Spouse bypass trusts

Insights

3rd Feb 2025

What is a spouse bypass trust?

A spousal bypass trust is an arrangement that lets pension benefits bypass the surviving spouse's estate for inheritance tax purposes, while still allowing them to receive income from the pension during their lifetime. Upon the pension holder's death, the benefits go into the trust rather than directly to the spouse. This protects the money from inheritance tax when the surviving spouse dies, while ensuring they can still benefit from it during their lifetime. The eventual beneficiaries (often children) receive the remaining funds from the trust after the surviving spouse's death.

Basic Options for Pension Death Benefits

The simplest approach is to either

Name specific beneficiaries on the pension scheme's nomination form - complete the scheme's expression of wishes form to specify who should receive any death benefits. While straightforward, this offers no ongoing protection for the funds.
Allow benefits to fall into your estate and be distributed through your will - the benefits become part of your overall estate planning but may create immediate tax charges.

Why a spouse bypass trust may be a better option

Benefits paid directly to a spouse become part of their estate for inheritance tax, potentially creating a 40% tax charge on their death. Benefits paid through your will may attract immediate inheritance tax if your estate exceeds the nil rate band

Different types of pension death benefits

Death benefits vary significantly between different types of pensions. Each pension type has its own rules about what happens to both the regular pension payments and any lump sum benefits when the pension holder dies. Finding out about lump sum payments on death, spose entitlements to ongoing pension after death and other aspects are essential when considering whether to set up a bypass trust.

Setting up a spouse bypass trust

Basic requirements and considerations include include :-

Named beneficiaries: The trust deed identifies potential beneficiaries, typically including spouse, children, and other family members, creating flexibility for future distributions.
Trustees: Appointed individuals or professionals who manage the trust assets and make distribution decisions.
Letter of wishes - non-binding guidance to trustees about the settlor's intentions for benefit distribution.
The trust operates through specific steps including expression of wishes nominating the trust as beneficiary. The pension provider pays lump sum directly to trust, trustees decide on distributions and beneficiaries receive capital or income as determined. Pension benefits do not form part of surviving spouse's estate.
Other potential benefits (other than reducing surviving spouse assets if over the IHT threshold) include protection from local authority assessment and adaptability over distribution and investment of trust fund.
Potential drawbacks include administrative requirements, the need for regular trustee meetings and decisions, legal and accounting fees for maintenance, record keeping and annual tax trust returns may be required