What is income?

Nick_Dr1

With the recent speculation regarding inheritance tax and pensions, I was wondering what actually counts as income?
For example, I am (I understand) allowed to give away as much as I want free from the IHT 7 year rule as long as its from income, but if I make a one off gift it is only potentially exempt (7yrs)

So if I have a DB pension, its obvious what is income. Any surplus each month could be given away.

But if I am taking drawdown from a DC scheme I am free to take as much as I want within the limits of how much I have.

If I don't actually need this 'income' but actually take it on a regular basis it would just mount up in my bank account. I could then give it away?

Same with taking regular money from an ISA? If I don't withdraw it, it it obviously isn't income, but if I do regularly, then it is?

So what counts as income?

Keep_pedalling

Your drawdown is income, but as your DB pension sits outside your estate why would you want to do it this way unless the rules change on this exemption?

Dividends and interest from ISAs is also income but if you are withdrawing capital it is not.

Nick_Dr1

I'm not saying I want to do it this way, I'm just musing on what constitutes income.

As regards ISAs, how does anyone tell if what I am withdrawing is capital or income, if I'm just withdrawing say £2000 per month every month from stocks and shares ISA and have been doing that for years?

leosayer

The link below says:

"The exemption only applies where the gifts are made from surplus income after tax. Examples of income will include pension income, interest from savings, dividend income, rental income or income payments received from a trust. "

https://www.gabyhardwicke.co.uk/briefing-notes-and-faqs/inheritance-tax-exemption-for-gifts-out-of-surplus-income/#:~:text=The exemption only applies where,payments received from a trust.

leosayer

The best way to demonstrate you are taking income is through record keeping eg. dividend vouchers from your ISA along with an automated transfer of that amount into the bank account where you make you surplus income payments from.

What isn't clear to me is whether living off your capital ie. by selling shares or drawing from your savings could mean that 100% of your income is surplus.

Keep_pedalling

Nick_Dr1 said:

I'm not saying I want to do it this way, I'm just musing on what constitutes income.

As regards ISAs, how does anyone tell if what I am withdrawing is capital or income, if I'm just withdrawing say £2000 per month every month from stocks and shares ISA and have been doing that for years?

If you want your executors to claim gifts from excess income you are going to have to keep good records of both your income and expenditure (download IHT403 to see what info is required). If you are drawing less than your total interest / dividends from your ISA then it is all income, if it is more then it is part  income and part capital but that would surest you don’t have excess income.

Nick_Dr1

leosayer said:

The link below says:

"The exemption only applies where the gifts are made from surplus income after tax. Examples of income will include pension income, interest from savings, dividend income, rental income or income payments received from a trust. "

https://www.gabyhardwicke.co.uk/briefing-notes-and-faqs/inheritance-tax-exemption-for-gifts-out-of-surplus-income/#:~:text=The exemption only applies where,payments received from a trust.

Useful, but they are only examples.It also says 
If you prepare income tax returns, your tax return will help you identify the sources of your income but you should remember to also take into account any income from ISAs, which will not show up on your income tax return, but which will still be considered income, for the purposes of the gifts out of surplus income IHT exemption.

So ISAs can be income, obviously. The grey area is that there are no dividend vouchers from ISAs inverted in funds. I've never seen one anyway. The funds keep growing. I can take "income" by selling units, or converting them into income units and not reinvesting the proceeds. That would make sense if all assets in an ISA are treated as capital. Perhaps that's my naivety - I'm not an accountant or tax inspector. I've always viewed ISAs as outside of tax as it doesn't go on a tax return, so I can cash in and spend it whenever I like with impunity, given it was taxed in principle on the way in.  I was assuming that if I took regular amounts and was able to evidence that this  happened regularly then it was income. There was an interesting point raised that surplus income is turned into capital if it is not spent within 2 years of generation on that web page. Seems reasonable I suppose, but the opposite of that if its its spent within 2 years then its income.

Still musing, but how are such gifts treated by the recipient. Is it income for them too and so needs to be declared, or are gifts treated differently?

NedS

Nick_Dr1 said:

With the recent speculation regarding inheritance tax and pensions, I was wondering what actually counts as income?
For example, I am (I understand) allowed to give away as much as I want free from the IHT 7 year rule as long as its from income, but if I make a one off gift it is only potentially exempt (7yrs)

So if I have a DB pension, its obvious what is income. Any surplus each month could be given away.

But if I am taking drawdown from a DC scheme I am free to take as much as I want within the limits of how much I have.

If I don't actually need this 'income' but actually take it on a regular basis it would just mount up in my bank account. I could then give it away?

Income is normally referenced to a period relating to how it is received - i.e, you receive a monthly income from your pension.

Where you receive monthly income, it counts as income during the period in which it is received, but if it is unspent at the end of the period, it then becomes savings or capital.

So if you wanted to make gifts from income, you would need to make such gifts on an ongoing monthly basis from income which was left over after paying all of your other monthly outgoings. I'm not sure allowing your excess income to mount up in your bank account and then giving it away counts as a gift from income, and may fall foul of the 7 year rule for gifts from capital. So when you give it away is also important.

Nick_Dr1

So if I draw excessively from my pension pots every month and give the excess away every month then this works?

leosayer

Nick_Dr1 said:

So if I draw excessively from my pension pots every month and give the excess away every month then this works?

It won't work if your executors don't have good records as described very well by Keep_pedalling

Notepad_Phil

Nick_Dr1 said:

So if I draw excessively from my pension pots every month and give the excess away every month then this works?

Well I would think that you could do that until DC pensions were brought inside inheritance tax (which they currently aren't) - but if the budget did bring them inside then I would think that you would have to keep any further drawdown from then on to a realistic level and have some evidence that your drawdown matched the income your pot generated, otherwise I would assume that the HMRC would take you as using your capital up rather than it being excess income.