Updated for the 2027 pension & IHT changes

A spousal bypass trust is a discretionary trust that can receive pension lump‑sum death benefits instead of paying them directly to a spouse or other beneficiary.  It is “a discretionary trust where an individual can place their lump sum death benefits.”

We explain what they are, why they’re used, and how the 2027 rules change the planning landscape.

1.  What Is a Spousal Bypass Trust?

A spousal bypass trust is a trust you set up during your lifetime and nominate on your pension expression‑of‑wish form.  If you die, the pension scheme can pay the lump sum into the trust rather than directly to an individual.

What this achieves

• Keeps the lump sum outside the survivor’s estate for inheritance tax (IHT).
• Gives trustees control over who benefits, when, and how.
• Protects assets from risks such as divorce, bankruptcy, or poor financial behaviour.
• Allows support for minor children or children from previous relationships.

2.  Why People Use Bypass Trusts

Although pensions can usually pass IHT‑free if kept inside a pension wrapper, bypass trusts still matter for:

Control

Trustees—not the scheme administrator—decide who receives benefits.
This trust can offer reassurance that decisions are not left to “an individual employee of an insurance company.”

Family complexity

Useful where:

• There are children from previous relationships.
• Beneficiaries are minors or vulnerable.
• You want to avoid relying on a new spouse to “do the right thing”.

Asset protection

Trusts can shield assets from:

• Divorce claims
• Creditors
• Spendthrift beneficiaries

Older pension plans

Some plans (e.g., Section 32, RACs) are not written under trust, so lump sums could fall into the estate without a bypass trust.

3.  Tax Treatment (Current Rules to 5 April 2027)

If death occurs before age 75

• Lump sums to individuals: tax‑free.
• Lump sums to a bypass trust:
  • Tax‑free if paid within 2 years and within allowances.
  • Otherwise, a 45% special lump‑sum charge may apply.

If death occurs after age 75

• Lump sums to individuals: taxed at their marginal rate.
• Lump sums to a bypass trust: 45% tax charge.
  • Beneficiaries may reclaim some of this depending on their tax position.

Trust taxation

Discretionary trusts face:

• 10‑year periodic charges (up to 6%).
• Exit charges on distributions.
• Use of the trust’s nil‑rate band.

4.  The 2027 Pension & IHT Changes

From 6 April 2027, DC pension lump sums paid to a bypass trust will be subject to IHT, even if the spouse is a beneficiary.

Key implications

• The spousal exemption no longer applies when paying into a trust.
• If a spouse survives, it may be more tax‑efficient to pay benefits directly to them.
• If death occurs after age 75, a trust could face:
  • 40% IHT, then
  • 45% income tax
    creating a potential double‑tax scenario.

When a bypass trust still works well after 2027

• No surviving spouse.
• Member dies before age 75.
• Strong need for control, protection, or complex family planning.
• Desire to keep assets outside beneficiaries’ estates for multiple generations.

5.  Planning for Death Before 6 April 2027

If a member dies before the rule change:

Option 1: Spousal Bypass Trust

• No IHT on transfer to trust.
• Still subject to 45% tax if death after 75.
• Trust charges apply.

Option 2: Dependant’s Drawdown

• Keeps funds outside IHT until 2027.
• Allows gifting using “normal expenditure out of income”.

Option 3: Direct to Spouse

• Spouse can plan flexibly.
• But risks IHT after 2027 if pension remains large.

Option 4: Direct to Next Generation

• Useful if spouse does not need the funds.

Practical step:
Review and update expression‑of‑wish forms to ensure all options remain available.

6.  When a Bypass Trust Is Most Suitable

A bypass trust is typically appropriate when you want:

• Control over who receives benefits and when.
• Protection from divorce, creditors, or poor financial behaviour.
• Support for minors or vulnerable beneficiaries.
• Wealth protection across generations.
• To avoid inflating a spouse’s estate (pre‑2027 or where spouse is not a beneficiary).
• To manage older pension plans not already under trust.

7.  Key Risks & Downsides

• Trusts face periodic and exit charges.
• Payments after age 75 face a 45% tax charge.
• From 2027, payments into the trust may face IHT at 40%.
• Use of the trust’s nil‑rate band may reduce future planning flexibility.
• Pension schemes are not obliged to follow the expression of wish.

FAQ - Spousal Bypass Trusts

What is a spousal bypass trust?
A discretionary trust nominated to receive pension death benefits instead of paying them directly to an individual.

Does a bypass trust avoid inheritance tax?
Before 2027, yes in many cases.  After 2027, payments into the trust may be subject to IHT.

Is a bypass trust still useful after 2027?
Yes—especially where there is no surviving spouse, or where control and protection are more important than tax.

What happens if the member dies after age 75?
Payments to a trust face a 45% tax charge, though beneficiaries may reclaim some of it.

Do all pension schemes follow the expression of wish?
No.  Trustees or scheme administrators retain discretion.

Spousal Bypass Trust vs Direct Nomination vs Dependant’s Drawdown

Pre‑2027 and Post‑2027 Rules Compared

1.  High‑Level Summary

2.  Detailed Comparison Table

A.  Tax Treatment Before 6 April 2027

B.  Tax Treatment From 6 April 2027

C.  Control & Flexibility

D.  When Each Option Works Best

Spousal Bypass Trust

Best when:

• No surviving spouse.
• Member dies before age 75.
• Family circumstances are complex.
• Beneficiaries need protection (divorce, bankruptcy, spendthrift).
• You want trustees to control distributions.
• You want assets kept out of beneficiaries’ estates long‑term.

Document quote: “the trust could be viewed as a vehicle for wealth protection.”

Direct Nomination

Best when:

• Spouse needs the funds.
• Simplicity and tax efficiency are priorities.
• You want to avoid trust charges.
• You want to avoid the 2027 IHT charge on trust payments.

Dependant’s Drawdown

Best when:

• Spouse wants flexible access.
• You want to keep funds in the pension wrapper pre‑2027.
• You want to use “normal expenditure out of income” gifting.

Retaining the pension wrapper and drawing income … may allow gifts under the normal expenditure out of income exemption.

3.  Pre‑2027 vs Post‑2027 Strategy Snapshot

If death occurs before 6 April 2027

• Bypass trust avoids IHT entirely.
• Dependant’s drawdown keeps pension outside IHT until 2027.
• Direct to spouse remains simple and tax‑efficient.

If death occurs on or after 6 April 2027

• Bypass trust becomes significantly less tax‑efficient (40% IHT + 45% income tax risk).
• Direct to spouse often becomes the most tax‑efficient route.
• Bypass trust still valuable where control/protection outweigh tax.

4.  Practical Planning Actions

• Review and update expression of wish forms.
• Nominate multiple options (spouse + trust + children) to preserve flexibility.
• Understand the scheme rules—some have integrated trusts.
• Consider whether the spouse actually needs the funds.
• Reassess older plans (Section 32, RACs) that may not be under trust.

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