• Private Client Practice
• Other PG Lore articles

It is a rare breed that willingly pays more tax than it need. Yet there is a surprising number of people that do so unwittingly. Death benefits, whether death in service, life assurance or pension death benefits, needn’t and shouldn’t suffer inheritance tax; but unless set up correctly they will.

Do nothing and when you die, unless you leave your death benefits to your spouse (in which case you are just delaying payment of inheritance tax until their death), you will pay 40% of your death benefits to the Tax Man and only 60% will go to your loved ones. That isn’t all. If your loved ones don’t spend all of those death benefits before they die the Tax Man will get a further 40% of the leftovers. By doing nothing you are effectively leaving the Tax Man a legacy of up to 64% of your death benefits.

Tax planning may be dreary but it is undoubtedly worthwhile and beneficial to the recipients of your estate – particularly if in practical terms it makes no difference to you. What are your options?

Nominate a Beneficiary

First, you could nominate someone to receive your death benefits. For those of you who didn’t nominate anyone when you first created your pension or life policy now is the time to do so. It is sensible to nominate two beneficiaries in case the first should die before you. By doing this, it will ensure that your death benefits bypass your estate and the people you have nominated will get 100% of their value. Problem solved. Perhaps.

The drawback of this option is that you are effectively taking your death benefits out of your estate and putting them into someone else’s. Unless the person you have nominated spends the entirety of your death benefits during their lifetime the Tax Man will still get a take when that person dies.

If your objective is to leave something for the next generation it is of no help if everything has been spent even if such extravagance does rob the Tax Man. There is a second option:

Set up a Discretionary Trust

Placing your death benefits into trust means they don’t form part of anyone’s estate. The flexible nature of these trusts is such that the trust itself, and not an individual, is chargeable for inheritance tax purposes but at a fairly benign rate (a maximum of 6% every ten years and a proportion of that amount if assets leave the trust between ten year anniversaries); not only have you avoided the inheritance tax charge on your own death but there will be no such charge on the death of anyone else.

A major saving of tax, but not a completely free lunch. There will be costs in administering a trust, for example paying for annual accounts and the preparation of tax returns and the inconvenience (or protection, depending on your view) of trustees, but with careful thought these can be kept pretty low. The lunch may not be free but it can be pretty cheap.

Advantages of setting up a discretionary trust:

• 1. The value of your death benefits is usually nominal when you set up the trust (until you die they are of no value, and to be worth anything then requires you to have paid the premiums right the way up to your death) which means you can get the money into the trust without the usual inheritance tax entry charge (up to 20%, with more if you die within seven years).
• 2. Provided the value of the trust remains below the annual inheritance tax threshold (£325K this year) the 6% charges (which the Tax Man would otherwise take off you every ten years) can be avoided. Several smaller trusts can be created if your death benefits are going to exceed the inheritance tax threshold.
• 3. Discretionary trusts are flexible: assets can be distributed to anyone of a class of beneficiaries. If the trust is properly drafted different rights can be created for different beneficiaries – for example your surviving spouse could be made entitled to all the income as it arises.
• 4. Rather than paying out cash the trustees can lend it. This is particularly useful for surviving spouses. Your spouse in effect has the money free of trust, but the trustees retain the right to call it back so that spouse has a debt in his estate to be deducted when calculating the inheritance tax liability on his death.
• 5. Whether you choose a simple nomination or the full blown trust your death benefits will be available the moment you die. Do nothing and they form part of your estate not just for inheritance tax but for probate too – your loved ones will only be able to get their hands on your cash once probate has been granted and that can take several months. Having cash immediately is very useful particularly if it can be used to pay such tax as there may be on the rest of the estate.

Planning with death benefits need not be difficult even if using trusts. Death in service, and pensions death benefits can be nominated by completing a simple form usually provided by the company or pensions provider. And life companies will usually provide a standard form of trust. However standard form trusts should be approached with care. In many cases they may be adequate, but if the hope is to have a trust running for a while for the benefit of a group of beneficiaries, there is no substitute for proper advice and a bespoke trust. Particularly where the death benefit attaches to other benefits too for example pensions or critical illness.

Death Benefit planning need not be complicated. And is pretty painless – it is easy to give away something you will never get your hands on. Whether nominating a beneficiary or placing your death benefits in trust is the best solution for you, they are both better than doing nothing. Just because death benefits won’t benefit you, there is no reason they should benefit the Revenue.

We have extensive experience providing tax planning advice on death benefits and will be happy to help you.

Amy Ridley, Trainee
Private Client Practice
email [email protected]
tel 020 7591 3371


• Other PG Lore articles