Spousal Bypass Trusts: Are They Set to Make a Comeback?
When people first hear the term “spousal bypass trust”, it can understandably raise eyebrows. After all, it sounds like something designed to exclude your spouse from receiving your assets. But in truth, a Spousal Bypass Trust (SBT) is not about disinheritance — it’s a planning tool that can help reduce inheritance tax (IHT) and provide flexibility in how death benefits are managed.
In light of proposed changes to the taxation of pension death benefits, these trusts may be coming back into focus. In this article, we look at how they work, the benefits and limitations, and what’s changing in the tax landscape from 2027 onwards.
What Is a Spousal Bypass Trust?
A Spousal Bypass Trust (SBT) is a discretionary trust typically used to receive death-in-service benefits or pension death benefits on someone’s passing.
Rather than leaving the lump sum directly to a spouse or children (which could inflate their own estate and future IHT exposure), the benefits are directed into a trust. The trust can then provide funds to beneficiaries (including the spouse), but without adding to their estate for IHT purposes.
A Simple Example
Imagine you’re earning £150,000 a year and have a death-in-service benefit worth 4x your salary. If you pass away, your spouse would receive £600,000.
If that £600,000 goes directly to them, it becomes part of their estate. Combined with their own assets, this could push them above the IHT nil-rate band — increasing the tax burden on their eventual death.
Instead, you can set up a Spousal Bypass Trust, nominate it as the recipient of your death-in-service benefits, and keep the £600,000 out of your spouse’s taxable estate, while still allowing them access to funds as a beneficiary.
Why Consider a Spousal Bypass Trust?
SBTs have long been used as a strategic estate planning tool, especially for those with:
- Large pension pots
- Significant death-in-service benefits
- Concerns about passing large sums to children outright
- Family dynamics involving divorce, remarriage or vulnerable beneficiaries
Key Advantages
- Reduces IHT exposure: Keeps lump-sum payments outside the spouse’s or children’s estate
- Maintains access: Spouse and other beneficiaries can still benefit
- Provides control: Trustees decide how and when to make distributions or loans
- Offers protection: Funds can be protected from future divorce settlements, creditors or financial immaturity
The Flexibility of Discretionary Trusts
An SBT is a type of discretionary trust, meaning that no beneficiary has an automatic right to the assets. Instead, the trustees have flexibility to:
- Make loans or gifts to one or more beneficiaries
- Delay access to young or financially inexperienced beneficiaries
- Provide ongoing support to a surviving spouse, while keeping control over the capital
This structure also helps reduce the risk of unintended consequences, such as a surviving spouse remarrying and assets being diverted from children.
SBTs and Pension Planning: The 2027 IHT Changes
The Background
Under current rules, unused pension pots can generally be passed down free from IHT, especially where the death occurs before age 75. This made SBTs less attractive in recent years.
However, from April 2027, proposed tax changes mean:
- Unused pension benefits will become part of the deceased’s estate for IHT purposes
- If pension death benefits go directly to a surviving spouse, there will be no immediate IHT (due to the spousal exemption)
- But the value received will inflate the spouse’s estate, increasing future IHT exposure
Impact on SBTs
If a surviving spouse is still alive, using an SBT to receive pension death benefits may not be tax-efficient — the payment to the trust is not covered by the spousal exemption.
However, if there is no surviving spouse, then directing benefits into an SBT for the benefit of children or grandchildren may be highly effective.
The key consideration is whether the goal is to:
- Minimise immediate IHT, or
- Protect long-term family wealth and manage future tax exposure
Are SBTs About to Become More Popular?
Possibly — but with caveats.
As the tax environment around pension pots and death benefits changes, advisers and individuals are revisiting SBTs. From 2027 onwards, directing death benefits into a trust could help reduce IHT for future generations — but the decision must be weighed against the loss of the spousal exemption if a spouse is still alive.
In short:
- With a surviving spouse: Payment to them may be more tax-efficient, but increases their estate
- With no surviving spouse: An SBT could be a smart way to protect family wealth and reduce IHT for children or grandchildren
Tax Implications of SBTs
Inheritance Tax (Trust Level)
SBTs fall under the relevant property regime, which means:
- A maximum 6% IHT charge may apply every 10 years (the “periodic charge”)
- Exit charges may apply if capital is distributed between anniversaries
These charges are usually far less than the 40% IHT payable on estates, so the trust can still be an efficient tool.
Income Tax Considerations
When an SBT receives pension death benefits or other income, trustees will be liable to trust income tax rates:
- Up to 45% on income not distributed
- If income is paid out, beneficiaries may reclaim some tax, depending on their individual rates
It is essential to consider:
- The age of the deceased (under or over 75)
- The lump sum and death benefits allowance
- Timing of distributions
- Beneficiaries’ income tax status
Key Considerations Before Using an SBT
Before setting up a Spousal Bypass Trust, ask the following:
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Who are the intended beneficiaries?
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Is there a surviving spouse?
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Are there concerns about children inheriting large sums directly?
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Are asset protection and family control important?
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What is the size of the pension pot or death-in-service benefit?
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How do the proposed 2027 changes affect your plan?
This is a complex area, and decisions made now can have long-term implications.
Conclusion
Spousal Bypass Trusts are not about cutting out a spouse — they’re about planning carefully for your family’s future. As the rules around pensions and inheritance tax evolve, SBTs may become more relevant again, particularly for families with larger estates or multi-generational planning needs.
The upcoming 2027 changes to pension death benefits mean now is the time to review your estate plan and ensure it still delivers the outcomes you want.
Need Advice on Spousal Bypass Trusts or Estate Planning?
At Merranti Accounting, we specialise in advising families and business owners on:
- Estate and IHT planning
- Pension death benefits
- Trusts and wealth protection
- Discretionary trust tax compliance
Contact us today to explore whether a Spousal Bypass Trust fits your long-term plans and how the 2027 changes could affect your existing arrangements.
