary is an additional (45%) rate taxpayer, there will be a credit to “use”

This outcome is supported by the Explanatory Note to the Finance Bill which states:-

However they will be able to claim the 45% special lump sum death benefits charge paid on the lump sum death benefit as a deduction against their own income tax.

On the basis of this, ‘there appears to be no limitation of the credit to the amount of their own tax liability on the benefit received.  This will mean that “net credit” is available to nil, basic and higher rate taxpayers (with, effectively, no tax on the benefit itself) and no additional tax payable by additional rate taxpayers as the 45% on the benefit will be “neutralised” by the credit.  This provision may also complicate trust administration when the trust holds assets other than just those representing the lump sum death benefits received on the member’s death.

COMMENT

By-Pass Trusts can still have a role to play in IHT planning – particularly for those who value control over pure tax savings.  This change will improve the position for families who wish to use them on a member’s death aged 75 or more. To make a decision in each case, advice will be essential and comparative calculations made to inform the decision.