Pension Death Benefits – Bypass Trust v Nomination

As part of the new pension changes that have recently come into force, there will be significant changes to the way that death benefits can be paid from your pension scheme.

Most UK registered pension schemes are established under a master trust or by deed poll. These schemes will usually have discretion written into the scheme rules which may be used for the distribution of lump sum death benefits which become payable on a members death.

Although the provisions of pension schemes and policy terms and conditions will differ, there are usually two options available to members who wish to take steps to ensure that any lump sum death benefits may be distributed in accordance with their wishes.

The member may:

Place their pension plan under a suitable pension trust, appointing their own trustees, 

or

Nominate a beneficiary or beneficiaries for the scheme administrator (this would be the trustees of a scheme established under trust or the administrator of a scheme set up by deed poll) to consider when exercising their discretion on who should receive any lump sum death benefits.

So . . . what are the differences between a nomination and a trust?

The following outlines some of the differences between a nomination and trust which you may wish to consider.

Scheme rules and policy terms and conditions will differ and it is recommended that you seek legal advice to make sure any decisions you make are appropriate to your needs.

Nomination

Overview

• The member notifies the scheme administrator of their preferred beneficiaries should any lump sum death benefits become payable under their plan.
• The member may alter their nomination at a later date by notifying the scheme administrator in writing.
• The nomination is not binding on the scheme administrator, although the nominated beneficiaries will be considered when they exercise their discretion.

Advantages

Simple process

• Payment may be made directly to beneficiaries by the scheme administrator without waiting for probate
• Payment will normally be free of IHT.
• On death before 75, death benefits (except scheme pensions) can normally be paid tax free within the Lifetime Allowance (LTA). This applies to survivors annuities and pension guarantee payments as well as inherited drawdown pots.
• On death at 75+, death benefits will be taxed as the recipients income, when they draw the funds.

Disadvantages

• The nomination is not binding on the scheme administrator. Although they would consider the members nomination, payment to the nominated beneficiaries cannot be guaranteed.
• The nomination must be reviewed regularly to make sure it reflects any changes in the members personal circumstances.
• A retirement annuity or buyout plan generally has no discretionary powers written into the policy terms and conditions, although, there may be a limited opportunity for a member to select how benefits may be paid i.e. as an income to a dependant instead of a lump sum. This means a nomination option will not be available and any lump sum death benefits will usually be payable to the members estate unless they place their policy under a suitable pension trust.

Bypass Trust

Overview

• The member completes a suitable trust deed, appoints their own trustees and nominates their preferred beneficiaries.
• The member may normally alter their trustees and preferred beneficiaries at a later date.
• The scheme administrator will pay any lump sum death benefit directly to the trustees appointed by the member.The trustees will distribute the lump sum in accordance with the terms of the trust.

Advantages

• The member is able to appoint their own trustees (this may provide greater certainty that their wishes will be carried out).
• Payment may be made directly to the trustees by the scheme administrator without waiting for probate.
• Payment will normally be free of IHT.

Disadvantages

• Complex documentation (in comparison with a nomination).
• Bringing a trust to an end is complex and may not be possible. The client will need to refer to their legal advisers if they wish to do this.
• New trustees will need to be appointed if existing trustees die or retire from their role as trustee.
• Depending on the terms of the trust, trustees are likely make payment to the members preferred beneficiaries, although this is not guaranteed.
• A member may not have the option to place their policy under a separate trust e.g. if their plan is held in an occupational pension scheme. In these circumstances the member will usually be able to make a nomination instead.
• The trust will be subject to the relevant property regime ie potential 20% charge on setting up the trust, the ten year anniversary charge (maximum 6%) and exit charges on capital leaving the trust (maximum 6%). These charges will only arise where the available nil rate band threshold has been exceeded.

The primary benefit of a bypass trust is to bypass payment to a chosen dependent, usually your spouse, to avoid their estate increasing. This favourably reduces the impact of IHT in the event of the dependents death whilst continuing to give the dependent total access to the money in the trust.