Bypass Trust. Guidance Notes. Overview

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1 Bypass Trust Guidance Notes This document is provided for use by professional advisers in conjunction with products provided by Talbot & Muir. The information in this document is based on our interpretation of the relevant HMRC guidelines, which are subject to change. Overview The bypass trust allows for members with a SSAS or SIPP (for which TM Trustees Ltd act as independent trustee) to nominate that their lump sum death benefits be paid to a family trust. This trust can accumulate income and capital in the fund, or distribute income and/or capital to beneficiaries. This arrangement will potentially reduce the charge to Inheritance Tax (IHT). The lump sum payable from the SSAS/SIPP will not normally attract IHT when it is paid to the beneficiary, but IHT may arise when the surviving spouse or civil partner subsequently dies, since the proceeds will form part of the survivor's estate. The current rate (for tax year 2013/14) of IHT is 40%, whereas the Trust will attract tax at the rate of only 6% every 10 years (pro-rata on wind up or on capital distributions). These rates only apply to assets valued in excess of the nil rate band, which currently stands at 325,000. The bypass trust has powers to distribute income and capital and also to lend monies to the beneficiary. This means that the survivor can have the benefit of the monies even though the funds are the property of the trust. A loan to a beneficiary is particularly useful as the loan does not incur an IHT charge on the trust, but it is deductible from the borrower's estate if it is still outstanding at the time of his or her death. By creating a bypass trust solely in conjunction with the SSAS or SIPP, the member may benefit from a full nil rate band for this trust and separately for each other discretionary trust associated with each pension policy or trust (provided these are not all effected at the same time). The bypass trust is particularly suitable for High Net Worth individuals and their spouse or civil partner (who may also be a High Net Worth individual, especially after inheriting). The inheritance tax treatment of bypass trusts is complex. While the bypass trust holds a purely nominal sum then no inheritance tax liability will arise. In the event of the bypass trust receiving a pension death benefit lump sum then the trustees should take advice at that point regarding the inheritance tax treatment of such sums. Bypass trust Guidance Notes June / 5

2 Where might a Bypass Trust not be the preferred option? Despite the flexibility and tax advantages of the bypass trust, the member may still prefer in some cases the freedom to nominate beneficiaries directly. Where a Pension Commencement Lump Sum on retirement or other retirement benefits have been paid from the SSAS/SIPP, on the subsequent death of the member a tax charge of 55% is payable. The beneficiary may prefer to receive a taxable spouse's income from the pension fund directly rather than a lump sum taxed at 55% being paid to the Bypass Trust. The cost and management time in maintaining the trust means that it may only prove suitable in cases where the nil rate band is likely to be exceeded, i.e. for beneficiary estates which in today's terms are likely to exceed the nil rate band of 325,000 for 2013/14, and possibly higher if there is likely to be unused nil rate band on the SSAS/SIPP member's death. Further details The Bypass Trust benefits from its own nil rate band (currently 325,000). The charge to tax thereafter is 30% of the rate of IHT applying to lifetime gifts (currently 20%) i.e. a rate of 6%. The lump sum settlement from the SSAS/SIPP to the Bypass Trust has to be made within two years of the death of the member, otherwise IHT is payable. If at the end of the two years the Trustees decide that the trust is no longer suitable for the circumstances of the beneficiaries, then they can wind up the Trust and distribute the assets before the two year tax-free period expires. Assuming no capital distributions or wind ups are carried out, the first tax charge (currently 6%) on the trust is otherwise on the first 10-year anniversary after these two years have expired. It is important to note that the 10 year periodic charge cycle begins at the point the member joins the Scheme, even where the Bypass Trust was established at a later date. However in practice no tax will be payable where 10 year anniversaries are reached and no death benefits have been received into the Trust, as the value of the Trust at that stage will be nominal. The trust is a discretionary trust. This means that the powers of the Trustees may be exercised at their absolute discretion and they are not under any duty to consult with any Beneficiaries or to give effect to their wishes. The Trustees may wish to review the suitability of the Trust prior to each 10-year anniversary, since the tax liability at each 10-year anniversary would normally be higher than on winding up the trust just before the anniversary. Assuming positive fund growth the valuation of the assets of the trust would be higher at the latest 10-year anniversary than the effective date, 10 years previously, which is used for valuing assets on wind up before the anniversary is reached. It should be borne in mind that the establishment of a Bypass Trust by an individual may affect all other trusts established by that same person (either before or after establishing the Bypass Trust). This is in relation to both income and capital gains tax allowances, which have to be divided by the number of trusts that individual has established, even if these taxes are not a consideration for all of the trusts. Bypass trust Guidance Notes April / 5

3 Example scenarios In these examples we have assumed that the 2013/14 allowances and rates apply in respect of Inheritance Tax. Therefore the rates are 0% on the first 325,000, and 40% on the balance. The rate of tax that we assume will apply to the Bypass Trust is the 10-year periodic charge of 6%. However, this charge to tax may be reduced by the tax-free nil rate band. 1 - John and Janet Smith John died in 2008, and on his death a benefit of 900,000 was payable from his Talbot & Muir SIPP. The Trustees of the SIPP exercise their discretion to pay this sum to John's wife, Janet. No IHT was payable as the sum was paid out of the SIPP within two years of John's death. Janet died six years after John in 2014, and left all of her assets, including those she inherited from John to their only child, Keith. Assuming that there was no investment growth, and assuming Janet did not spend any part of the death benefit sum, upon Janet's death a charge to IHT would be made on the lump sum of 900,000. This tax charge would be as follows: 0% (John and Janet's combined nil rate bands) 40% = 100, Robert and Sarah Jenkins Robert was a member of a Talbot & Muir SSAS, and established a Bypass Trust at the same time he joined the SSAS, in In 2014 Robert dies and the death benefit of 900,000 is paid to the Bypass Trust. Robert's wife Sarah dies seven years later in Upon Sarah's death, the Bypass Trust is wound up, and the assets are distributed to their children, Richard and Nicola. The tax charges payable in this case are: With reference to the Bypass Trust established by Robert in 1993, 10-year periodic charges apply in 2003 and However, there would be no tax payable as the value of the assets held in the trust prior to Robert's death is nominal. At the point the Bypass Trust is wound up in 2021 a proportion of the 10-year periodic charge is payable as follows: o 0% o 6% = 34,500 x 5/10 = 17,250* * The 5/10ths proportion applies as this represents the period 2016 to 2021, as the two-year period following Robert's death is not subject to tax. From these two examples, which both assume the same death benefit sum of 900,000, it can be seen that the IHT tax charge payable on the death of Janet Smith was 100,000, and the amount payable on the Bypass Trust established by Robert Jenkins is 17,250, giving a tax saving of 82, Mark & Rebecca Jones Mark set up his pension arrangement in 1974, and established a Bypass Trust at the same time. He died in 1993, and the value of his pension fund at that time was 700,000. This amount was paid as a death benefit into the Bypass Trust. Rebecca survived Mark by fifteen years, dying in The Trustees of the Bypass Trust decide to wind up the Trust in 2013, twenty years after Mark's death. Bypass trust Guidance Notes April / 5

4 Ten year periodic charges will apply in 1984, 1994 and 2004, although in practice there will be no tax payable in either 1984 or In 1984 the value of the Trust is nominal, as no death benefits have been received into the Trust at that stage. In 1994 the tax charge does not bite either as the two-year exemption following Mark's death still applies. The first periodic charge where a tax charge will apply in practice arises in Assuming the value of the Trust at that date is 700,000 the tax payable is 20,250, representing 9/10ths of the 10-year periodic charge for the years A decision to wind up the Bypass Trust is taken by the Trustees in 2013, at which point the Trust is valued at 1.2 million. This chosen date is in advance of the next 10-year anniversary, the importance of which being that the rate of IHT applying is fixed according to the value of the Trust at the previous 10-year anniversary in 2004 i.e. 700,000. This gives a tax rate of 3.21%, and if this is the case the tax payable will be 37,560. If the wind up of the Trust were delayed until the next 10-year anniversary was passed in 2014 a 10-year periodic charge of 52,500 would apply. Tax payable calculation Value of Trust in ,000 Less nil rate band - 325,000 Taxable amount 375,000 Lifetime gifts tax at 20% 75,000 Rate = 75,000/ 700, % Effective rate = 30% of Rate 3.21% Less appropriate fraction (39/40 th ) 3.13% Tax payable = 3.13% of 1.2m 37,560 Disclaimer The Bypass Trust and any notes relating to its use are for general guidance only, and are based upon our current understanding of UK law and HM Revenue & Customs practice. Neither Talbot & Muir nor TM Trustees Limited take any responsibility for the interpretation of the law and tax legislation or future changes in the law or HMRC practice. Tax liabilities and the ability in law of the Settlor to establish a Bypass Trust are dependent on individual circumstances and no assurance can be provided that the use of the Bypass Trust is suitable for any specific individual circumstances. We strongly recommend that separate, independent legal and taxation advice is sought before a Bypass Trust is established by any individual, and that ongoing advice is obtained throughout the life of the Trust. Bypass trust Guidance Notes April / 5

5 Talbot and Muir Clarendon Street Nottingham NG1 5HQ Telephone Facsimile Talbot and Muir Limited provides administration to Self Administered Pension Schemes. Talbot and Muir SIPP LLP provides administration to Self Invested Personal Pensions, and is authorised and regulated by the Financial Conduct Authority. Talbot & Muir is the trading name for Talbot and Muir Limited (company number ) and Talbot and Muir SIPP LLP (company number OC306490), both registered in England, registered address: 22 Clarendon Street, Nottingham, NG1 5HQ. This document is based on Talbot & Muir s interpretation of current legislation and HM Revenue and Customs practices. Whilst every endeavour has been made to ensure that our interpretation is correct, Talbot & Muir cannot give any guarantees in this respect. Neither Talbot & Muir, nor its partners or staff, intend that this document or any of its contents should be construed as providing advice or as a definitive summary and are unable to take any liability for any actions taken by any party as a result of reading this document or any consequences thereof. Talbot & Muir recommend that no irrevocable action should be taken until full and additional advice has been taken.