These issues can best be illustrated by how clients’ pension funds are treated under different types of registered pension schemes available from the Skandia Group.

These issues need to be considered in the wider context of the client’s overall planning objectives.

Consolidation of existing pension funds into a Collective Retirement Account – one settlement and nil-rate band

Benefits from more than one registered pension scheme may be consolidated into one Collective Retirement Account. In this circumstance, should the client die before retirement and the proceeds of the Account are paid to a spousal bypass trust, there is the potential for a greater periodic charge if the value of the Trust Fund is greater than the nil-rate band at the 10-year point.

The periodic charge date would be based on the creation date of the bypass trust. This would mean there was only one date to manage and one set of reporting requirements.

Consolidation of existing pension funds into a Skandia Personal Pension Scheme or Skandia Executive Pension Scheme – multiple settlements and nil-rate bands

Where benefits from more than one registered pension scheme are consolidated into either of the above registered pension schemes, it needs to be established whether the death benefit from each transfer was previously held under trust and what date the trust was created.

For calculating the periodic charge in future years, should the client die before retirement and the proceeds be paid into the spousal bypass trust, identification of each payment is necessary. There would be multiple settlement dates and reporting to manage.

Potentially, any periodic charge would be lower as each settlement would have its own nil-rate band to set against the 10-year value. This would have value where the total value being considered is likely to exceed the nil-rate band.

The values cannot be proportionately spread across each settlement. They will be based on the percentage value of the pension fund transferred into a trust, ie one trust, with multiple settlements, each settlement based on the value transferred.

Managing multiple settlements inside one trust, rather than just having one trust, may have additional ongoing administration costs as well as extra management time, which may negate the potential advantage of a lesser periodic charge at the 10-year point.

The periodic charge is currently capped at 6%. A simple calculation for a £500,000 Trust Fund, minus the nil-rate band of £325,000 in 2009/10, would mean £175,000 is liable at 6% = £10,500 or a charge of 2.1% of the value. However, the IHT saving of 40% significantly outweighs this.

Summary

Individual consideration is required as to the importance of multiple settlements based on the client’s specific circumstances. Understanding the two options available will ensure financial advisers can choose which best suits their client. The cost in extra time and money where multiple settlements are used (and achieve multiple nil-rate bands) must be balanced against the potential risk of an increased periodic charge. The Collective Retirement Account option does offer a less complicated ongoing scenario for financial advisers.

Registered pension scheme death benefits within a spousal bypass trust – background

Lump-sum death benefits from registered pension schemes are normally free of IHT. Subject to amendments to legislation introduced in the Finance Act 2007 this position is correct, provided the following conditions apply:

• the payment is made within two years of the scheme trustees being notified of the member’s death, unless the scheme administrator had been made aware of the member’s death earlier in which case the two-year period will start from that earlier date, and
• the discretionary power to distribute the lump-sum death benefit rests with the trustees or scheme administrators of the registered pension scheme concerned.

Once a lump-sum death benefit has been distributed from the scheme(s) at some future time, the value of the payments will normally then fall within an estate for IHT purposes. If the beneficiary is the surviving spouse or civil partner* the surviving partner’s estate will increase in value by the value of the payment from the registered pension scheme. This could result in any unspent monies on the partner’s death being subject to IHT at 40%.

Use of a spousal bypass trust offers a solution to this problem. HM Revenue & Customs (HMRC) treats payment of a lump-sum death benefit from a registered pension scheme to a discretionary spousal bypass trust as a settlement. Provided the scheme pays the value within the two-year period of notification of the scheme member’s death as set out in amendments to the 2007 Finance Act, there will be no immediate liability to IHT.

What lump-sum death benefits could a spousal bypass trust receive?

There are four types of lump-sum death benefit which the trustees of the registered pension scheme could, at their discretion, pay to the trustees of a separate spousal bypass trust. These are:

• Uncrystallised defined benefit lump sum – this would normally be a death in service lump-sum benefit from a registered pension scheme or a lump sum from a guarantee under a scheme pension.
• Uncrystallised lump-sum death benefit – normally a return of a non-Protected Rights investment within a registered pension scheme that has yet to be crystallised, or Protected Rights where there is no surviving spouse or civil partner.
• Unsecured lump-sum death benefit – a lump sum available on the death of the member while in income withdrawal which will be subject to a withholding tax charge of 35% on the capital value before the transfer of the benefit to the spousal bypass trust.
• Pension Protection lump-sum death benefits from a scheme pension and Annuity Protection lump-sum death benefits.

Issues following payment of the lump-sum death benefit to a spousal bypass trust

There will be no tax charge payable on the transfer into the spousal bypass trust. However there is the potential for IHT charges to apply to these funds within the spousal bypass trust at every 10-year anniversary period of the trust (periodic charge), or when property leaves the trust (exit charge).

When determining the 10-year anniversary, Section 81 of the Inheritance Tax Act 1984 applies when the lump-sum death benefit paid from the registered pension scheme is paid to the trustees of the recipient spousal bypass trust. Section 81(1) states that where property ceases to be comprised in one settlement and becomes comprised in another, property is treated as remaining in the first settlement.

The 10-year period runs from when the member joined the registered pension scheme if that scheme was established under trust, or when the benefit was established under trust within that scheme, if later. Where funds in one trust are paid to a later trust the property is treated as remaining in the first trust for the assessment to both periodic and exit charges under the spousal bypass trust.

This can create significant issues where pension funds held under trust in various registered pension schemes are consolidated into one registered pension scheme where the transfer values are immediately held under trust in the receiving scheme.

In this situation, the proportionate values of the overall lump-sum death benefit and the relevant settlement dates will need to be separately identified.

If the receiving registered pension scheme does not immediately hold the transfer values it receives under trust, the continuity of the original settlement dates is broken. The settlement date will then begin from when the benefits are again placed under trust.

If the death benefits under the registered pension scheme are not put under trust before the member dies, any payment from the scheme to a spousal bypass trust will form an additional payment to the existing trust with the benefit of only one nil-rate band and the settlement date being that applying to the spousal bypass trust when it was established.

The issues arising in the following sections of this document assume that the death benefits held within registered pension schemes have been placed under trust prior to the member’s death.

Separate payments into a bypass trust from separate registered pension schemes

The funds from each scheme would be treated as creating separate settlements, each with its own nil-rate band and 10-year anniversary period. This period is fixed by the date that the member joined each registered pension scheme, if that scheme was established under trust, or when the benefits were first placed under trust in that scheme, if later. The assets held in the bypass trust will need to be separately identified for valuation purposes in settling any periodic or exit charges that may apply.

Transfers from one registered pension scheme to another before the member’s death and then subsequently into a spousal bypass trust on the member’s death

Where this occurs HMRC will adopt a practical approach for valuing potential periodic and exit charges.

If there are no funds in the recipient registered pension scheme at the time it receives the transfer, HMRC considers there to be only one settlement.

If there are funds in the recipient scheme at the time of the transfer (other than because of the transfer payment itself) there will be separate settlements. Following the member’s death, there will be an apportionment of the bypass trust assets in line with the treatment indicated above for separate settlements.

For a client who consolidates funds from several registered pension schemes into one scheme before death, there is a need to identify the settlement dates applicable for each transfer (other than the first transfer if no funds existed in the recipient scheme at the time the scheme received the first transfer payment).

It is important for financial advisers, when considering the use of a bypass trust, to identify the individual settlement values making up the total lump-sum death benefit that could pass into a bypass trust later. Doing this could significantly reduce the liability to periodic and exit charges. It will also ensure the trustees of the bypass trust correctly assess when they should undertake any later periodic charge reviews.

Exit and periodic charges

Where any property ceases to be relevant property, it will be subject to a potential exit charge based on the time that has elapsed since the settlement started or from the date of the last 10-year anniversary if later.

The tax chargeable before the first 10-year anniversary would be an appropriate fraction of the ‘effective rate’ (see below). The
appropriate fraction will be 30% x 1/40 for each successive quarter since commencement of the settlement.

For calculation purposes the quarter expiring before the day on which the property became comprised in the settlement can be
ignored. The ‘effective rate’ is the average rate that would be charged if an individual had made a chargeable lifetime transfer (CLT) equal to:

• the value of property comprised in the settlement or related settlements (ie created on the same day by the same Settlor)
  immediately after it started, plus
• the value of property subsequently added to the settlement immediately after its creation.

In determining the rate of tax applicable to the above mentioned transfer, any chargeable transfers made by the individual during the seven years immediately before the transfer will be taken into account.

On creating the bypass trust, potentially exempt transfers (PETs) are excluded unless they later become chargeable because of death within seven years. Often, where the Settlor has made no chargeable transfers in the seven years preceding the settlement, there will be little, if any, tax payable on property ceasing to be relevant before the first 10-year anniversary. Indeed, a Settlor having made no previous CLTs may deliberately settle assets within their nil-rate band, knowing there will be no exit charge before the first 10-year anniversary.

Lifetime of the Trust

The Perpetuities and Accumulations Act 2009 which received Royal Assent on 12 November 2009 does change the longer term planning where bypass trusts (also known as pilot trusts) are created. Any pilot trust created on or after 6 April 2010 will have a perpetuity period of 125 years, although any other shorter trust period is valid. For any death benefits paid from a trust based pension scheme to that trust the 125-year period limit will start from the date that those benefits were first held under a pension trust which may be a significant period in the past and care should be taken by the Trustees of the bypass trust not to breach the 125-year perpetuity period if a payment is received from a trust based pension scheme.

Bypass trusts created before 6 April 2010 will have perpetuity periods that will have different terms applying that comply with the perpetuity rules that apply to such trusts. Commonly this will be a fixed 80-year period from the start of the trust or 21 years beyond the member’s death. Those terms will continue to apply to pre 6 April 2010 bypass trusts and again, care should be taken by the Trustees not to breach the 125-year perpetuity period if a payment is received from a trust based pension scheme.

A client is currently considering consolidating funds built up under two registered pension schemes into one new scheme to ultimately provide retirement benefits.

The current fund values within his two registered pension schemes are £250,000 and £100,000 respectively.

While transferring the funds into the new registered pension scheme, his financial adviser is also considering the situation that could arise on the client’s death before a Lifetime Annuity is purchased.

Currently the client’s wish is for the lump-sum death benefit on his death to pass to his surviving spouse under an expression of wish. However, the financial adviser has noted that, by doing so, his spouse’s estate for IHT purposes would increase.

As a planning exercise, the financial adviser has suggested setting up a separate discretionary trust (the spousal bypass trust) with an initial nominal investment into an insurance investment bond of which the spouse and the client’s children are discretionary beneficiaries.

The intention, in the event of the member’s death, is to nominate the trustees of that trust as the recipients of any lump-sum death benefit from the new registered pension scheme. In this way, the capital passing into the separate spousal bypass trust will not form part of the spouse’s estate for IHT planning purposes. It will, however, give the spouse access to capital and/or income at the trustees’ discretion.

In considering this proposal, there are a number of important issues that the trustees of the separate bypass trust will need to be aware of:

1. 1Where benefits on the member’s death are transferred into a spousal bypass trust, HM Revenue & Customs (HMRC) will subject the transfer of such value to periodic and exit charges based on the date the value was originally put under trust, ie it is effectively a continuance of the original settlement.
2. It is important, therefore, for the financial adviser to identify when the lump-sum death benefits under the existing two registered pension schemes were put under trust, if at all. This information determines on consolidation into the new registered pension scheme the potential dates when periodic and exit charges may arise after the member’s death when the value is subsequently transferred to the separate bypass trust. The financial adviser identifies the date when the existing schemes placed the death benefits under trust. These were 8 December 1995 for the fund of £250,000 and 16 June 1997 for the smaller fund.
3. The financial adviser will need to be able to identify the values of each settlement within the new registered pension scheme. If the member dies and there is a resulting transfer of the settlement value, each settlement is separately identifiable for the trustees of the bypass trust. This will make it easier for them to identify when, and whether, any periodic or exit charges may apply in the future to that trust.

While the client is alive, there are no periodic or exit charges due on the funds held under the new registered pension scheme.
 
Application of periodic and exit charges following the client’s death

The client dies in December 2010. The value of the original transfer payments has increased to £310,000 and £160,000 respectively within the registered pension scheme, providing an uncrystallised lump-sum death benefit of £470,000. This value passes to the trustees of the spousal bypass trust which was set up on 1 October 2008 with a payment of £1,000.

However, this is not a single settlement. The three separate values mean the trustees of the spousal bypass trust must evaluate potential periodic and exit charges at three different dates.

The periodic charge anniversary applying to each respective settlement is as follows:

• 8 December 2015 for the first settlement value of £310,000 passed into the bypass trust.
• 16 June 2017 for the smaller lump-sum death benefit value of £160,000 passed into the bypass trust.
• 1 October 2018 for the £1,000 invested in the bypass trust itself.

If the value of the individual settlement at its periodic charge date, plus any distributions made in the previous 10 years and CLTs made in the seven years before creation of the trust, is less than the nil-rate band, there will be no periodic charge for the trustees to pay at that time.

However, if the aggregate value of the individual settlement, plus any distributions made in the previous 10 years and CLTs made in the seven years before creation of the trust, is greater than the nil-rate band applicable at the time, a periodic charge will arise.

Any distribution would normally be apportioned across the settlements, the apportionment being based on the value of each settlement as a proportion of the total trust value at the time the distribution was made. The example shown illustrates how the tax calculations could work in such a situation.

Tax calculations

The trustees distribute £20,000 to the surviving spouse and £10,000 to a surviving child on 1 May 2012. At the time the distribution is made the values of the individual settlements are £330,000, £168,000 and £2,000 ie 66%, 33.6% and 0.4% respectively.

The distribution will therefore be apportioned such that £19,800 is applied to the first settlement, £10,080 to the second settlement and £120 to the third settlement. Assuming the member had made no previous CLTs for any of the settlements the theoretical CLT calculation would be as follows:

Any consolidation exercise undertaken to transfer benefits from multiple registered pension schemes into one new registered pension scheme, where the use of a spousal bypass trust for death benefit purposes is being considered, will require the collation of information in respect of the death benefit values and settlement dates applying to those funds.

The following flowchart highlights the approach to be taken to identify the relevant details of any existing pension arrangement a client holds. This information is essential in determining the make up of those funds from a settlement date perspective.

Being able to identify and record the settlement dates and ongoing value of each settlement will be extremely important. Recorded information can easily be passed to the trustees of the separate discretionary trust should, at a future date, the lump-sum death benefit value from the registered pension scheme(s) be passed into that trust. This will enable the trustees of that trust to identify potential periodic charge periods and the values for calculation purposes of both periodic and exit charges that may apply in the future.

It should also provide an additional benefit, where it is identified that a number of settlements exist, in reducing the value of each settlement for assessing the potential periodic and exit charges applying to the overall value of the trust fund.