The payment of death benefits from the pension to the bypass trust will be tax free if:
- The member died before their 75th birthday; and
- The payment is made within two years of the death (or the date the scheme administrator was aware, or should reasonably have been aware, of the death); and
- The funds have already been crystallised or there is sufficient remaining lifetime allowance available.
If the member dies after on or after their 75th birthday, or the death benefits are paid to the trust more than two years after the scheme administrator knew of the death, then the special lump sum death benefit charge of 45 per cent will apply. The scheme administrator will deduct this amount before paying the balance to the trust. It is important to note that there is an associated tax credit with this payment.
As a discretionary trust, special IHT charging rules apply after the death of the settlor. There may be IHT charges on every 10-year anniversary of the trust (the periodic charge) or whenever property leaves the trust (the exit charge).
It is important to note that when property moves between different discretionary trusts, the trusts are treated as one for the purpose of the 10-year periodic charge and exit charge, with the start date being when the first trust began. In this instance, the member will be treated as creating the trust when they joined the pension scheme. If the pension scheme paying out the death benefits received transfers in, it will be the date of the first pension scheme that will be the start date.
The calculation of IHT periodic and exit charges can be complex, especially when there have been multiple transfers into the pension from several different originating schemes. It may be necessary to seek specialist advice, but the maximum liability will be 6 per cent of the value of the trust property at the 10-year anniversary. Frequently it will be much less, or even nil.
Income generated within the trust is also subject to tax. The first £1,000 of gross income is taxed at standard rate – ie 7.5 per cent on dividends and 20 per cent on other income. Anything above this is taxed at the special trustee rate of 38.1 per cent on dividends and 45 per cent on other income.
When trust assets are sold, the process for calculating gains is the same as for individuals, but any tax will be payable at trust rates of CGT (20 per cent, or 28 per cent for residential property). The trustees are only entitled to half the individual annual CGT exempt amount – £6,150 for the current tax year.
Claiming the tax credit
When the trust makes distributions to the beneficiaries there is a tax credit attached reflecting the 45 per cent rate already paid. This can be offset against the beneficiary’s other income in the tax year.
The amount that can be claimed is the proportion of the tax charge that is attributable to the amount received by the trust beneficiary. For example, if two beneficiaries each receive 50 per cent of the lump sum death benefit received by the trust, they can each set off against their own income tax liability 50 per cent of the tax charge paid by the scheme administrator.
