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A Pilot Trust

In today's sophisticated financial market, many people have death-in-service benefits through their employment or death benefits via their pension scheme. These benefits are generally nominated in favour of the surviving spouse so are not treated as assets of the deceased's estate. But there is a potential IHT problem.

Generally speaking most people nominate their death benefit to be paid directly to their spouse or partner but that is as far as much 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 their 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 nominating the death-in-service benefit or pension death benefit into a 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 be a beneficiary of the trust and receive funds. 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 reducing the value of the estate for IHT purposes.

By using a spousal by-pass trust, not only can the survivor have the full benefit of the monies payable but an IHT saving can be made at the same time!

Spousal by-pass trusts are not limited to death in service benefits and pension benefits. They can be used in conjunction with any form of life insurance. Therefore anyone with any type of term life insurance or mortgage protection insurance should consider placing the benefit of the policies into such a trust. The surviving spouse can still be a trustee and therefore control how the funds are used. This way considerable IHT savings can be made.

In this trust you have nominated your spouse (after your death) to be a beneficiary and also your children. The other (default) beneficiaries would only take if your spouse and children all die while there are funds in the trust. As it is a discretionary trust any of the nominated beneficiaries may benefit as the trustees decide in their discretion.

In respect of any death in service benefits or life policies then you need to make arrangements with your employer/insurance office that the sums due on your death are paid to the trustees of this trust. This will involve completing a simple nomination form. Often the trust will not receive assets until you die so although it is up and running now there will be no administrative tasks to do until assets are paid into the trust at which time its existence should be notified to the revenue by completing their trust notification form.

Of course nothing prevents you or family members from passing assets into the trust now or in future years by, for example, making use of your future annual IHT exemptions.

One other advantage of a pilot trust is that should a spouse remarry or a beneficiary divorce assets can be protected from being lost to the family in these circnstances.