Withdraw from Pension, contribute to ISA

Culzean

I thought this might be a good place to check what 'appears' an obvious plan I'm intending to follow

My wife and I are both 61, just retired and have final salary pensions that will be adequate to support us

We also have fairly decent SIPPs and are now planning on taking an annual sum up to the 40% tax threshold and putting into ISA's. It seems the logical thing to do. The only consideration I can see is the tax on death situation. We both assume we will live beyond 75, we could wait until then but then we would be unlikely to be able to get any significant proportion of our fund out at 20% before we passed away

Is there something fundamental that I am missing?

dunstonh

Withdraw from Pension, contribute to ISA

Myself and a colleague were just saying the other day that we wondered how many people would be foolish enough to do that thinking it was a good thing to do.

It seems the logical thing to do.

Pensions and ISAs share the same investment options and the same charges. They are both tax free whilst invested. The pension is outside of the estate so no IHT. The ISA is within the estate and potentially chargeable to IHT.

You pay no tax on the pension if you die. The beneficiary only pays tax on the pension if they take anything out of the pension. If they leave it in the pension, there is no tax to pay and they can continue it.

Is there something fundamental that I am missing?

Losing 20% of the value to get money out of an investment that has the same charges and investment options doesnt add up in most cases (exceptions can apply).

Culzean

Never really thought of myself as foolish but then nor am I totally au fait with current pension rules, hence my post

Taking out of pension and into ISA would allow us to gift the children and therefore avoid a chunk of IHT that would come if we sat on it. Indeed the thought was to open ISA's in the childrens names

I thought if we survived 75 then our children would pay 45% tax on anything passed on? If they pay that at the point of withdrawal isn't that the same thing, or have I got that wrong?

xylophone

https://www.rowanmoor.co.uk/sipp/death-benefits/#before

atush

the whole point it, there will be NO IHT as pensions are outside of your estate, and the money can remain in the pension and be inherited tax free if stays there and is drawn as income.

Only should they decide to remove the money all in one go, will it be taxed if you died after age 75.

By all means, if you want to gift them some money at 20% tax, then withdraw some and gift it straight to them- no need to put it in an ISA first. Gift each child one years extra withdrawals. Should be a tidy enough sum if you both do it.

Culzean

atush wrote: »

the whole point it, there will be NO IHT as pensions are outside of your estate, and the money can remain in the pension and be inherited tax free if stays there and is drawn as income.

Only should they decide to remove the money all in one go, will it be taxed if you died after age 75.

By all means, if you want to gift them some money at 20% tax, then withdraw some and gift it straight to them- no need to put it in an ISA first. Gift each child one years extra withdrawals. Should be a tidy enough sum if you both do it.

Thanks, this all assumes we live beyond 75

I get that if they decide to draw in one go it gets taxed (at 45%?). But if they drawdown as an irregular supplementary income (none are particularly flush) is that taxed at their marginal rate?

The idea of putting into ISA was simply to incentivise them to keep hold of it and not blow it.

Culzean

xylophone wrote: »

https://www.rowanmoor.co.uk/sipp/death-benefits/#before

Thanks for that ... helpful

atush

If you feel they will be irresponsible, then leave it until the second death so you wont have to worry about them 'blowing it' as you wont be around to watch?

Or bypass the adults and leave the money in trust for grandchildren?

Pincher

You can take out 25% from the SIPPs tax free. If you make sure they use it towards a mortgage, then it's a hindrance to blowing it..

You must marry Gerald the dentist if you want this money is even more traditional.

jamesd

Culzean wrote: »

We also have fairly decent SIPPs and are now planning on taking an annual sum up to the 40% tax threshold and putting into ISA's. It seems the logical thing to do.

Yes, it's potentially a sensible thing to do, in spite of the discussion between dunstonh and a colleague.

The advantage is increased protection from tax changes. With deficits and one or two parties that might govern in the future potentially increasing public spending there's always the chance of an increase in income tax. By moving the money from a pension to an ISA you protect yourself from such an increase in income tax.

Culzean wrote: »

The only consideration I can see is the tax on death situation. We both assume we will live beyond 75, we could wait until then but then we would be unlikely to be able to get any significant proportion of our fund out at 20% before we passed away

This is a concern. One way to address it is to use life insurance or life assurance to provide payment outside your estate to whoever you wish, since insurance payments are outside the estate. The other way is to avoid paying 20% in the first place, since paying it isn't essential.

Culzean wrote: »

Is there something fundamental that I am missing?

It's possible to eliminate the income tax when taking out the money. One way is to buy enough VCTs to offset the income tax. VCTs provide 30% income tax relief so buying VCTs to the value of 2/3 of the taxed income being taken will eliminate the income tax in the basic rate range. So buy £20k of VCTs to eliminate all of the income tax on £30k of basic rate taxed income.

VCT risk levels vary substantially. There are some that make secured loans and pay 10-11.2% tax free annual dividends, not guaranteed, after allowing for the effect of the tax relief on the purchase price. Little chance of a substantial loss on those. Others invest in early stage startup companies without security on property for the money and are very high risk, probably not the ones to go for.

The VCT tax relief has to be repaid if sold within five years, unless it is a sale by the estate of a person who has died. It's normally better to hold VCTs for more like 7+ years.

Don't let the tax consideration be the only one but if the combination of income tax relief and income is appropriate then this can be quite useful.

Another option is to live in Portugal for a while. Portugal has the option of applying for a 0% tax rate on foreign pension income and lump sums. So you could take out your whole pension pots free of UK tax while using this. You must remain out of the UK for several years after doing this to avoid UK rules that will charge you the tax anyway if you return too quickly. You don't have to continue living in Portugal, just outside the UK. Since there is no option to pay money into ISAs while not UK resident you lose this possibility until you return to the UK. If you do. This option is mainly suitable for those who plan to leave the UK long term but can be useful to others.

jamesd

Using ISAs for the children and potentially grandchildren is a useful way to avoid future inheritance tax bills.

The children would only pay 45% on most of the money inherited in a pension if they took it all out as a lump sum. After you've reached age 75 the money is taxed at their income tax rate, as any other normal income. If they take out enough to get their income over £150,000 then they pay 45% on the amount over that. Or 40% on the amount over basic rate and below top rate. Or 20% if they do it gradually. Or 0% if they use the VCT or other approaches. If you were to die before age 75 the whole amount is tax free to whoever gets it, including taking it all at once as a lump sum. All of this is outside your estate.

Another method that you can use to reduce inheritance tax liability is an equity release mortgage, perhaps the type that allows regular drawing as income. Give the money away and the released equity isn't part of your estate any longer, so there may be no inheritance tax bill on the property value or other money.

There is one very substantial benefit of giving the money away now. You get to see them enjoying its benefits, something that you can't do when you're dead.

If you're paying them money regularly, another incentive to them not blowing it is the knowledge that you may not provide more in the future, since while alive you can change how much you pay and who gets it whenever you like.

If you're truly concerned about them blowing the money a discretionary trust is an option. The catch is that trusts are essentially taxed as higher rate tax payers are taxed, so it's not tax efficient.