Spread the tax free cash from sipp

edited 30 November -1 at 1:00AM in Pensions, Annuities & Retirement Planning
37 replies 2.8K views
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  • jamesd wrote: »
    I suppose I should write a bit more about the 55% tax charge. It's on all the money in the pension pot at the time. What happens if you take the 25% lump sum out of the pension pot? You pay the 55% on only the remaining 75%. Inheritance tax on the 25%. That could well be a better deal than 55% on it all.

    There wouldn't be an IHT liability on passing an estate to a spouse.

    I've not read all the comments, but i'm unsure why IHT is coming into question versus the 55% tax charge - the 2 are uncomparable.
  • jamesdjamesd Forumite
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    Right, nor a 55% tax charge on passing the pension pot to a spouse's pension pot. The discussion now is about the non-spouse inheritance situation.

    The two are being discussed because it's one concern of SeniorSam how to maximise the value of the estate and there is likely to be some IHT liability. One of the choices is whether to try to keep money in the pension pot or expose it to IHT after the second death.
  • The summary:

    In the event of your death whilst you are in income drawdown (or if your over 75 with uncrystallised funds) your beneficiaries will have the following options:

    Taking a lump sum
    Any beneficiary can inherit some or all of your remaining fund as a lump sum less a 55% tax charge (note this charge is not inheritance tax, pensions are usually held in trust outside your estate and therefore inheritance tax isn't usually applied).

    Continuing with income drawdown
    Your spouse or any other dependant can continue to receive your fund as income drawdown, or flexible drawdown if they already have a secure pension of £20,000. The pension pot is not usually subject to inheritance tax, but any income taken would be taxable on the recipient on a PAYE (Pay As You Earn) basis.

    Converting your drawdown to an annuity
    Your spouse or any other dependant can use your remaining income drawdown fund to purchase an annuity. The pension pot is not usually subject to inheritance tax, but any income taken from this annuity would be taxable on the recipient on a PAYE (Pay As You Earn) basis.

    Second Death and IHT Liability
    From the options above, continuing with income drawdown is the most tax-efficient method of providing for children too. Taking a Lump Sum costs 55% and then presumably the resulting pension for your wife also will be subject to 55% tax on passing it down the line again.
    Converting to Annuity - the pension will cease. Continuing with Income Drawdown will only be taxed (other than income tax) on the 2nd death.
    IHT is applicable to both option 1 and 2 equally.

    EDIT: I think if we can agree that all funds are subject to a 55% charge after age 75, the question becomes a little more straightforward
  • edited 31 October 2012 at 5:57PM
    jamesdjamesd Forumite
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    edited 31 October 2012 at 5:57PM
    Here's an alternative summary for a drawdown pot, where benefits have been taken (after crystalisation):

    1. A spouse or some types of financial dependent can inherit 100% of the pension pot with no tax charge, whatever your or their age and whether you've taken any benefits from it or not.

    2. Others can't take it directly into a pension. A spouse can choose not to have it go into a pension. In these cases there is a 55% tax charge, whatever your or their age and whether you've taken any benefits from it or not.

    3. After one of the first two choices, the money, either inside or outside a pension pot, can be used to provide an income using income drawdown or can be used to buy an annuity, or some mixture. Any portion taken outside a pension pot can be used for anything else instead.

    If inheritance tax may apply, these considerations are of possible interest. The current inheritance tax rate is 40%, or 36% if a charity tax donation is made.

    4. Taking the tax free lump sum out of a pension pot is likely to be more inheritance tax efficient than paying the 55% charge inside the pension, generally applies to those paying basic rate tax in retirement.

    5. Taking income from a pension pot is initially likely to be less inheritance tax efficient than paying the 55% pension charge because there would probably be 20% income tax to pay on the income, then 40% IHT on the money if it wasn't spent. But reinvesting into other tax wrappers can save more tax while alive, so potentially being a better choice than using the pension.

    6. Taking income from a pension pot and gifting it to others as a regular payment out of income is likely to avoid inheritance tax and be more efficient than leaving it in the pension pot because your income tax rate is likely to be less than or at least no higher than the inheritance tax rate.

    7. If you are a higher rate income tax payer in retirement, the 55% pension tax charge is likely to be less costly than taking the pension income, paying 40% to 50% income tax, then having 40% inheritance tax charged. As usual, regular gifting out of income can avoid the inheritance tax part of this double taxation.

    8. If you choose the regular gifting out of income option, consider skipping at least one generation, to your grandchildren rather than your children. This avoids inheritance tax issues with your children's estates.

    If benefits have not been taken:

    9. There is no 55% tax charge, regardless of whether the money is paid into or outside a pension pot. At age 75 benefits are considered to have been taken even if they haven't been.

    10. Inheritance tax applies as usual, meaning none on any money going to a spouse, usual limits and rates for others. But pensions are normally in trust and that may avoid the IHT issue because the payout may not be part of the estate.

    11. Taking the pension tax free lump sum and risking 40% inheritance tax is cheaper than paying the 55% pension tax charge. Term life insurance or life assurance can be used to cover the difference for non-spouse beneficiaries, almost certainly at lower cost than the at least 15% tax difference.
    mania112 wrote: »
    Taking a Lump Sum costs 55% and then presumably the resulting pension for your wife also will be subject to 55% tax on passing it down the line again.
    That is not an accurate statement at any age. You're suggesting that the spouse would have a 55% tax charge on a lump sum transfer to them but there's no way for a spouse to both pay 55% initially and then have 55% on the same money at their death.

    A spouse or financial dependent of some restricted types can inherit the whole lump sum into a pension of their own with no 55% tax charge. There is no "also" to the being subject to the 55% tax charge, there was no tax charge in the original transfer to the spouse.

    Taking a lump sum outside a pension pot would have the 55% tax charge for the spouse, but then there wouldn't be another pension 55% tax charge because the money wouldn't be in a pension.
    mania112 wrote: »
    EDIT: I think if we can agree that all funds are subject to a 55% charge after age 75, the question becomes a little more straightforward
    Two problems:

    A. It's not true that there is always a 55% tax charge after age 75. The spouse/dependent rule doesn't change at 75. What changes at 75 are being treated as crystallised and more frequent GAD checks.
    B. It's no more or less simple that the 55% or nil charge case because that's the same before and after age 75, just depending on whether a spouse or financial depended take the money into a pension pot (nil) or if it's inherited in some other way (55%).

    There used to be different rates but the current government switched to a single 55% rate.
  • edited 31 October 2012 at 8:16AM
    SeniorSamSeniorSam Forumite
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    edited 31 October 2012 at 8:16AM
    That's very clear James, it clarifies a few earlier points. Thank you!

    Sam

    31st Oct ........ just checked the edits and all very helpful indeed. Thanks again
    Sam
    I'm a retired IFA who specialised for many years in Inheritance Tax, Wills and Trusts. I cannot offer advice now, so my comments are just meant to be helpful.
  • edited 30 October 2012 at 11:39PM
    jamesdjamesd Forumite
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    edited 30 October 2012 at 11:39PM
    Just be sure to check the latest edit where I've made a few more clarifications just after the time of your post. :) And the more recent one. :)
  • kidmugsykidmugsy Forumite
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    Given that you can gift surplus income free of IHT as long as regular gifting becomes part of your normal expenditure, the IHT-effective trick is to get the income rolling, either by annuity or income withdrawal, and give away the surplus.
    Free the dunston one next time too.
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