IHT. Gifts from excess income. Accumulation units

Ebkent

I am recording my income and expenses so I know what my excess income, so I can gift the balance.
I have quite a few fund and investment trust holdings. I understand that any cash dividends can be treated as income.
But what  about accumulation units  ? Can I calculate the amount of income and use it in my IHT income figures ?
Would  it help to sell the parts of these holdings to realise the dividend total.?  Or should I switch to income units, and reinvest the dividends if desired ?

Jeremy535897

By definition, the income is automatically reinvested and therefore is not available to cover expenditure. See https://www.gov.uk/hmrc-internal-manuals/inheritance-tax-manual/ihtm14250

Robert_McGeddon

Jeremy535897 said:

By definition, the income is automatically reinvested and therefore is not available to cover expenditure. See https://www.gov.uk/hmrc-internal-manuals/inheritance-tax-manual/ihtm14250

I think (and hope!) the HMRC article is a little narrow in its interpretation of income and allowability.  If the acc unit investment is held outside a tax wrapper then there will likely be notional distributions upon which count as taxable income - a £100 notional distribution might attract £20 BR tax leaving effectively £80 as post tax income.  This is obviously income oriented.  Some of the holding could be sold to provide the cash to make a gift out of income.  This gives the same result as dividends from a distributing fund so why should it be treated differently?  Nevertheless, I will switch all my non-SIPP funds to distributing to avoid the potential issue.

On a broader front, I take income (for the gifting calculation) to be income from all sources e.g. PAYE, lettings, interest, pensions as well as the dividends or notional distribution above. These are aggregated. It then doesn't matter where the gift is made from - it could be a bank account unconnected with the acc or dist funds above. In the case of acc funds the gifting element doesn't need to be withdrawn to qualify and could remain invested.

I write this as an interested party, not a tax advisor!

Ebkent

Thank you for your very comprehensive reply. I have been trawling through my Hargreaves portfolios noting my dividends this afternoon.  I am going to start buying some new funds, so I might as well choose income paying funds, but will probably leave the existing accumulation units alone.
I have a Sipp Income Drawdown fund that I assume I can include the dividend income. I think I read somewhere that If I make another income drawdown the 25% tax free cash (TFC) can be included as income ?
 Can I include the income from my uncrystallised Sipp ? 

Sorry about all the questions . Thanks again.

Jeremy535897

The key is the phrase "normal expenditure out of income". If the income is notional or otherwise unavailable, the expenditure cannot be "out of" it. However, I don't think HMRC has ever suggested that you have to make gifts out of the same bank account the income went into.

Robert_McGeddon

Ebkent said:

I have a Sipp Income Drawdown fund that I assume I can include the dividend income. I think I read somewhere that If I make another income drawdown the 25% tax free cash (TFC) can be included as income ?
 Can I include the income from my uncrystallised Sipp ?

I think either you're confused or I am!

I think the income from your SIPP is what you actually withdraw from it and submit on your tax return - if you prepare one. If you're using UFPLS then 25% will be tax-free (and not declared on your tax return) whilst 75% will count as taxable income. Both count as income for the gifting calculation. If you're using FAD then a withdtawal could be 100% taxable, 100% tax-free or anything in between, with the income available for gifting being the gross withdrawal less any tax.  Any dividend income inside the SIPP adds to the capital value of the SIPP and does not form part of what's income for gifting purposes.

What income do you have in your uncrystallised SIPP? Surely £Nil until you crystallise it and then withdraw something.

Jeremy535897

Ebkent said:

Thank you for your very comprehensive reply. I have been trawling through my Hargreaves portfolios noting my dividends this afternoon.  I am going to start buying some new funds, so I might as well choose income paying funds, but will probably leave the existing accumulation units alone.
I have a Sipp Income Drawdown fund that I assume I can include the dividend income. I think I read somewhere that If I make another income drawdown the 25% tax free cash (TFC) can be included as income ?
 Can I include the income from my uncrystallised Sipp ? 

Sorry about all the questions . Thanks again.

Your post crossed with mine. The SIPP is only relevant if you draw funds from it. While funds remain within it, they are not income in your hands. 

The IHT manual says:
"Income is not defined in the IHTA84 but should be determined for each year in accordance with normal accountancy rules. It is not necessarily the same as income for income tax purposes. Income is the net income after payment of income tax."

I am not convinced that a one off lump sum from a pension scheme (whether tax free or not) would be "income" for this purpose.

Ebkent

Thank you again, Jeremy, for your reply. 

I did some more searching , about using the TFC part of an income drawdown as excess income and I found this article. I am not allowed to post a link as I am a new member but if you search for ‘ iht gift from excess income tax free cash from pension techzone’ you should find the link. They state 
”HMRC have confirmed to us that regular withdrawals from flexible pensions, irrespective of the levels withdrawn and whether taken as tax free cash or taxable income, always count as income for the purpose of the IHT exemption. This creates an opportunity for at least 25% of the pension fund to be taken and gifted both income tax and IHT free.”

This would seem to very advantageous. I am 70 and in very good health. If I die after age 75 the TFC is effectively lost and my son will get the inherited drawdown fund and that will be subject to his marginal tax rate. 

If I do 5 annual drawdowns of 20% of the fund and pass the 25% TFC each year to him as excess income, he won’t be liable to any tax at all. 

Effectively if I do this my uncrystallied SIPP fund will disappear and all investments and their dividends will be in the income drawdown account, and I understand that income is allowable for this exemption. So I seem to kill two birds with one stone ?

Any thoughts ?

Jeremy535897

Thank you for that. It is very helpful, although it confirms my instinct, as it says "regular withdrawals". It also goes on to say:
"Firstly, the gifts have to be part of normal expenditure. Taking the full 25% tax free cash entitlement and giving it away is a one-off gift. The exemption clearly will not apply and the gift will be a potentially exempt transfer. There has to be an established pattern of gifting. Spreading the gifting of tax free cash over a number of years using a phasing strategy, so that all the tax free cash is taken by the client's 75th birthday, is a better option."

He may not be liable to tax, but you will be, on the amounts drawn in excess of your tax free entitlement. You will also enter flexible drawdown, although I doubt very much that it will matter to you. I am also assuming that you have sufficient other funds to provide for your likely long remaining life.

Ebkent

Thanks Jeremy. It is very useful to be able to bounce these ideas off of someone .

A couple of points.
I have sufficient income to live on from a Final Salary pension and State Pension.
I have always regarded my Sipp as a tax efficient way to pass the money on to my son.
About 33% of my SIPP is already in Flexible Income Drawdown.
I was envisaging drawing down in equal amounts from my uncrystallised fund over 5 years thus establishing regularity
 I would only withdraw the TFC as cash, on each of the 5 years, leaving the rest of the fund in the Income drawdown fund , so I would not suffer tax.
I am with HL and they allow this flexibility.

Does this sound sensible ?

Thanks again

Ebkent

Robert McGeddon 
sorry I missed your post earlier
Thanks for your response above. It is probably me getting confused. I have 3 HL accounts, an Isa, a Sipp, (uncrystallised) and an Income Drawdown fund, where I have already taken the UFPLS . I do not withdraw any money from the latter, as I would have to pay income tax on it.  As I had seen you could include Dividends in the total income figure, I realised I had dividend income in all 3 accounts.  But perhaps I can only use the ISA dividends ? Thank you