How would inheriting a SIPP work in practice?

zagfles

I've been ploughing through the pensions tax manual and various pension providers' sites trying to understand this. These are my conclusions (but don't rely on them I could be wrong!):

• The LTA of the deceased member is relevant, not the LTA of the beneficiaries. So inherited pensions do not count against the beneficiarys' LTA.
• Only need worry about the LTA if the member died under 75. If over 75 then all the LTA tests are done (for DC anyway).
• LTA charge (if relevant) is shared between beneficiaries
• No LTA charge if wait over 2 years before designating funds, but income is then taxable.
• It seems the LTA charge is 55% for a lump sum (BCE7) or 25% for flexi-access drawdown or annuity (BCE 5C/5D). So that would seem to make it a complete no-brainer to go for drawdown rather than lump sum, as the withdrawals will be tax free as I understand it (since member died under 75 otherwise LTA doesn't apply). Could withdraw it all tax free as soon as the drawdown is set up and 25% LTA charge paid. Why would anyone ever take a lump sum and pay 55%?? I might be missing something here?

https://www.gov.uk/hmrc-internal-manuals/pensions-tax-manual/ptm087000

https://www.gov.uk/hmrc-internal-manuals/pensions-tax-manual/ptm072430

cjking

Does that mean inherited funds can't be combined with the beneficiaries own pension savings? Otherwise there would be no way to distinguish which funds were subject to beneficiary LTA and which weren't.

zagfles

HappyHarry wrote: »

Good questions.

If the funds were in drawdown when the original pension holder died, then the funds have already been tested against the lifetime allowance, and will not be tested again against the beneficiaries' lifetime allowance.

If the funds had not been previously tested, then they will be tested against the beneficiaries' Life Time Allowance.

More details here: https://www.gov.uk/tax-on-pension-death-benefits

Really? That's not my understanding. AIUI it's only the deceased's LTA which is relevant, not the beneficiary's. But as you're an IFA I hope you're right!

zagfles

cjking wrote: »

Does that mean inherited funds can't be combined with the beneficiaries own pension savings? Otherwise there would be no way to distinguish which funds were subject to beneficiary LTA and which weren't.

My understanding is that a separate beneficiary's drawdown fund is established and which has no effect on the beneficiary's LTA, it's completely separate. But HH seems to disagree...

caveman8006

The extra wrinkle on all this, of course, is that if you die before 75 and leave a drawdown pot that has grown significantly since it was crystalized, the whole proceeds (including investment gains that might amount to significantly more than the LTA) can be passed on free of any LTA penalty tax as well as being IHT free. But if you survive to age 75, you will be hit for the 55% penalty tax on any investment returns that have taken your pot over the LTA. As an extreme example: a 55 year-old who goes into drawdown with a £1m fund that earns 7% per annum would have a fund worth about £3.85m on the eve of their 75th birthday: if they died that day they could pass on the whole fund tax free; the next day they would be liable for a £1.5m penalty tax with little way of mitigating it. This rule is truly bizarre and I personally doubt if it can survive in the current form

zagfles

caveman8006 wrote: »

The extra wrinkle on all this, of course, is that if you die before 75 and leave a drawdown pot that has grown significantly since it was crystalized, the whole proceeds (including investment gains that might amount to significantly more than the LTA) can be passed on free of any LTA penalty tax as well as being IHT free. But if you survive to age 75, you will be hit for the 55% penalty tax on any investment returns that have taken your pot over the LTA. As an extreme example: a 55 year-old who goes into drawdown with a £1m fund that earns 7% per annum would have a fund worth about £3.85m on the eve of their 75th birthday: if they died that day they could pass on the whole fund tax free; the next day they would be liable for a £1.5m penalty tax with little way of mitigating it. This rule is truly bizarre and I personally doubt if it can survive in the current form

Yes it's odd there's no BCE 5a on crystallised funds equivalent for death under 75. That's the anomaly rather than the tax applied at 75 through BCE5a.

But it can be mitigated easily enough by drawing down on the pension before reaching 75. Also could pay 25% LTA tax rather than 55% and take (taxed) income. It's a bit of an odd situation anyway - why would someone crystallise a £1m fund, not take the TFLS, and then not touch it before 75?

caveman8006

I doubt if it is that strange a situation for high net worth individuals with significant savings elsewhere in ISAs etc who are aiming to maximise IHT relief. (In any case, the situation would be virtually the same if the full 25% tax free lump-sum was taken at the outset, as the remaining £750k drawdown fund would still have used up the full LTA allowance and the £2.9m pot at age 75 would still face a £1.2m tax charge if not inherited before). It is not easy to mitigate this by taking as taxed income: even if the investment returns were taken as income each year, the proceeds would be well into the higher rate income tax band and if left until the last minute to maximise chance of full, iht-free pass-on, they would be subject to whatever "super" tax was being applied to the mega-wealthy at the time.

PensionTech

Wading in here:

If the funds had not been previously tested, then they will be tested against the beneficiaries' Life Time Allowance.

I don't think this is right. See here:

https://www.gov.uk/hmrc-internal-manuals/pensions-tax-manual/ptm073600

Particularly this:

An uncrystallised funds lump sum death benefit may be tested against the member’s available lifetime allowance. It depends on how old the member was when they died and when the lump sum is paid.

If the member was aged under 75 when they died, and the uncrystallised funds lump sum death benefit is paid within 2 years of the date the scheme administrator first knew of the member’s death (or if earlier, the date they could first reasonably have been expected to know of it), the lump sum is tested against the lifetime allowance.

If the total benefits taken in respect of the member are more than their lifetime allowance the excess is liable to the lifetime allowance charge. If the excess is taken as a lump sum, the tax rate of the lifetime allowance charge is 55 per cent. More information on the lifetime allowance test for death benefits can be found at PTM088600.

If the member was aged under 75 when they died, and the uncrystallised funds lump sum death benefit is paid more than 2 years from the date the scheme administrator first knew of the member’s death (or if earlier, the date they could first reasonably have been expected to know of it), the uncrystallised funds lump sum death benefit is not tested against the lifetime allowance.

If the member was aged 75 or over when they died the uncrystallised funds lump sum death benefit is not tested against the lifetime allowance. There will have been a BCE 5B when the member was 75.

zagfles

caveman8006 wrote: »

I doubt if it is that strange a situation for high net worth individuals with significant savings elsewhere in ISAs etc who are aiming to maximise IHT relief. (In any case, the situation would be virtually the same if the full 25% tax free lump-sum was taken at the outset, as the remaining £750k drawdown fund would still have used up the full LTA allowance and the £2.9m pot at age 75 would still face a £1.2m tax charge if not inherited before). It is not easy to mitigate this by taking as taxed income: even if the investment returns were taken as income each year, the proceeds would be well into the higher rate income tax band and if left until the last minute to maximise chance of full, iht-free pass-on, they would be subject to whatever "super" tax was being applied to the mega-wealthy at the time.

For a start 7% is a very optimistic long term rate of return. A more realistic 5% would be well within the basic rate band.

Secondly the idea of a pension isn't to avoid IHT, so it seems quite sensible to tax it in this way. It's just an anomaly that there isn't a BCE5a equivalent for death before 75, ie LTA charge on increase in crystallised funds. Maybe that'll be changed in the Autumn statement I'm sure Phillip is looking for ways to increase taxes and at the same time clamp down on "loopholes" which are exploited by the "rich"...

HappyHarry

PensionTech wrote: »

Wading in here:



I don't think this is right. See here:

https://www.gov.uk/hmrc-internal-manuals/pensions-tax-manual/ptm073600

Particularly this:

An uncrystallised funds lump sum death benefit may be tested against the member’s available lifetime allowance. It depends on how old the member was when they died and when the lump sum is paid.

If the member was aged under 75 when they died, and the uncrystallised funds lump sum death benefit is paid within 2 years of the date the scheme administrator first knew of the member’s death (or if earlier, the date they could first reasonably have been expected to know of it), the lump sum is tested against the lifetime allowance.

If the total benefits taken in respect of the member are more than their lifetime allowance the excess is liable to the lifetime allowance charge. If the excess is taken as a lump sum, the tax rate of the lifetime allowance charge is 55 per cent. More information on the lifetime allowance test for death benefits can be found at PTM088600.

If the member was aged under 75 when they died, and the uncrystallised funds lump sum death benefit is paid more than 2 years from the date the scheme administrator first knew of the member’s death (or if earlier, the date they could first reasonably have been expected to know of it), the uncrystallised funds lump sum death benefit is not tested against the lifetime allowance.

If the member was aged 75 or over when they died the uncrystallised funds lump sum death benefit is not tested against the lifetime allowance. There will have been a BCE 5B when the member was 75.

I stand corrected.

Thanks PensionTech. That nuance had escaped me.