Dispelling myths around trusts

Published  28 March 2024
   60 min CPD

Join Fiona Hanrahan and Gregor Sked, Senior Technical Managers, where they’ll talk over dispelling myths around trusts in both the protection and pensions industries.

Trusts have a very important role in financial planning and when used with protection policies they can offer significant benefits to clients and their families. Yet so few policies are written in trust. During the first half of this session, we’ll address the protection trust gap in the UK as well as highlighting the importance of ensuring trusts form part of your protection advice.

When it comes to pensions, we’ll cover off what options are available when someone dies and what tax if any would be payable by the recipients. We’ll also talk about when you might want to set up a trust to receive pension death benefits and will work through a case study to help.

Learning objectives:

  • Have a better understanding of the role trusts play in ensuring good protection outcomes.
  • Be more confident knowing how to avoid certain trust pitfalls when dealing with different protection planning scenarios.
  • Understand what options are available from pensions when someone dies and how they’re taxed.
  • Appreciate when using a trust to receive pension death benefits might be useful.

What’s covered

  • The importance of financial planning and when to use it with protection policies to maximise the benefits to clients and their families.
  • A discussion on the protection trust gap in the UK.
  • What the alternatives choices are when someone dies.
  • When you might want to set up a trust to receive pension death benefits.
  • View and download the webinar slides (PDF)

Alright, today we are gonna be dispelling myths around trusts for protection policies and pension death benefits.

I'm Gregor Sked, Senior Protection Technical Manager, and I'm joined by my colleague of Fiona Hanraham, Senior Pensions Technical Manager.

Now today is going to be jam packed full of information to help your pension and protection advice, and we'd love to hear from you over the next hour, so please do use the Q&A facility to send across any questions and anything where maybe unable to reach or get respond to over the course of the webinar will follow up with you directly in the coming days.

Now lastly, today's webinar is being recorded so you will be able to watch those back at your own leisure, and you'll also receive a link to watch the recording alongside your CPD certificates that should land in your inbox in the next 24 hours.

So today's session is received is CPD able so to make sure we are CPD worthy session, we've got four learning objectives. Now they are firstly to have a better understanding of the role that trusts play in ensuring good protection outcomes. Be more confident knowing how to avoid certain trust pitfalls when dealing with different protection planning scenarios. Understand what options are available from pensions when someone dies and how they're taxed. And finally appreciate when using a trust to receive pension death benefits might be useful.

Now trusts are a fantastic tool when it comes to financial planning, but are they used as much as they should be, particularly in the protection advice space. Now Royal London commissioned some research last year into answering the question around are trusts used as much as they should do in the protection of a space.

And interestingly, what we found was a lot of advisers, almost most of the majority of advisers, telling us that trusts are becoming more business as usual alongside their protection and device with 8 in 10 advisers telling us that they always or sometimes discussed trusts.

The slight conundrum is that that's not always reflected in a correspondingly high rate of protection policies being written into trust, with around 3 in 10 customers following through with their protection policy being written into trust.

So why do people need protection advice?
Well firstly, protection advice is about making sure there's money on the table when the worst happens and the reason that protection device is so important is that without an advisor, do people know what they're buying? Do people take out an insurance policy themselves online? Do they know what they're covered for? Have they considered putting that policy into trust? And for those that do take out a life policy, what's their intention?
Are they taking out that policy known that the person that might benefit from the money if a claim happens, we'll have to jump through hoops and hurdles to get it?

Now the protection gap and also the trust gap is a slightly age old industry problem.
The protection gap has been a bit of a thorn on the industry site for decades, and I would also say the trust gap is even wider now.

Now the number of individuals, so single life term assurance sales in 2022 is we can see in the box on the left-hand side of the screen which just over 1.5 million on the right hand side that's the number of single life term policies are written into trust in the same year, 16.6%. Now the good news is that that figure is growing and it's nearly get rid of it 3% increase from the previous year.

However, at 16.6%, it's certainly a long way from where we should be. So why are so few life policies actually written into trust now. In our research from last year, we got some key areas that advisers addressed as to some of the reasons that they've found barriers to Protection policies being replaced in trust and these include things like complexity, lack of time during client meetings to discuss trust and also client is struggling to think of enough trustees as some of the most common barriers to trusts.

Now I think yeah, this started I really wanna just remind ourselves as to what the role trusts play in protection planning. Now we're going to have a wide range of expertise on today's webinar and you'll have varying experience of trusts.

So just to set our scene, what exactly is a trust?
Well, a trust is a sensually aware holding property for the benefit of someone without giving them full control. And there's typically three main parties involved within a trust. So we've got at the very top of this clock, we've got the settlor, sometimes known as the donor, and that is the person that is putting an asset into trust, for example, while a life insurance policy. Now settlor or donor is the person that is effectively legally transferring that ownership off the asset to the trustees and the trustees, well, these are going to be the legal owners of the trust property. Now their main role is to optimally administer the trust property for the benefit of the beneficiaries as we work where we run the clock. The beneficiaries are the intended recipient of the trust property. Now in the centre of this little clock we've got the trust deed now. The trust deed is that legal document that's sets out the trust rule and also the trustees’ powers, effectively, this is the trust.

Now to help support both the settlor, the donor and the trustees with their roles the there's something called a letter of wishes that there's often used now a letter of wishes are really good idea to have in place, and they're effectively a way of giving trustees a bit of guidance on how the donor wants the trust assets to be distributed, and also finally, under what circumstances.

So what are the main reasons for trust being used now?
There are many uses for a trust, such as it's a way of cascading wealth down to future generations without losing control of how and when that wealth is passed on, when assets are written into trust, they're removed from the donors estate. Therefore, they're very key tool when it comes to clients looking at a state planning. Assets that are within the trust are managed by the trustees on behalf of the beneficiaries, so they can be a particularly useful tool when beneficiaries are young or maybe vulnerable and are unable to manage that particular asset or assets themselves. Where single life policies are not in trust it's a requirement of life offices to see if something called a grant of probate or certificate of confirmation up in Scotland, and that's effectively the confirmation that someone can deal with the deceased individual as a state, and that has to be seen before a claim will be generally paid out.

Now figures from the start of 2024 suggests that the average wait claim for probate is around 15 weeks from submitting the application, and they can also be a really effective tool for protecting assets in the event of divorce, where means testing's being carried out or even bankruptcy as well.

Now you might have come across the phrase right hands, right time, right money in your career. It's a fantastically sharp way to bring to life the benefits of a trusted clients, and particularly we're looking at putting life policies into trust. It makes sure that the right hands at the right time receive the right money. I love that little phrase.

So what are the main types of trust?
Now, there are many different types of trusts which I think can certainly add to the complexity in protection device. You're generally gonna be using one of two types of trusts, either a bare trust or a discretionary trust. Now your bare trust. These are generally known as the simplest type of trust, whereby the donor must name the beneficiary or beneficiaries, and the trust will always pass the assets to the named beneficiaries. To the named beneficiaries cannot change. So these types of trusts offer little in the way of flexibility and also the named beneficiary dies and their share will pass to their state and not to any of the other named beneficiaries.

Discretionary trust probably the most common type of trust that we see in the protection advice space. And this type of trust gives whoever the donor appoints as the trustee how much wider range of powers to choose, who should benefit, how much each person should receive, and also when they should receive it. So much greater flexibility if things need to change.

Just on that discretionary trusts point for a moment. If you look through A life companies discretionary trust form, you might come across a clause that refers to discretionary beneficiaries. Now these are really individuals to whom the trustees can appoint trust property. Now there's a couple of reasons why this clause exists. So firstly, under English trust law, a discretionary trust can be put in force for up to 125 years to avoid the risk of property being put into trust indefinitely.

Now having that list of discretionary beneficiaries really gives provision to the person or even persons to access the trust property, should the trust reach that 125 year mark. It is quite unlikely as normally by that point in time you would expect most of the trust property or should probably have been dispensed.

Secondly, from a tax perspective without that clause, there is a risk that property off the trust could revert back to the estate that the donor, and it could be subject to the pre owned asset tax regime.

Now this default list will typically include as a standard definition way, and with the spouse or civil partner, former spouse, civil partners, children, maybe remoter descendants, and maybe some other options as well. But generally, you'll see some of those options included within this default list.

It can also be quite common to see reference to any person who has an interest in an estate by a will and intestacy rules, or survivorship. The question on the right hand side is do these lists really cater for the modern family unit?

Now the ONS suggests that cohabiting couples are the fastest growing family type and with the law not necessarily offering the same protections as married couples, there are more and more cohabitees being left financially exposed. In an industry first, Roland have recently included cohabitees within their discretionary trust definition of a partner. So this means that clients who are cohabiting can be chosen by the trustees to receive death benefits if they're not named by the client.

And this is a huge step forward and really ensuring that improved customer outcomes are being achieved and also avoiding cohabiting partners from being left out.

We've mentioned, trustees a couple of times now, but what actually makes a good trustee?
So I think the first thing is do your clients trust them? If they don't trust them to water their plants while they're away on holiday, are they really going to be an sufficient individual to manage potential financial assets? Trustees should have a sound financial history as well.
Locations are very important one, are the other end of the country? How easy will it be to get hold of them? Should they need to enact as their roles a trustee? And how old are they?
So in England, Wales, Northern Ireland, a trustee must be at least 18. But in Scotland, trustees can be at least 16.

It's also worth considering a maximum age for trustees. There's no legal maximum age that a trustee need can be, but does the donor at want to outlive the trustees? So having a maximum age is a consideration is quite important.

Well, I'm hopefully gonna be sharing a few areas of trusts and debunk some of these common myths. One of the things that I found really important over the last 12 or so months of discuss and trust is actually bringing it to life with scenarios that advisers come across on a day to day basis. And I think having that understanding of a role of a trust is really important but actually bringing it to life through case studies can really help.

So what I'm gonna do is share 3 common protection planning case studies and we're going to consider the role of trusts in each of them. So let's start with one of the most common, which is a client with a single life insurance policy.

So let's meet Jakub. So he's a new client of yours, and you're meeting him to discuss his finances and have a look at his financial position. Jakub's wife passed away in 2021.
She left behind a full unused nil rate band. Both Jakub and his late wife never had any children together, and he has a single life only policy with a sum assured £250,000. The policy at this point in time is not written into trust.

So what does Jakub’s Estate look like at the moment?
But he's got a net estate value of £750,000 which is made up of a taxable estates worth of £500,000 and his single life policy worth £250,000. He's got a nil rate band of £325,000, but again thanks to the transferable nil rate band he can use his late wife's full unused nil rate band giving them that total nil rate band of £650,000.

For ease we’ll assume that isn't entitled to the residency no rate band.
Now, if the estate was taxed at the current IHT rate of 40%, it could create a tax liability for about £40,000. Now, if Jakub Estate wanted to use a probate specialist, then what you might find is that probate specialist tend to charge on a fee, tends to be a sliding scale fee of anywhere between 1 and 5%.

So let's say we'll go for a middle of the road 3% fee. We might see an addition of an additional £22,500 fee on top of that tax bill. So what might be a simple solution to not only reduce the potential IHT liability on his state, but also help keep Jakub’s estate in good route to achieve these good outcomes. Well, really, we could look at writing that single life policy into trust as to what type of trust might be suitable.

Well, again that would be dependent on Jakub's need for flexibility and considering the discretionary or bare trust available to me earlier on in this instance, we're gonna go with the discretionary gift trust. Now on the right hand side, we've got the discretionary trust and if we assigned the life policy into that trust, it's removed from Jacobs estate for inheritance tax purposes. We're going down the discretionary trust route here to give Jacob a bit of flexibility over the course of the next few years.

Now we know Jakub has a tax bliss dates a £500,000, but by putting that life insurance policy into trust, we now know that we can see that that means he has a net estate value of £500,000. Because we've removed life policy from his estate.

Now that's within Jacob's available nil rate band, so it's going to result in no inheritance tax liability and a tax bill of nil. Now, there may still be a requirement for the estate to use the services of a probate specialist, but maybe with a smaller state there could be a lower fee here as well. Of course, this is a great tax planning exercise, but remember, having the policy and trust also give Jakub of that control over who receives the policy benefits on death and ensures that the beneficiaries will be with access the funds without going through probate or confirmation.

So for straightforward scenario similar to this one, is a trust the only option?
Well, there are some life companies, Royal London are included in that that offer an alternative to writing certain type of policies into trust. It is generally referred to as contractual beneficiary nomination and it's relatively a simpler alternative to helping clients achieve those three good protections outcomes, we looked at earlier. Right hands, right time and right money.

Like with Royal London contractual beneficiary nomination as available on single life, life or critical illness and whole of life policies, it's available during the application process and what it means is that there's no more ways to help customers achieve these good protection outcomes.

So on eligible policies, your clients can learn nominate beneficiaries to receive any benefits paid on death. Now compared to a trust, the key difference with this route is that is the terms of the policy that govern who gets paid. So it's quite similar to how a joint life for a life of another policy would work. And there's no need for a trustee or any trustees.

Now with contractual beneficiary nomination, clients can change their nominated beneficiaries at any point in time, and those named beneficiaries will have that contractual right to the benefits from the policy. So that means that the benefit isn't included in the client's state and it shouldn't be subject to inheritance tax.

Where contractual beneficiary nomination has been used then the payment to the beneficiaries also doesn't need to wait for probate or confirmation before it's granted.

Now I'm off to that, often asked when would you use beneficiary nomination over a trust?
Well, for straightforward cases where the client knows who they want to receive the policy process on death beneficiary nomination is a great solution. If clients are maybe hesitant about a trust for any reason, or they're unable to set one up while they're with you, nominating beneficiaries can be a really good default option. Now, even if a policy has beneficiaries nominated, it can always be written into trust at a later point in time for more complex requirements, particularly where clients are looking at inheritance tax planning, we would certainly still recommend that trust is used.

At the start, I mentioned that the that growing, hopefully not going to be growing many further, trust gap and our research highlighted some of those challenges that advisers have told us that they face when discussing trusts and complexity of trust. Certainly, one of the most common reasons why advisers often bypass them. With beneficiary nomination instructing what happens to the death benefits couldn't be more straightforward. After all, clients must have someone in mind who they want to benefit, otherwise, why would they be taking out the policy?

So lets head back on to trust for a moment, and I often hear joint life policies shouldn't or can't be written into trust. So let's just address that. Now we've got another case study client here, we've got Ben and Laura. They're married. They've got a joint life, first death policy, it's not written in trust.

There's likely that their objective behind that policy was about providing financial support to the surviving partner if the other died. Now let's say Ben died and Laura needed to make a claim on her joint life policy. Laura is able to claim the full sum assured, without the proceeds causing any potential transfer and there's tax issues.

The right person will benefit from the proceeds i.e. Laura and with joint life policy claim.
Life policies obviously won't ask for a grant of probate or certificate of confirmation, meaning there shouldn't be any delays in Laura getting the money.

So we've likely met their objectives. Does that mean that we shouldn't be writing jointly policies in the trust? Well, it's not necessarily that straightforward because there's a couple of additional scenarios that we should be considering. So firstly, what if both Ben and Laura died at the same time? Or if both Ben and Laura died within a short space of time of one another. So what would happen in either of these scenarios?

Well, firstly, if they died at the same time, then the life company would need to see a grant of probate or certificate of confirmation on the second death. While there may not be any IHT concerns on first death for a married couple, the second death life policy could very well form parts of this state on death. Now there are trusts that are specifically designed for joint life first death policies, and these generally include a special survivorship clause. Also referred to 30 day wording and we're a trust has one of these clauses within it. The benefits paid out on claim will either be held absolutely for the surviving plant owner or held in trust for their chosen beneficiaries.

So let's say Ben and Laura are involved in a road traffic collision. Ben passes away at the scene and Laura survived the collision. But she's left in the critical condition. What happens next is ultimately dependent on whether Laura survives, so if she survives for 30 days following the death of Ben under the terms of this type of trust clause, Laura will become absolutely entitled to the policy benefits. OK, the second scenario is therefore, what if they both die within 30 days of each other?

Well, in our scenario, we have Laura died from her injuries after a few days after Ben. Then the policy benefits will be held in trust for their chosen beneficiaries, and it won't form parts of any inheritance tax calculation.

So the final protection planning scenario that I'm gonna look at is where we've got a client with a multi benefit protection policy. Now these are becoming much more common than there are a great way to provide clients with a portfolio of protection products. So we may be looking at a mixture of things like life cover, income protection and maybe some critical illness cover as well.

So let's look at Alice and Graham. They've got that multi benefit protection policy that has that range of covers within it. It's not in trust yet. The question what you think about is what do you need to be aware of before writing this type of policy in trust?

So one of the most important things to bear in mind when dealing with multi benefit policies and then trust is how are the policy benefits defined by the life insurer? Because not all insurers will have the same definition for their benefits. So let's take terminal illness as an example. It's a very common feature of many life policies these days, so you can generally make a claim if you're diagnosed with a life expectancy of less than 12 months, typically. Now claiming a life insurance policy in that situation gives clients the opportunity to get their financial affairs in order.
But is it a good idea from a financial planning perspective to have a potentially large sum of money entering your state just before you're about to pass away? Is there enough time to spend it? Might the illness that the individual has impact their ability to spend it? And what's their intentions to gift it to loved ones? Could that prevent additional challenges and problems as well?

I suppose the answer to how bad ones future financial headache might be will really be determined on their state. Now, if a life policy is written into trust and a client is diagnosed with a terminal illness, they're the life assured. But of course they're not dead.

They are in a position to claim on the policy while they're alive. But is it possible to claim the proceeds if it's written in trust?

Well, this is where understanding how the benefits are defined by life insurer is really important now for the purpose of setting up a trust. Generally speaking, the benefits from a policy might be classed as a retained benefit, so that means that the donor, assuming they're also the life assured, can benefit from the proceeds from a successful claim. Or we may come across benefits that are called gifted benefits, meaning the donor affectively cannot benefit. They are always paid to the trustees.

Now the Royal London discretionary trust names a third category, which is personal benefits. And these are benefits which will always be held for the donor. So this is things like income protection and certain rider benefits as well.

Let's imagine for a moment we've got a client with a life policy. They're unlikely to ever benefit from that as they need to pass away before a claim can be made, so it actually makes sense to gift it now. Life policies are generally considered to be a gifted benefit, but what if a client was diagnosed with a serious illness? As another example, well, this is where the nuances between providers can start to appear, and it can cause some confusion.

It is common for some insurers to treat benefits like critical illness, total permanent disability, terminal illness as a retained benefit. After all, the client is still alive and likely needing access to the policy proceeds, but be aware that there are some providers that do take a different approach and treat these as gifted benefits, so it really important just to familiarize yourself with how the benefits are defined with different life insurers.

So today we've covered a few common pitfalls when it comes to writing protection policies into trust, and the last 12 months when I've really been ramping up, our conversations are in trust with advisers. I've heard a lot of common questions and also myths when speaking to advisers about trust, and I thought I'd share a few of the common ones I've heard with you just now.

I would also love to hear from yourselves, so please do send into the chat box and the queue box any myths that you've come across when dealing with trusts, or maybe if there's myths you'd like us to demystify, let us know in the Q&A or the chat box.

So that's some of the common myths I've come across over recent months. Beneficiaries must be over 18. Reality is there are no age restrictions for beneficiaries. If a life policy pays the proceeds out to the Trust Bank account, then the trustees are optimally responsible for the distribution of the funds as and when they see fit. So the donor readily really should have that letter of wishes and enforced to help with that but there's certainly no requirement for beneficiaries to be over the age of 18.

Trustees cannot be resident overseas. Well, actually it is possible for a donor to name overseas trustees. There are some considerations to bear in mind. I guess firstly, administratively, have an overseas trustees can cause the lease. Certainly if we're dealing with the trusts, multiple trustees, maybe in multiple countries from a tax perspective, with the trustees are all non UK resident now or in the future than the trust could be taxed differently. So again, it's important if all trustees are non UK resident, that they do seek specialist advice.

All protection policies can be written in trust once in force, so it is very common to see personal protection plans written into trust once the policy is in force. However, for business protection and relevant life plans, these generally need to be written in trust from the outset. Why is that the case? Well, it's mainly due to the taxation of capital gains tax rules and the second hand policy rules. So really just if we just explain a little bit further if you were to change ownership for example from a company to the trustees and you've done it for consideration, then the consideration being the benefit to the individual as a reward for employment, it could trigger a capital gains tax liability on the trustees on claim.
So this just something really important to bear in mind with business protection and then relevant life policies that they need to be put in trust from the outset.

It's not possible to make loans from a trustable. It’s certainly the case when it comes to trusts. You can make loans from certain trust, so many trusts give trustees the power to make interest free. Loans to beneficiaries now, these loans do need to be repaid to the trust on death if they're repaid from the deceased beneficiaries Estate, then it would be the deductible from their state, thereby actually reducing the estate value when calculating any IHT liability. This can be particularly useful where in a state includes debt, such as a mortgage, to be repaid, as unless that debt is actually paid from the estate, it's not deductible for IHT purposes. Now the lender of the money you're also allows the original debt to be repaid from this date and is therefore deductible in the IHT calculation. And when the estate is settled, loan is repaid to the trust. So at that point it doesn't form part of any of the discretionary beneficiaries estates. So actually allows time to consider any other planning that may be appropriate. For example, if a beneficiary maybe has a significant wealth and they have an IHT issue themselves, so they don't want to receive the money and we would rather it passed on to the next generation and also keeping in trust can also protect the money from creditors of the beneficiary if they themselves are in financial difficulty.

And the last common myth I've had is Royal London, trust can be used with other companies life policies using other life company policies with a role and trust or vice versa isn't something that we would be recommending.

Now hope what we've seen today demonstrates the importance of ensuring trusts or contractual beneficiary nomination form part of a clients protection advice. But I wanted to just touch on a few other areas that help that can really help make trusts part of your business.

In terms of the benefits to your business hopefully what would that they can demonstrate some of the real high quality advice that trusts can help add to the conversations you're having with clients from a future review opportunity. If you are using trust or beneficiary nomination as a way of reengagement with clients in months and years to come, using things like letter of wishes as a touch point can be a really good start. Making sure clients are happy with what's their letter of wishes states. Do they want to make any changes to the letters of wishes and actually do they even have a letters of wishes in force.

If clients have gone down the beneficiary nomination reengaging with them every year just to make sure they're happy with who they're named beneficiaries are. Do they want to make any changes? Can also be a really good way to make sure that it's still as accurate and up to date as possible.

Referral opportunities as well so if you're engaging with a client's trustees, does that create an opportunity to discuss their protection needs? Maybe offer a trust review server to look at whether any existing light policies they have are written into trust. And that the consumer GT has certainly put everybody's attention towards ensuring clients or avoiding possible harm and being offered products and services that enable them to pursue their future financial objectives.

If you recall what I was speaking about right at the beginning of the session, do you clients take out life insurance with the intention of making it difficult for their intended recipient to get hold of the money? Because not writing life policies into trust or nominating beneficiaries ultimately leave the direction of a client's death benefits to chance.

So with little to no control, or who receives the benefit, the potential delay in receiving the benefits until probate or confirmation has been granted, and also the added problem policy could add to or create an IHT liability. Does the absence of trust and beneficiary nomination Support that consumer duty requirement to avoid cause and perceivable harm?

Look, before I hand over to Fiona, I'm just gonna finish by highlighting that the breadth of support available to you following today's session. If you would like to hear more about trusts or beneficiary nomination, then please do speak to your dedicated Royal London account manager. Now on that note, I'm going to hand over to Fiona to talk through the role of trusts in pension planning.

Thank you so much for that Gregor and hi everyone. I'm Fiona Hanrahan, senior technical manager on the pension side at Royal London. So now we're going to move on and have a think about pensions, but before we get to how a trust can be used with pension death benefits, I'm going to go over what death benefit options are available from pensions and how they're taxed. And I'll also cover off what's changing from the 6th of April 2024 as a result of the lifetime allowance abolition. And then we'll have a look at when a trust is useful for pension death benefits, and we'll use a case study to help with that.

So we'll begin by looking at the options that are available from pensions when someone dies, and I want to start with some warnings and a couple of really important things to point out when it comes to these options are, firstly, that the scheme rules rule.

Now what I really mean by this is that the legislation could differ from what a scheme actually offers. A good example is some older plans might not offer the full flexibility which has been available now you know for a number of years. Here, we're really thinking about beneficiary drawdown which will define properly in a minute.

So it's really vital to check that a member's plan, for example, offers beneficiary drawdown if that is something the member or beneficiary would want to have. You know, you can't really just assume that it's the case, and this is particularly important in the context of what we're talking about today, as when someone dies and if plan doesn't offer beneficiary drawdown, the beneficiaries can't transfer to a plan that does offer it without being in drawdown first. So they would potentially be restricted here to only having a lump sum option and you know, that could have unwanted tax consequences.

Also, most schemes are discretionary, which really just means that the trustees are scheme administrators of the scheme retain the discretion as to who to receive any pension death benefits, which means as a follow on from that that they're normally exempt from inheritance tax. Again, some older plans will not be set up like this. For example, some old 226 plans, or some section 32s, and this is not the end of the world. Here is a trust could be set up to, you know, receive those pension death benefits, making them exempt from inheritance facts. But the point we're making here is that those deaths, that discretion may not necessarily be automatic.

So as usual with pensions, there's some important terminology to get right, and this is particularly important when it comes to pension death benefits. And this is because what you're called or what you are can determine what options you can receive.

So let's start with dependant then. So a person who was married to or a civil partner of the member at the date of their death is a dependent of that member. That's quite straightforward. A child of the member and that would include a legally adopted child as a dependent if of the member, if that child is under the age of 23 or is over the age of 23, and in the opinion of the scheme administrator was at the date of the members death dependent on that member because of a physical or mental impairment.

Now, a person who wasn't married to the member or was not in a civil partnership with the member or was not a child, and they can still be independent of that member if, in the opinion of the scheme administrator at the point of that death, they were financially dependent on the member or their financial relationship with the member, was one of mutual dependence, and the scheme rules will normally set out what they sort of mean by that. It normally just means the existence of a joint bank account or a joint mortgage, etcetera. So people living together could be dependency here.
And the person could be a dependent if they were dependent on the member because of some physical or mental impairment even as an adult.

So moving on to nominee, then an individual. So right away, the nominee cannot be a trust, a charity or a company, for example, who's not a dependant of the member and who has been nominated by either the member or the scheme administrator, which would normally have been done through an expression of wish, if this was the member or part of the application form. So this individual could be a sibling, a friend, a niece and nephew, and adult child, grandchild, etcetera.

An individual nominated by the scheme administrator would only count as a nominee of the Member if there are no dependents of the member, or no individual or charity that have been nominated by them in relation to those benefits. And that's a really important point, as if you don't keep your expression of wishes up to date or it doesn't reflect your wishes, it could end up meaning someone only has the option of a lump sum, as we'll see in the next slide.

And successor, finally, this is an individual, so again the successor cannot be a trust, a charity, or a company. For example, who has been nominated by either the dependent, the nominee or successor. So that sort of after that first death.

And beneficiary drawdown, I wanted to just define what that was because well mention it a few times. Beneficiary drawdown is really just the collective name given to drawdown payable to either a dependent a nominee or a successor. So if you ask if a scheme offers beneficiary drawdown, that will allow the pension funds to pass through various generations until they're depleted, taken as a lump sum or an annuity is purchased.

So who can get what's and the most important point to note here is who gets the money determines, you know, what they can get. So this is why I spent some time at the start going over that terminology. So if you're a dependent, you can have the option of a lump sum and or income if you're a nominee it's the same lump sum and or income. And if there's no dependant or nominee, then the scheme administrator can nominate someone, and again they would have that potential for lump sum and or income.

The last bits is the important bit. Anyone else, but if a dependent or a nominee exists, they won't have that option of income potentially, but they would have that option of lump sum.
So that really is crucial. For example, if adult children haven't been nominated, then the only option they might have is a lump sum, and that could have major issues in relation to taxation.

Getting the names on the form is key even if your first choice would be a spouse or writing something like, I would like my spouse to receive the death benefits, but in the event that he or she is no longer alive or doesn't want the benefits, I would like my children instead to receive them. That will ensure that both the spouse and the adult children remember who aren't dependents could have that option of income, or, more likely, drawdown, we're talking about here. Importantly, the law or the legislation doesn't ask for percentages, so you don't need to put them. They are just the nominee names, so an up to date if region of wish is vital in circumstances like these.

And when it comes to how it works, remember here we're talking about a fully flexible scheme, or one which offers all options. You have to make sure that that is the case. On the death of the member the beneficiary would then decide what they would like, whether that's a lump sum and annuity or drawdown. If the beneficiary takes a lump sum or buys annuity, then the money would sort of leave the pension system. At that point, it can only be passed on through the generations or passed on that beneficiaries death if they go into drawdown first.

Now it's really important that the Member, you know, the person who died, can't dictate how their beneficiaries take those death benefits. They, in theory could take a lump sum immediately on day one, or go into drawdown and deplete that as fast as they like. The disease can only express A wish and a discretionary scheme, who should receive the benefits? For example, if I died and I left my pension benefits to my adult children, they could absolutely take it out as a lump sum and spend it on whatever they liked the next day.
And some people might not like that because, for example, in Scotland and you would be an adult from age 16 at that point in England from age 18, so there could be very young people potentially inheriting lots of money to spend on what they like in this situation, like I said, people might not like that. And this is where a trust might be useful, which we'll go into later.

So if the money does stay in the pension system where it can move through those generations, but at each stage the beneficiary could take it as a lump sum annuity or drawdown. And remember, as we said, you can't control from beyond the grave how they take it? The recipient chooses how and when they take their benefit.

Another important part of this relates to the taxation, which we'll come on to, I think of it as whoever is in the hot seat, or whoever's plan is, and the timing or the age at which they die determines the taxation for the next person who inherits it. Once it's in beneficiary drawdown, the age they original member died from potentially years ago is an important but we'll talk more about tax in a bit.

Now the expression of question, as we said at the start, most schemes are discretionary, which means the scheme administrator retains the discretion as to who receives those death benefits. Filling out an expression of wish form lets the scheme administrator know who you would like to receive your benefits on your death. But they're not bound by that. You are simply expressing your wishes.

The scheme administrator will gather evidence on the death of a member, including that expression of wish, so therefore an up-to-date expression of wish shows a clear intention, what you want to happen, but the scheme administrator would potentially consider other evidence as well, and as no beneficiaries entitled to anything, remember the those administrators are using their discretion, there is usually no inheritance tax issue. In the vast majority of circumstances the scheme administrators will follow that expression of wish.
Again, as I'm sure you'll appreciate, it's vital that they're kept up to date and it makes a payment of benefits straightforward and obviously likely speeds it up too. So it's worth considering it review time if there have been any changes in circumstances, for example a death in the family, new children, new grandchildren or a divorce, and remember, an ex spouse can still be a dependent so it's vital that this is appreciated.

When it comes to the expression of wish make sure it's clear you make a distinction. For example, if you want a Venice beneficiary to be offered drawdown, and of course make sure it's an available option. It's also worth mentioning here that a death in service lump sum, for example that four times salary written under the pension rules is separate from any pension benefits we're talking about here. So, separate from any return fund or drawdown options that I'm not available from the pension. So make sure the intentions for both the pension fund with regard to death benefits and this death in service, make sure they're both clear and ultimately they could be different.

OK, now we know what options might be available from pensions and who can get what.
We'll move on to how they're taxed and I will say the taxation of pension death benefits is often described as confusing and the withdrawal is a lifetime allowance hasn't helped this because last tax year, this tax year and next year are all different in terms of how pension death benefits are taxed. But over the next three slides, I'll hopefully help clear up any confusion.

So I'm sure you're aware from the 6th of April 2024 the lifetime allowance will be abolished and will be replaced by the lump sum allowance and the lump sum and death benefit allowance. Now we've displayed them as sitting one within the other, and I think that's a really good way of thinking about it because the lump sum allowance will use up lump sum and death benefit allowance if you reduce one, you reduce the other.

Anything taken as a lump sum during your lifetime will reduce your lump sum and death benefit allowance, or in other words, reduce what your beneficiaries can take tax free as a lump sum on your death before age 75. So overall, from your pensions, you or your beneficiaries can get out tax free as a lump sum £1,073,100. Unless you've got some form of protection, that would mean that could be higher or you've taken some benefits before the 6th of April 2024, which reduces your lump sum and death benefit allowance.

And the first thing to appreciate with these new allowances is that they're only relevant or reduced when you take tax free lump sums from your pension either by yourself during your lifetime or your beneficiaries on your death before age 75. So you use them up in a completely different way than the lifetime allowance. For example, crystallising 800,000 under the cuts of current or old rules would have used up 800,000 of your lifetime allowance. But in the future, from the 6th of April 2024, crystallising 800,000 will only use up 200,000 of the lump sum allowance, and also 200,000 of the lump sum and death benefit lends. Remember, if you reduce one you reduce the other.

And again remember, any death in service lump sums written under the pension rules will be measured against your lump sum and death benefit lines. There'll be no option other than to take them as a lump sum. And remember the lump sum and death benefit allowance isn't relevant when you reach age 75 as all death benefits on death after age 75 will be subject to the marginal rate of tax for the beneficiary. No option to get any of that tax free.

So this slide is concerned with the taxation of defined contribution death benefits from the 6th of April 2024, and we're talking about death before age 75. So this is how we're expecting the taxation of death benefits to look after the lifetime allowance has been abolished. So we're looking at death before age 75 and only thinking about DC benefits as they are the situations that would be a likely source of any tax free lump sums.

So firstly, we'll clean up the two year rule when someone dies and the provider is informed 2 years starts ticking from that date and if two years lapses the tax treatment or favourable tax treatment is sort of removed and broadly the benefits become subject to income tax, the removal of the lifetime allowance hasn't impacted this rule and therefore hasn't changed.

So we're just going to focus on the left hand side and what's changed and the vast majority of pension death benefits are paid out well before this two year rule becomes a problem.
So looking at our top left hand corner, then uncrystallised benefits. So with uncrystallised benefits, when someone dies and it's established within two years, what's happening to those benefits the beneficiaries marginal rate of income tax will apply to lump sums that exceed the deceased lump sum and death benefit allowance. So similar to how it was, we've just substituted lump sum and death benefit lens for lifetime allowance.

A couple of things to point out though, are that if the beneficiaries instead chose drawdown, there wouldn't be that tax charge. Remember, the new allowances are only concerned with lump sums. So absolutely here highlighting the value of advice as well as highlighting a consumer duty cross cutting rule around avoiding foreseeable harm, which Gregor mentioned, by making sure drawdown is an option for beneficiaries, you are absolutely avoiding that tax charge or foreseeable harm in other words.

So although that lump sum and death benefit allowance is 1,073,100 and kind of looks and feels and sounds like the lifetime lines calling it, the lifetime allowance isn't quite right because the lifetime allowance was used up during one of kind of 14 benefit crystallisation events. So going into drawdown buying annuity, it cetera would have used up your lifetime allowance, which would therefore have reduced what's left for your death. So I would get used to using the new language around lump sum lines and lump sum and death benefit allowance.

So let's move down to our crystallised box and think about crystallised benefits, again, when it's established within two years, what's happening to those. Now this is different because now you are certainly from the 6th of April 2024 we have a potential liability to marginal rate income tax for the beneficiary that we didn't have before, although again only on lump sums that exceed the lump sum and death benefit allowance.

Something really important to point out here, though, is that benefits in drawdown or benefits in payment before the 6th of April 2024 will not be measured against that lump sum and death benefit allowance on death after the 6th of April 2024. So this potential tax charge might not be an issue or might be an issue for those who have crystallised all or the majority of their benefits before the 6th of April 2024.

HMRC thinking here really is that when someone went into drawdown before the 6th of April 2024, they have been tested against the lifetime allowance so it would seem unfair to test them against the new lump sum and death benefit allowance in the future when in the past dying in drawdown wouldn't have been a benefit criticizing event. So there will be people who have gone into drawdown years ago or even last year or up to the 6th of April 2024 and faced a lifetime allowance tax charge. But they'll also be people going into drawdown now who won't face a lifetime allowance tax charge because there isn't one.
And they wouldn't be the referred against that lump sum and death benefit allowance after the 6th of April 2024.

So there's potentially planning aspects or pros and cons to consider of crystallizing benefits before the 6th of April 2024. But remember, it's only relevant if you're going to die before age 75, because after age 75, everything's taxable anyway. And if you're beneficiaries go into drawdown, they wouldn't face that tax charge as remember, the only limits are on tax free lump sums after the 6th of April 2024.

Now this is just to clarify the situation on death after age 75, the removal of the lifetime lines hasn't changed, what happens on death after each 75 as death after age 75 was never a DCB. Whether the benefits are crystallised or uncrystallised taken as a lump sum or income, they're all subject to marginal rate tax in their entirety. Remember, any tax free cash entitlements die with you on death after age 75 as the beneficiary will face marginal rate tax on that full benefit. So that lump sum and death benefit lines is not relevant after age 75.

So sticking with our trust theme, we wanted to cover off using a trust to receive pension death benefits and how this differs on death before and after age 75. So we've talked a few times about that lack of control from beyond the grave when it comes to how or when beneficiaries spend any pension benefits or who they pass them to when they die.
And if this was a concern, a trust could give the trustees that control. Remember, these would be people you would trust to follow your instructions or what are your plants, as Gregor said, so this could provide a certain income to beneficiaries restrict when they get access, et cetera.

There could be a tax reason such as inheritance tax or there could be simply some other reason why a trust is used. So how does a trust work with pension death benefits? And here I've replicated Gregor’s slide to use it to show how it would likely work with a pension.

Now each provider may have their own trust forms and there might be variations, so here I'm describing how it would typically work. So if you decide to set up a trust to receive your pension death benefits, you will be the settlor as the pension benefits won't pass to the trust until you die, you need to set up the trust with something else. I trust needs to be set up with something. Normally this would be a nominal amount so as not to get into any CLT issues such as £10, and this would just normally be stapled to the trust form and live with it.

Your trustees would be people you choose, and therefore trust to distribute the benefits as per your wishes and as well as the trust form you might want to write a letter to your trustees, again, as Gregor said, setting out what you would like to happen. When the settlor dies or the person with the pension money, the money would then pass to the trustees and at this point it leaves the pension world. From then, the trustees would invest as per their powers and distribute the funds as per the instructions from the settlor.

So when it comes to tax, how does that work on death before age 75, the benefits are paid to the trust without the deduction of any tax, unless the funds are in excess of the lump sum and death benefit lengths. Here we're assuming after the 6th of April 2024 if this is the case, 45% tax charge will apply to the excess. The trust itself will face inheritance tax, periodic and exit charges. Remember, it's left the pensions world and any income tax based on how the funds are invested. There would be no entry charge on the payment from the pension to the trust.

On death after age 75 before benefits are paid to the trust the pension provider will deduct a tax charge of 45% from the full value now, in the face of it, this tax charge looks like something to be avoided if at all possible. But if the ultimate beneficiary of any benefits from the trust as an individual, then they will receive a reclaimable tax credit, which means they can claim back any difference between their marginal rate of tax and that 45% that's already been paid. So I would say provided the reasons for setting up the trust in the first place remain valid beyond age 75, the tax charge reason alone would not necessarily be a reason for changing the expression of wish or bringing the trust to an end, but could be done if you choose to.

Now let's meet Julie. As you were probably expecting by now, let's have a think about a case study to display what we're talking about here. So Julie is age 75 and in pension drawdown and a few years ago, she set up a discretionary trust to receive 100% of the benefits from her pension. When she dies now, the main reason for setting up that trust was that Julie has two children from a previous marriage, as well as two children with her current husband. And really, she wants her husband to continue to receive an income after she dies. They've effectively both been enjoying the income that she's had from her drawdown plan up until now, but she wants her children to receive the funds of the lump sum when he dies. So any remaining funds after he dies, she wants them to be distributed equally to the four children.

Now, as I'm sure I hope you've picked up this couldn't be guaranteed under the standard pension rules as we've discussed a few times now, if Julie Husband were to inherit that pension plan through the pension rules sent up to him, what happened on his death or you could spend it all immediately.

So Julie White now wants to discuss whether the trust is still the better option now she's over age 75. Considering that tax charge of 45%, that will apply as well as that potential for periodic and exit charges. Now remember, as we said, although that tax charge of 45% does sound like something you would want to avoid if at all possible. Remember the beneficiary of any benefits from the trust can offset their share of the tax charge deducted by the provider against their own tax.

So let's look at how that will work with some numbers. So let's assume on Julie death the value of the fund is 200,000 and before the payment is made to the trust, the provider will deduct that tax charge of 45% because Julie was over age 75. And that tax charge would £90,000, obviously huge.

So this means £110,000 will be paid to the trust if one beneficiary were to receive 1/4 of the funds from the trust, they would be classed as having paid tax already at 45% on their share of 27,500. Each beneficiary should account for the gross amount of the benefit they received from their trust and their self assessment return, or on that R-40 repayment claim form. And that's the total of the amount paid to them by the trust and the proportion of the tax charge attributable to that amount that they got.

The relevant proportion of the tax charge is treated as tax previously paid by the beneficiary. So the overall effect is really that any tax on the benefit is paid at their individuals marginal rate as if they received the payment from the pension scheme directly. So if the proportion of the tax charge exceeds the individual's total income tax liability for a year, then they can get that reclaim to them.

So let's assume Julie beneficiary received that amount of 27,500, the quarter of 110,000 from the trust. This would be classed as a gross payment of 50,000 a quarter of 200 if that's easier to think about with tax already paid of 22,500. So that 50,000 would be added to their total income to determine how much tax should have been paid.

So let's assume the beneficiary that got this gross payment of 50,000 earns 50,500 and lives in England because that's easier. This means the payment should have had higher rate tax deducted or £20,000, 40% of 50,000. So this means that the additional 2500 remember 22,500 was what was paid in tax. That gets to be treated as tax already paid and can be claimed back by that recipient.

So ultimately, this beneficiary here has received a gross 50,000 or net 30,000, which would be the same as them receiving a gross 50,000 from a pension, which would have been the case on death after age 75 anyway.

So after discussion with her adviser Julie decision with her adviser, Julie still feels that a trust will achieve her objectives of having control. It's important to her that our children from her previous marriage have the potential to receive some of her pension death benefits. The tax charge of 45% isn't as bad as she first thought. The adviser points out that Julie can change her mind at any point and instead update or set out a new expression of wish that the pension funds are paid straight to beneficiaries instead. So that would be relevant. For example, if our spouse predeceased her, it might make sense for that new expression of wish to be completed with each of the children receiving 1/4 each, for example. And the Adviser stresses they will discuss this each year at her annual review.

Now, as I said earlier, the taxation of death benefits can be confusing. But right now especially, it's important to make sure you're up to date with any legislative changes. The consequences of not being up to date could mean a beneficiary faces a tax charge, which could have potentially been avoided, and that absolutely does not fit in with the consumer duty as I said a couple of times and we've said a few times, not all schemes offer all options.

Don't assume beneficiary drawdown is an option. For example, make sure the scheme offers not only what the member wants and needs, but the beneficiary too. And again, that could mean that a tax charge is avoided. Is a trust required? Is it a complicated family situation? Are there in any inheritance tax issues? And lastly, I think we've shown the importance of making sure any expression of wish forms are kept up to date and relevant.

Now that's all Gregor and I were going to say. If you're listening live, look out for that link with instructions to how to get your CPD certificate and also please look out for any future invitations to our webinars. We hope you enjoyed the session today and please take care and we hope to see you very soon.

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To gain your CPD certificate answer the following questions.

1. How many single life term policies were written in trust in 2022?
2. Upon a claim for death or diagnosis of terminal illness, a critical illness or Total Permanent Disability, there will be no immediate liability to inheritance tax as this will not be part of a client’s estate. If the proceeds from the plan are in trust past what anniversary of the date the trust was created, might a liability arise?
3. Joint life policies should be written into a trust with a specific clause, what is this most commonly known as?
4. David dies in May 2024 aged 63.  His pension fund was £1,500,000 at his death.  Which of the following is correct in terms of the options his beneficiaries have and how they’re taxed?  David hadn’t taken any benefits before his death and he had no lifetime allowance protection.
5. From 6 April 2024 if someone takes a PCLS of £50,000 and goes into drawdown with the remaining £150,000, how much is the lump sum allowance (LSA) and lump sum and death benefit allowance (LSDBA) reduced by?
6. If the special lump sum death benefit charge is payable on death after age 75, what tax charge is deducted by the provider before funds are passed to the trustees?

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