We often meet homeowners who worry about how their pension savings will pass on after death. Our aim is to set the scene in plain English and help you weigh control against simplicity.
We explain what it means when someone considers directing their pension fund into a discretionary trust on death. We show the trade-offs: trustees can protect assets and guide beneficiaries, but keeping funds inside the pension wrapper often gives better tax treatment and less administration.
This matters most for blended families, second marriages and those with vulnerable beneficiaries. It also matters when there are risks from divorce, creditors or local authority care funding assessments.
We preview the key tax points you must know: income tax on death benefits, inheritance tax if money moves into a trust, and the cost of investing outside the pension. By the end, you will know what to ask your provider, independent financial adviser (IFA) or solicitor — and when to seek specialist advice.
Key Takeaways
- Control vs simplicity: trusts give control; pensions often give simpler, more tax-efficient outcomes.
- Who it helps: most useful for blended families, second marriages and vulnerable beneficiaries.
- Tax matters: check income tax on death benefits, potential inheritance tax exposure, and the impact of the April 2027 pension IHT reforms.
- Practical checks: confirm whether your scheme will pay into a trust and understand how the age of death affects tax treatment.
- Get advice: speak to your provider, IFA and a solicitor experienced in trust planning before making changes.
What a bypass arrangement is and how it works in practice
A bypass arrangement channels lump-sum death payments into the hands of trustees rather than directly to family members or the estate.
A bypass arrangement is a discretionary trust set up during the pension member’s lifetime. Its main purpose is to receive lump-sum death benefits through a nomination or expression of wish form completed with the pension provider.
Typically, you create the trust with a nominal sum — often £10 — and then complete the provider’s expression-of-wish form asking the scheme to consider paying death benefits into that trust on your death. The scheme administrators and trustees must still exercise their own discretion when deciding on any payment — no nomination is absolutely binding in most cases.
Many schemes treat your nomination as guidance only. That means even with the correct form in place, the scheme retains the power to pay the estate or a named individual if its rules require it or if the administrators consider it appropriate in the circumstances.
Quick checklist for your provider
- Does the scheme accept trust nominations, or does it only accept binding nomination forms naming individuals?
- Will scheme administrators follow an expression of wish directing payment to a trust?
- What specific wording do trustees need in the trust deed for the scheme to accept the arrangement?
Why people consider leaving pension to a discretionary trust uk
It’s common to want to protect family wealth while still providing for a surviving partner — especially where there are children from a previous relationship.
Many clients ask how to maintain control of pension funds for their children or grandchildren after death. They worry a surviving spouse might later remarry and nominate new beneficiaries, meaning the original member’s children could lose out entirely — what’s known as sideways disinheritance.
In a discretionary trust, trustees hold the funds and have absolute discretion over who benefits, when, and how much. No beneficiary has an automatic right to anything. That is the key protection mechanism, and it helps enormously in blended families where preserving assets along bloodlines matters.
Trustees can also protect young or vulnerable beneficiaries. They can make staged payments, fund education over time, or provide interest-free loans repayable to the trust. This reduces the risk of a single lump sum being misspent or claimed in a beneficiary’s divorce — with the UK divorce rate sitting at around 42%, that’s not an unlikely scenario.
There are practical gains and costs. Holding money in a discretionary trust can shield it from local authority care funding means tests and family law claims, but it does add administration, annual trust tax returns (SA900) to HMRC and trustee responsibilities. England invented trust law over 800 years ago, and the discretionary trust remains one of its most powerful tools — but it is not without obligations.
For a step-by-step guide on how to set one up and what to expect, see our short guide to start a trust fund.
Your main alternatives: nominee drawdown, successor nominations and direct lump sums
Choosing between drawdown, successor rules and direct lump sums shapes how value flows after death. We set out the three routes families commonly use and the practical trade-offs of each.
Nominee / dependant drawdown: the beneficiary keeps the fund inside the pension scheme and draws income over time. This usually preserves the tax-efficient pension wrapper environment — investment growth is free of income tax and capital gains tax (CGT) while it stays inside the scheme — and lets beneficiaries manage withdrawals around their own income tax bands.
Successor nominations: after the first nominated beneficiary dies, they or the scheme can nominate the next generation. However, the original pension member has no control over these onward nominations — your original intentions can easily fade if the first beneficiary chooses different successors.
Direct lump sums: cash paid straight out of the scheme is simple and quick. It suits smaller pension pots or when heirs need immediate funds. But depending on the member’s age at death and the timing of payment, it may trigger income tax or — from April 2027 — inheritance tax consequences.
Decision snapshot: if you want simplicity and tax efficiency, nominee drawdown usually wins. If protecting assets across generations and preventing sideways disinheritance matters most, the extra structure of a discretionary trust may justify the additional cost. For more on bypass arrangements see bypass trusts.
Income tax on pension death benefits paid to a discretionary trust
The tax treatment of post-death payments is the single biggest practical issue trustees will face. We break the rules down so you can see the likely outcome for beneficiaries.
Death before age 75 and the LSDBA
If the member dies before age 75 and the scheme pays the lump sum within the two-year relevant period, death benefits are normally paid tax-free up to the member’s available lump sum and death benefit allowance (LSDBA).
Any amount exceeding that allowance is taxed as pension income in the hands of the trustees or beneficiary — not as a capital payment.
The two-year relevant period
Scheme administrators must normally pay within two years of becoming reasonably aware of the member’s death. If the payment is delayed beyond this window, the favourable tax-free treatment may be lost entirely — turning what should have been a tax-free payment into a fully taxable one. Delays can therefore have serious consequences, so trustees should press for prompt payment.
Death after age 75 and the 45% charge
Where the member dies after age 75, lump sums paid into a discretionary trust usually face a 45% special lump sum death benefit charge on the entire amount before the trustees receive the funds. This is a significant cost and one of the main reasons many advisers recommend keeping pension funds in drawdown rather than directing them to a trust.
Reclaiming tax when distributions reach beneficiaries
When trustees later distribute money to an individual beneficiary, that payment is treated as the recipient’s income and carries a 45% tax credit.
Beneficiaries who are basic-rate or non-taxpayers can reclaim the overpaid tax through Self Assessment or by using form R40 if they do not normally file tax returns. Scheme administrators must provide details of the gross payment and tax deducted within 30 days, and trustees must give the same breakdown to beneficiaries within 30 days of making a distribution.
Clear, timely figures from scheme administrators and trustees make the reclaim process straightforward for beneficiaries. Without good paperwork, reclaims become difficult and delayed.
For practical steps on minimising wider inheritance tax liabilities, see our guide on reducing inheritance tax on pensions.
Inheritance tax and relevant property charges: what trustees may face over time
When death benefits move out of the pension wrapper and into a discretionary trust, the long-term inheritance tax picture changes significantly.
How pensions can become relevant property
Pension arrangements can be treated as settlements for inheritance tax purposes. While benefits remain inside a registered pension scheme, they currently sit outside the estate for IHT. Those exemptions stop applying once money is paid out of the scheme and into a discretionary trust — the funds then enter the relevant property regime.
Periodic and exit charges trustees must watch
Once death benefits are held as relevant property inside a discretionary trust, trustees face two main IHT charges.
- Periodic charges: levied on every ten-year anniversary of the trust, calculated on the value of trust assets above the available nil rate band (currently £325,000, frozen since 2009 and confirmed frozen until at least April 2031). The maximum rate is 6%, but for many family trusts with values below the nil rate band, the periodic charge is nil.
- Exit charges: apply when capital leaves the trust between ten-year anniversaries and are calculated proportionally based on the time elapsed since the last periodic charge. These are typically modest — often less than 1% of the value distributed.
Ten-year anniversaries and scheme join dates
Crucially, the reference date for a ten-year charge can link back to when the member joined a trust-based pension scheme, not simply when trustees received the death benefit funds. This quirk of the rules can bring an anniversary date forward significantly and alter the charge calculations — potentially catching trustees off guard if they haven’t checked the original scheme dates.
Multiple arrangements, multiple nil-rate bands
Having several pension schemes may create separate settlements, each potentially with its own nil-rate band allocation. Consolidation can reduce the number of settlements and alter how many nil-rate bands are available. Trustees must check historic transfers, scheme start dates and any previous chargeable lifetime transfers before acting — getting this wrong can mean an unexpected IHT bill.
| Issue | What trustees should gather | Practical effect |
|---|---|---|
| Start dates | Dates when each scheme was joined or transferred | Determines ten-year anniversaries and periodic charge timing |
| Scheme type | Whether each arrangement was trust-based or contract-based | Affects whether separate settlements exist and how nil-rate bands apply |
| Historic transfers | Records of any consolidation or value transfers between schemes | Can change settlement count and IHT liability calculations |
| Payment timing | Dates when death benefits were paid out of the scheme | Two-year payment windows can affect income tax exemption status |
Treat the paper trail as vital: poor records can raise liability and professional costs significantly. Gather everything before your first ten-year anniversary, not after.
Before you act, gather scheme start dates, transfer history and provider paperwork. For guidance on practical estate planning steps and protections, see our resource on securing your family’s future with inheritance tax planning.
Ongoing tax and costs once money leaves the pension wrapper
Once death benefit payments move outside the pension wrapper and into a discretionary trust, the ongoing costs and tax rules change in ways many families miss.
Income tax on investment returns is charged at trust rates — currently 45% on non-dividend income and 39.35% on dividends (with only the first £1,000 taxed at the basic rate). These rates are significantly higher than most individuals would pay, and the tax reduces the cash available for beneficiaries compared to keeping funds in the pension wrapper where investment growth is tax-free.
Trustee income tax and the tax pool
When trustees pay tax on interest or dividends, that tax forms a tax pool. This pool provides beneficiaries with a tax credit when income is distributed, meaning lower-rate or non-taxpaying beneficiaries can reclaim some or all of the tax paid by the trustees.
However, the reclaim process requires clear records and timely tax statements from trustees. Without proper documentation, beneficiaries face additional work and possible delays in recovering overpaid tax through Self Assessment or form R40.
Capital gains and reduced allowances
Capital gains on investments sold within a trust are taxed at 24% for residential property and 20% for other assets. The trust’s annual exempt amount is just half the individual level — currently only £1,500. That means even relatively modest sales to raise cash for distributions can trigger noticeable CGT bills.
Inside the pension wrapper, investment gains are entirely free of CGT. This difference alone can erode trust fund value considerably faster than many families expect.
Administration and ongoing fees
Trustees must file an annual trust tax return (SA900) with HMRC, maintain the trust’s registration on the Trust Registration Service (TRS), and keep detailed records of all transactions and distributions. Professional trustee and accountancy fees add up over time.
- Record keeping, TRS registration and annual SA900 returns
- Trustee responsibilities and solicitor support for decisions
- Accountant costs for ongoing tax filings and beneficiary statements
For smaller pension pots, nominee drawdown may deliver the same practical outcome with substantially less tax and administration. Reserve the trust route for situations where the control genuinely justifies the cost.
For proposed changes that may affect the taxation of unused pension funds on death, see the government’s consultation note on inheritance tax on unused pension funds and death benefits.
How the rules may change: pension IHT reforms expected from April 2027
New rules due from April 2027 could reshape how unspent pension pots are treated for inheritance tax — and the impact on families could be significant.
What the government proposes: unused defined contribution pension savings may be counted as part of the deceased’s estate for IHT purposes. This removes the long-standing separation between pension wealth and the taxable estate that has made pensions one of the most IHT-efficient assets to hold.
Double exposure risk
Practical effect: the same money could face IHT at 40% (on the portion above the nil rate band of £325,000 per person) and then income tax when beneficiaries withdraw funds from the pension. That double exposure could halve the net amount available to the family — turning a £200,000 pension pot into roughly £100,000 after both charges.
Knock-on housing impact
Including pension value in estate totals may push households over the £2,000,000 threshold where the residence nil rate band (RNRB) begins to taper. The RNRB — currently £175,000 per person, frozen until April 2031 — reduces by £1 for every £2 the estate exceeds £2,000,000. For families who rely on the full RNRB to pass the family home to their children, adding a large pension pot to the estate calculation could trigger the taper and raise the IHT bill by tens of thousands of pounds. Remember, the RNRB is only available where a qualifying residential interest is passed to direct descendants — children, grandchildren or step-children — not to siblings, nieces, nephews or friends.
What we suggest you review now
- Confirm beneficiary nominations with every pension provider and update them where needed.
- Review spouse and civil partner transfers — these remain IHT-exempt and may preserve more value than other routes.
- Reassess your drawdown strategy so income timing fits family needs and tax planning before the rules change.
| Issue | Immediate action | Why it matters |
|---|---|---|
| Nomination forms | Verify provider records and update annually | Ensures intended beneficiary treatment if rules change |
| Spouse transfers | Assess whether transfer of pension rights to a spouse or civil partner is appropriate | Preserves the spouse exemption from IHT for many estates |
| Drawdown timing | Model withdrawals for income tax efficiency before April 2027 | Reduces the risk of double taxation on the same funds |
These measures remain proposals and the final rules may differ from what’s been announced. Plan, don’t panic — but do seek tailored professional advice before making any irreversible changes.
Conclusion
Choosing the right route for pension death benefits means weighing long-term family control against complexity, cost and tax efficiency.
A bypass arrangement using a discretionary trust can give real, lasting control. It often suits blended families, clear bloodline wishes, vulnerable heirs and cases where staged support or repayable loans are needed to protect wealth across generations.
However, that control comes at a price: potential immediate income tax on lump sums (45% for deaths after age 75), possible relevant property IHT charges at ten-year intervals, and ongoing administration including trust tax returns, trustee responsibilities and professional fees. These costs need to be weighed carefully against the protection gained.
For simpler family situations, smaller pension pots or where tax efficiency matters more than intergenerational control, keeping funds inside drawdown with nominated beneficiaries usually works better and costs significantly less.
Next steps: confirm whether your scheme allows discretionary trust nominations, update your expression-of-wish forms, review your will and speak with a regulated financial adviser and a solicitor experienced in trust and pension planning. For guidance on nil-rate band options see our article on the nil-rate band discretionary trust.
Our aim is to protect not just the tax outcome but the clarity and peace of mind for your family when pension death benefits are paid. As Mike Pugh says: plan, don’t panic — and always get specialist advice. The law, like medicine, is broad: you wouldn’t want your GP doing surgery.