Asset Preservation Trusts

The new pension freedoms rules mean that you can nominate your money-purchase pension to whomever you like; there are tax advantages to doing so.

This doesn’t apply to Asset Protection Trusts, where the tax treatment is fixed when the original lump sum is paid from the pension. Plus, the usual IHT periodic and exit charges apply to Asset Protection Trust’s assets.

Asset Preservation Trusts still have an important role to play for some clients and shouldn’t be discounted just because, at first glance, they may look complex or less tax efficient.

If the client wants more control over who gets what and when, that’s where an asset preservation trust might deliver an edge that’s worth the extra complexity and a bit more tax.

We recommend setting up a separate asset preservation trust for those clients seeking additional peace of mind, particularly if circumstances are complicated. For example, a client who has remarried and has children from a previous marriage may prefer to pass his pension to his own children if his wife has a substantial pension of her own, or vice versa.

It is also quite common to have a beneficiary who is vulnerable and unable to manage their own affairs or is simply hopeless at handling money. These are the sorts of circumstances where an asset preservation trust can really help.

Trustees can be appointed who know the family, are fully aware of their circumstances, and are therefore able to assist on an ongoing basis. The trustees should obtain advice on how to invest the pension funds that they are responsible for by drawing up an investment policy statement and appointing an independent financial adviser (Trustee Act 2000).

No one knows for sure what life has in store for them and their future, so having an asset protection trust with your own trustees is a very useful safeguard should the need arise. An Asset Preservation Trust can be set up as part of the nominations you make alongside your other requests.

Defined Benefit or Final Salary Schemes?

We have confined our advice in the past to defined contribution schemes, but many clients are members of defined benefit schemes, typically providing death-in-service benefits of two to four times their salary.

If you were to die in service, the trustees would pay out as per your expressed wishes, depending on your salary, which could be quite a large payout. The monies will form part of your survivor’s estate, and any increase in the size of the estate may give rise to additional inheritance tax.

If your surviving spouse remarried and then pre-deceased their new spouse, who would benefit from the estate?

If you have a death-in-service policy, the existing trustees will normally allow the benefit to be assigned to an asset protection trust. You would be able to control who the potential beneficiaries are, which is a much more satisfactory arrangement. This option will allow more control and potentially save a great deal of tax.

An Asset Preservation Trust can be established and is set up to hold lump-sum death benefits from a pension scheme. It enables the death benefits to be held in trust for the deceased member’s spouse, civil partner, or other beneficiaries without forming part of the beneficiaries’ estates.

The trustees can pay out capital and income to the beneficiaries or, if the trust provisions allow, grant them loans, which will normally be a debt on their estate for IHT.

As the trust is subject to the relevant property regime, it will be subject to the 10-yearly periodic charges and proportionate exit charges on capital leaving the trust. The timing and calculation of any charges largely depend on the structure of the pension scheme(s) involved.

The payment of lump-sum death benefits into an Asset Preservation Trust is tax-free where the scheme member dies before age 75 and benefits are within the lifetime allowance. Where the scheme member dies at 75 or older, the death benefits will be subject to a 45% special lump sum tax charge.

However, when an individual beneficiary receives a payment from the trust from funds that have been subject to the 45% special lump sum tax charge, the individual will receive a 45% tax credit. The intention of the tax credit is to put the individual in the same position as if they had received the payment directly from the pension scheme. This means that any individual whose marginal rate of tax is less than 45% can claim a tax refund.

The use of Asset Preservation Trusts and nomination forms for death benefits in the pension freedom environment

Perhaps the first thing to say is that the term ‘asset preservation trust’ simply means setting up a discretionary trust during a lifetime, usually with a nominal amount of around £10. On the nomination form, the member indicates their wish that their death benefits be paid to the trust upon their death (which isn’t binding on the trustees or provider). The death benefits are therefore ‘bypassing’ the surviving spouse’s estate, although the spouse normally retains access to the funds. A bypass trust isn’t exclusive to pension death benefits.

The main reason (quoted pre-6th April 2015) for using this type of trust was to ensure that the deceased’s beneficiaries had access to the pension death benefits without the beneficiaries’ own estates being increased for inheritance tax (IHT) purposes.

Since 6 April 2015, it has been possible for pension death benefits to be left in the pension wrapper, so the same end result can be achieved without the need for an asset preservation trust (of course, it may not be possible for all pension funds to access inherited drawdown).

In the table below, we have summarised some of the main pros and cons of having pension funds paid to a trust, into the nominee’s flexi-access drawdown account, or directly to a beneficiary.

 Asset Preservation TrustPaid as a lump sum directly to the beneficiaryPaid into the dependent’s or nominee’s flexi-access drawdown
Protected from assessment in relation to means-tested benefits and long-term care funding?YesNoNo
Greater protection if the beneficiary dies, becomes bankrupt, or divorces?YesNoNo
Is payment subject to pension scheme trustees’ discretion?YesYesYes
Members can choose their own trustees?Yes. The original member will have provided instructions for the trustees (not later beneficiaries).n/aNo. Each subsequent beneficiary will guide the trustees regarding who their own beneficiaries should be.
Facility to make loans that, if not repaid, will reduce their estate on death?YesNoNo
Payment tax-free on death before 75?YesYes


NB: If funds pass through the generations, the tax rate could alter based on the age at the death of the last beneficiary.

Rate of tax payable on death after 75?45% (a payment made to a beneficiary then comes with a 45% tax credit that can be offset so they end up paying tax at their own rate)Beneficiary’s tax rate(s)

Beneficiary’s tax rate(s)

NB: If funds pass through the generations, the tax rate could alter based on the age at the death of the last beneficiary.

Potential for periodic charges?
Ongoing taxation of the funds (income and capital gains)
Trust rates are 20% on gains above the exempt amount and 45% on income above £1,000 (38.1% for dividends). The investment choice will determine the outcome. Investment bonds are often used for tax efficiency.It depends on recipients’ personal tax rate(s) and what the fund is used for or invested in.Tax-free growth and income within the fund

Not particularly, but all bespoke trusts should be regularly reviewed.

This is advisable to ensure the planning fits in with your wider objectives and IHT planning requirements.

NoIt depends on the product.

Further comment

The trust above is not referring to the scenario where a contract-based pension, such as a section 32 or retirement annuity (and some PPPs and SIPPs), has the death benefits assigned to a specific trust during a lifetime (sometimes referred to as a carve-out trust’). Although the transfer of the pension can effectively end the trust, it is irrevocable in that situation. A nomination in favour of a trust can normally be changed at any time simply by completing a new nomination form.

On death after 75, if funds are paid to a trust, there would be an upfront 45% tax charge, so only 55% of the funds would move into the trust. When funds are paid out to a beneficiary, they receive a tax credit for the 45% tax paid, and this can be offset against their own tax bill for the tax year of receipt. However, a payment to a beneficiary may not, in some cases, be made for several years, leaving only 55% of the pension fund to grow within the trust.

Contrast this position with 100% of the funds moving into flexi-access drawdown and the beneficiaries just paying tax at their own rates when any income is withdrawn from the fund.

The advantages of the trust would need to outweigh the disadvantages of the 45% upfront tax rate, even if it can be reclaimed at a later date (in most cases, beneficiaries would pay tax at less than 45%, particularly if the funds are shared between several of them).

However, bearing in mind that the tax position of a dependent’s or nominee’s flexi-access drawdown fund is taxed on any subsequent generations of beneficiaries, depending on the age at death of the last beneficiary, a tax-free income position could become taxable for a future generation. If all funds are placed in trust, tax-free on the death of the member aged under 75, this situation can’t arise, and nor can future changes in pension legislation affect this.

If paid to a trust, while there could be an IHT liability at every 10-year anniversary of the trust, this would be at a maximum rate of 6% and frequently much less. Payments out of the trust to a beneficiary could give rise to an exit charge based on the rate of tax paid (or deemed to be paid) at the last 10-year anniversary or when the trust was established. This needs to be considered against the risk of a marginal rate income tax charge that could be payable if the funds were left in the pension fund and then paid out after the death of a beneficiary aged 75 or over.

It is important to bear in mind that different providers and products have their own structure and rules on which death benefit and trust options are available. There are also wide variations between nomination forms, with some including an option for the member to make a binding nomination (with possible IHT consequences). It is important to take extreme care when completing nomination forms to ensure that the correct boxes are checked and the right information is added to avoid any unintended consequences later.

Periodic charge update for pension-linked trusts

Where pension death benefits are paid to a trust, many people assume that the first 10-year anniversary will be 10 years after the death benefits were paid into the trust (or 10 years from when that trust was set up). However, HMRC takes the view that where the death benefits come from a trust-based pension scheme, the commencement date of the trust is the date that the individual joined the pension scheme. This aspect isn’t new.

It has been thought until now that if the pension arrangement is governed by a deed poll rather than a trust, this is classed as a ‘contract-based’ arrangement, with any bypass trust only starting from the date that the trust was actually established. However, HMRC has apparently confirmed its current position that if, under the ‘contract-based’ scheme, the scheme administrator has discretion over overpayment of death benefits to anybody in the discretionary class, those funds are classed as being held in a settlement, i.e., they are treated the same as if the pension were trust-based.

This means that if the scheme administrator gives death benefits to a trust, those benefits will be treated as being held in trust from the date the member joined the pension scheme. If the member joined from a trust-based scheme or a deed poll scheme where the administrator has discretionary powers, that date will be the trust start date.

It happens most often with contract-based plans like retirement annuities and section 32 plans when the pension arrangement is written subject to an integrated trust. This means that the scheme administrator must pay the trust a lump-sum death benefit. The trust’s start date is either

  • The start date of the pension plan if the plan was placed in trust from the outset (or if the funds have been transferred from a trust-based pension plan, the start date of that plan)
  • Or, if the plan isn’t placed under a trust from the outset but the death benefits were payable at the scheme administrator’s discretion, HMRC will regard the death benefits as being in trust from the outset. Therefore, if an integrated trust is implemented later, the trust start date will still be treated as the start date of the pension plan.

Depending on the particular circumstances and the amount held within the trust, periodic charges may not be relevant, but it’s important to be aware that once death benefits have been paid into the trust, it isn’t safe to assume that there will be no periodic charge assessment until the next 10-year anniversary from when the trust was set up.

As an example, if the death benefits came from a trust-based pension plan that started in January 2010, which had a previous transfer from a trust-based pension that started in February 1999, and the death benefits were paid to a bypass trust in October 2015, the first periodic charge assessment point would be February 2019 (as the start date of the trust is classified as February 1999).

Please note that this is based on current legislation and therefore may be subject to change.

If you have any queries, please do contact us.

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Picture of Ray Best

Ray Best

Like his academic development, writing came late to Ray. He has written several published works, “Inheritance Tax Planning – My Way” and “Shareholder Protection & Partnership Protection” and has had four feature articles published in Tax Adviser magazine, but the publication he is most noted for is the joint collaboration with Tony Granger “Inheritance Tax Simplified”.

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