Spousal By-Pass Trust for Pensions

Published / Last Updated on 07/03/2023

Pensions are Already in a Trust

  • Master Trust - Most UK pension schemes such as personal pensions, self invested pensions, stakeholder pensions, company money purchase schemes and workplace pensions are already set up under a ‘Master Trust’ i.e., your pension fund is in trust for you ready to pay out when you retire or die. 
  • Discretionary Trust - If you die prematurely, the pension is already in trust meaning death benefits can usually be paid out to loved one’s tax free if you die before age 75 and only potentially taxable when you draw benefits or if benefits are paid to loved ones when you die after age 75.  The pension master trust is a discretionary trust meaning that benefits are paid out at the discretion of the pension scheme trustees i.e., you do not actually control who your pension will be paid out on death to, the trustees decide but consider your wishes via an ‘expression of wishes’.
  • Expression of Wishes – Most people complete this as part of their application form confirming who they would like to receive any remaining pension fund on death and the pension scheme trustees will take this into account when they pay put funds as they usually look to which of your loved ones were financially linked or dependent on you such as your spouse, civil partner, partner children, co-habiting partner, other relatives etc.
  • Default - On death, by default, your pension fund will usually be paid by the pension scheme trustees to your spouse or civil partner (if they survive you) or children.  There are reasons why you may not want these people to directly get these funds.

Reasons for Loved Ones to Not Inherit Your Pension

  • Inheritance Tax – your spouse or civil partner may already have enough wealth or income and by receiving the additional pension fund on death it adds to their inheritance tax bill on 2nd death.
  • Protect Vulnerable Beneficiaries – if your beneficiary has means tested benefits such as universal credit or if there is or may be a need for means tested social care, the vulnerable beneficiary could lose their benefits support.
  • Wastrels or Addiction – your loved ones may not understand the value of money, they may be spenders, give money away, gamblers, alcoholics, or drug abusers.  You may not wish them to have direct access and control of their inherited pension fund on death.
  • Split Families – it is well known that around 1 in 2 relationships breakdown.   You may not want your spouse or partner to remarry and risk losing their share of your pension fund on relationship breakdown.  You may be worried about your adult children and their relationship as you may not want your children to risk losing their share of your pension fund on relationship breakdown.

What is a Spousal By-Pass Trust?

Is a means to instruct your pension scheme trustees via your ‘expression of wishes’ to pay out your pension benefits on death to a separate trust rather then directly to your loved ones for inheritance tax protection, loved ones that are vulnerable persons on means tested benefits or wastrels, addicts or in unstable relationships.

NB:  It is perhaps more accurate to call it a By-Pass Trust rather than a Spousal By-Pass Trust as not only your spouse can benefit but other beneficiaries such as children, other dependents and loved ones etc.

  • Your join your pension scheme.
  • You separately set up a Discretionary Trust (whilst alive) for a nominal amount e.g., £1.  You also categorise your potential beneficiaries of the trust e.g., my family, my spouse, my partner, my children but do not name them individually.  The trust is left then dormant until death (sometimes known as a pilot trust).
  • Your complete an Expression of Wishes form for your pension scheme directing your pension scheme trustees to pay your pension benefits on death to your separate discretionary trust.
  • You complete a Letter of Wishes for the trustees of your separate discretionary trust giving them details of how funds inside the trust can be paid out, to whom and under what circumstances.
  • Your pension fund is then held in a separate trust on death.  You have by-passed your spouse/loved ones with a ‘spousal by-pass trust’ although they will still usually be potential beneficiaries.

You are in Control

This means control and have chosen your trustees, chosen how your pension fund is distributed, you have chosen to protect your pension fund from means tests or relationship breakdown, you have chosen who benefits from your trust and under what circumstances.

Taxes and Administration

The discretionary trustees must register the trust with HMRC’s Trust Register.  If the funds inside the trust are invested in assets such as investments or property that produce income, the trust may have to complete tax returns.  In addition, there may be a periodic charge every 10 years for inheritance tax at 6% of the value depending upon inheritance tax nil rate band available to the trust at the time.  These administration matters are relatively easy to deal with but the benefits of having a spousal by-pass trust will usually outweigh these.

Worth a Read/Watch:

Bypass Trust  Spousal Bypass Trust  Pilot Trusts  Pilot Trusts 2013  Pilot Trusts 2017


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