The cost of control
One of my pet hates at the moment is when someone refers to an expression of wish as a “Pension will”. Such a title, in my opinion, is misleading and gives the impression that an expression of wish can achieve far more than is possible.
A will specifies where and to whom your assets are to pass to on your death. The terms of a will can create trusts to control who receives what benefits and when. An expression of wish on the other hand merely provides guidance to pension scheme administrators/trustees as to who to consider as recipients of the death benefits. Once the scheme administrator/trustees have made a decision as to who is to benefit, the recipient, whether they opt for a pension or a lump sum, takes complete control as to how they use the pension fund during their lifetime and who in turn they may wish to benefit from the fund on their death.
In the three years since the introduction of pension freedoms the desire by some to make an expression of wish all encompassing has led to unnecessary complexity and in some instances increased the risk of potential charges to inheritance tax. The worst case I have come across to date is where the member laid out sixteen different scenarios as to who he wished to benefit depending on differing circumstances at the time of his death. Many of these conflicted; presumptions were made that trustees could hold back paying benefits until certain beneficiaries attained a particular age and as it continued it moved from asking the trustees to consider who should benefit to giving direct instruction.
This is an extreme example, but the desire to control who benefits and when from their pension after their death is not uncommon for many individuals. This is particularly apparent if a member has children from a previous relationship but wants their new partner to take an income from the pension on their death and then on the partner’s demise any remaining pension fund to pass to the late member’s children. This cannot be achieved by an expression of wish alone.
The use of by-pass trust arrangements may not play a part in inheritance tax planning since the arrival of pension freedoms but they still have a role to in scenarios such as this. Once the pension benefits are paid to a discretionary trust, the trustees appointed by the member can ensure that their wishes are carried out by paying the partner an income and on the partner’s death any remaining funds can pass to the member’s children.
If the member died aged 75 or over then a special lump sum death benefit charge at the rate of 45% would apply on the pension fund being paid to the trust. That said, on later payment of some or all of these monies, the beneficiary will receive a tax credit covering the 45% tax paid. The tax credit can be used to offset any additional tax liability in the year of payment or if their tax liability for the year is less than the amount of the tax credit they can claim a refund of the difference. So, for example, if the beneficiary was a basic rate taxpayer and received £5,500 from the trust and a tax credit of £4,500 they would be due tax of £2,000 on the gross payment. If they had no other tax liability then would be able to reclaim the additional £2,500 of the tax paid from HMRC.
There is a cost to achieve this control. First there is the loss of any future growth on the 45% tax charge which had been deducted at outset, then there is the income, capital gains and inheritance tax charges that would be applicable on the discretionary trust and finally the cost of administrating the trusts. It could prove to be expensive, but for some a necessary price worth paying.
This blog first appeared in Professional Adviser