Bypass Trusts and Pension Estate Planning: Protecting Wealth Across Generations

For clients with substantial pension pots, death benefits planning is not simply a case of completing an expression of wishes form and hoping the money reaches the right people. The combination of a pension and a bypass trust is one of the most powerful estate planning structures available in the UK — and one that has, historically, allowed pension wealth to pass across two generations without attracting inheritance tax at either stage. With the legislative landscape now shifting — unused pension funds are brought within the scope of IHT from 6 April 2027 under the Finance Act 2026 — understanding how this structure works, when it is appropriate, and what it costs remains essential for any HNW family with significant pension assets.

What Is a Bypass Trust?

A bypass trust is a discretionary trust established specifically to receive pension death benefits. Rather than the pension scheme trustees paying a lump sum directly to a named beneficiary — say, your spouse or children — the funds are paid into the bypass trust, which is administered by a group of trustees (typically a combination of family members and a professional trustee) for the benefit of a defined class of beneficiaries.

The beneficiaries of the bypass trust typically include a wide class — spouse, children, grandchildren, and potentially other family members or dependants — but no single individual has an automatic entitlement to any specific amount. The trustees exercise genuine discretion over how, when, and to whom the funds are distributed.

The Traditional Inheritance Tax Advantage

The structure generates a significant IHT advantage by virtue of two separate rules operating in sequence.

First, the pension fund itself is not in the deceased member's estate for IHT purposes. Registered pension schemes are held outside the estate under a form of trust, and the scheme trustees have discretion over the distribution of death benefits. A completed expression of wishes guides — but does not bind — the scheme trustees. On this basis, no IHT is charged on the pension when the member dies.

Second, when the scheme trustees exercise their discretion to pay the lump sum into the bypass trust, the funds move into a discretionary trust rather than into any individual beneficiary's hands. They are not treated as income or capital in any beneficiary's hands at this stage. Beneficiaries may receive distributions from the trust over time, and those distributions may be planned — for example, using beneficiaries' income tax allowances and nil rate bands — to minimise tax on each payment.

The result is that the same pension fund can bypass the estates of two consecutive generations, which explains the name.

Why Bypass Trusts Matter Now More Than Ever

Prior to the legislative changes first announced in the 2024 Autumn Budget, an uncrystallised pension passed on death was almost universally free of IHT. Under the Finance Act 2026 (which received Royal Assent on 18 March 2026), from 6 April 2027 most unused pension funds and death benefits will be brought within the scope of IHT, reversing the historic position. The personal representatives of the estate will be liable for the IHT due on the pension element.

With this change now legislated, the first-generation shelter — the pension being outside the estate — is largely removed for most estates. However, the bypass trust's second-generation shelter — keeping the funds away from the beneficiaries' own estates — remains valuable.

Moreover, a bypass trust provides a structure for controlled, discretionary distribution even where funds have been subject to IHT at the first stage. This may be particularly valuable where beneficiaries are themselves high earners, are likely to face IHT on their own estates, are going through divorce proceedings, face creditor claims, or are otherwise vulnerable in a way that argues against a direct lump sum payment.

We are monitoring the implementation of the 2027 changes closely and will update our guidance for clients as the detailed rules and HMRC guidance are finalised. The position as of June 2026 is that the changes are enacted in the Finance Act 2026 and take effect from 6 April 2027, with some operational detail (including how schemes and personal representatives report and settle the IHT) still being worked through.

How It Works in Practice

The sequence of steps for establishing and operating a bypass trust is broadly as follows.

Step 1: Establish the trust deed. A specialist estate planning solicitor drafts a bypass trust deed, naming the trustees and defining the class of beneficiaries. The trust deed should be carefully drafted to ensure it is genuinely discretionary and does not give any beneficiary a fixed entitlement that would compromise the trust's tax treatment.

Step 2: Update the expression of wishes. The member completes a new expression of wishes with their pension scheme, nominating the trustees of the bypass trust as the intended recipients of any death benefit lump sum. The scheme's own trustees are not legally bound by this instruction, but in practice most schemes follow the member's wishes where there is no reason not to do so.

Step 3: On death, the scheme trustees exercise discretion. When the member dies, the pension scheme trustees consider the expression of wishes and — if they concur — pay the death benefit lump sum to the bypass trust rather than directly to family members.

Step 4: The bypass trust trustees manage and distribute. The trust trustees then hold and invest the funds, distributing them to beneficiaries at their discretion over time. Distributions can be planned to coincide with beneficiaries' lower-income years, to use annual allowances, or to fund specific needs such as education, property purchases, or retirement.

Tax Treatment of the Trust

A bypass trust is subject to the UK's relevant property trust regime for inheritance tax purposes. This means two ongoing tax events to be aware of.

The ten-yearly periodic charge arises every ten years based on the value of trust assets above the available nil rate band (currently £325,000). The maximum rate is 6% of the excess. For large pension pots, this can create a significant periodic tax liability, though careful planning around distributions in the years leading up to each ten-year anniversary can manage it.

Exit charges arise when funds leave the trust and are paid to beneficiaries. The rate depends on how long the funds have been in the trust and the proportion of the nil rate band used.

These charges are a real cost of the bypass trust structure and must be weighed against the benefits. For very large pension funds passing to beneficiaries with their own substantial estates, the trust charges will typically be materially lower than the IHT that would otherwise apply on direct inheritance.

When Does a Bypass Trust Make Sense?

Not every client with a pension needs a bypass trust. The structure adds legal complexity, establishment cost, and ongoing administration. We recommend it in the following circumstances.

Large pension pots: Where the pension fund is substantial — typically £500,000 or more — the IHT and succession planning benefits justify the cost.

Beneficiaries with their own large estates: If your spouse or children already have significant personal wealth, any direct inheritance from your pension only compounds their own eventual IHT exposure. A bypass trust can prevent the same capital being taxed twice across two generations.

Protecting vulnerable beneficiaries: Where a beneficiary has a disability, an addiction, a difficult marriage, or an unsophisticated attitude to money, a trust provides a protective structure that direct payment does not.

Cross-generational planning: Where the pension owner wishes to benefit grandchildren or other younger-generation family members in a way that a simple spousal nomination would not achieve.

Business owners: Business owners whose estates are otherwise sheltered by Business Relief may have pensions as their most exposed asset for IHT purposes. A bypass trust addresses this directly.

HMRC Anti-Avoidance and Genuine Discretion

HMRC scrutinises bypass trust arrangements and has challenged structures where the discretionary nature of the trust is a fiction — for example, where the trustees have an informal side-arrangement that binds them to pay all funds to a specific beneficiary on demand. For a bypass trust to work as intended, the discretion must be genuine.

This means:

• The trustees must actively exercise their judgment on each distribution
• No beneficiary should have a legal right to demand payment
• The trustees should keep minutes of their decisions and the reasoning behind them
• There should be no pre-existing agreement that undermines the discretionary nature of the trust

We work only with properly structured arrangements and recommend that clients use experienced estate planning solicitors for trust drafting.

Our Approach to Bypass Trust Planning

Establishing a bypass trust is never a decision to be taken in isolation from the broader estate plan. We assess each client's position across their full range of assets — pension, property, investments, business interests — before recommending a trust structure. In some cases, the priority is simplicity and a well-drafted expression of wishes is sufficient. In others, a bypass trust is the most significant estate planning step a client can take.

How Global Investments Can Help

Our pensions and estate planning specialists work together to assess whether a bypass trust is appropriate for your circumstances. Where we recommend one, we introduce you to specialist estate planning solicitors and coordinate the drafting and registration of the trust alongside updating your expression of wishes with each relevant pension scheme.

We continue to monitor the implementation of the 2027 IHT changes and will advise clients on any planning that may be appropriate in advance of the new rules taking effect. If you have a large pension and have not reviewed your death benefits nominations recently, we recommend a conversation with us ahead of the 2027 changes taking effect.

Please note that trust and tax law is complex and subject to change. The information in this guide reflects the position as of June 2026 and should not be relied upon as personal financial or legal advice. You should seek regulated financial and legal advice before establishing any trust arrangement.