A Pilot Trust is a discretionary trust set up during the Settlor's lifetime usually for the benefit of the Settlor's wife and children.
It has a number of uses, but is popularly used as a destination for lump sum death in service benefits under a pensions scheme. The trustees of a pension scheme will usually exercise their discretion to make this payment in accordance with the employee's wishes and customarily the employee will request that payment be made to the surviving spouse.
On the face of it this is sensible, as most it provides funds directly - and without having to wait for probate - to the surviving spouse. However, there are adverse implications of adopting this route:
1. The unsuitable second husband or wife. If the surviving spouse has control over the funds, they may be available to a new partner - particularly if a second marriage is followed by divorce.
2. If the surviving spouse becomes bankrupt, the funds will be used up, rather than saved for the children.
3. If the surviving spouse has to go into a care home and fees are high, these funds will be applied in payment of fees before local authorities will provide assistance.
4. If the funds go to the surviving spouse directly, on the second death, they will form part of the surviving spouse's estate and may attract inheritance tax @40%.
If instructions are given to make the payment to the trustees of a Pilot Trust, the trustees will then hold the funds on a discretionary basis for the surviving spouse and children. The terms of the trust are such that the trustees can make interest-free loans to the beneficiaries. Using this power, they can make such a loan to the surviving spouse - which achieves the same result as a direct payment from the pension scheme to the surviving spouse, except that the funds can be reclaimed by the trustees before any of the first three eventualities mentioned above, and, at the death of the surviving spouse, will be outside his or her estate - and therefore outside any liability to inheritance tax. The funds can then be divided amongst the children after substantial tax saving.