What is income?

Nick_Dr1

So here's an interesting quote form the IHT manual referenced above.

If a gift is made out of a current account you only need to check that the gift could have been made out of income. You do not need to match the gift to specific money in the account.

also

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..

So one interpretation of this is that income is whats left in my current account after I have paid all taxes. Taking regular chunks of money from my ISA and transferring it to my current account should be effectively be counted as income then. No income tax on ISA drawing though. I can then gift some of my current account on a regular basis (regular is up for discussion but monthly would be acceptable) and as long as the current account stays positive, Mr IHT isn't going to worry about it.

Now I am not saying this is a sensible way of doing anything, it only got me wondering what would be the situation if I had regular drawing from pension pots (to maintain their value over time) and those drawings were very large (ie very big pension funds) and far in excess of what a normal person could spend.

One answer would be to spend more money and buy a Lambo every week/month/year I suppose. Depreciation should get rid of all the value!

dunstonh

So one interpretation of this is that income is whats left in my current account after I have paid all taxes. Taking regular chunks of money from my ISA and transferring it to my current account should be effectively be counted as income then. No income tax on ISA drawing though. I can then gift some of my current account on a regular basis (regular is up for discussion but monthly would be acceptable) and as long as the current account stays positive, Mr IHT isn't going to worry about it.

The problem with the vagueness of the rules is that some people will get away with something that others have been pulled up on.     Some executors will not be willing to accept things that others may do.    Some executors will not battle HMRC or do the admin work required to prove a scenario.    
So, knowing the potential for issues, does allow some planning in advance.

If you are making capital withdrawals on investments to increment a current account, then that scenario would not work as capital withdrawals are not income.

However, if you have used accumulation units and making capital withdrawals that are within the ballpark of the dividend/interest rate then that would work.   However, having income units would simplify things and make it easier to prove, should it be asked.

Now I am not saying this is a sensible way of doing anything, it only got me wondering what would be the situation if I had regular drawing from pension pots (to maintain their value over time) and those drawings were very large (ie very big pension funds) and far in excess of what a normal person could spend.

Broadly speaking, that would be fine as you are not abusing the system.  However, you would then have to ask whether an annuity with value protect could be a better option (higher income paid under PAYE and death benefits outside of the estate)  or an annuity with a 30 year guarantee.  So, payments continue under income tax rather than involving a lump sum.

The budget next week will tidy things up. If death benefits on pension are unchanged then you don't need to do anything.  If a wealth tax on death is introduced (more likely than pensions being brought into the estate), then it would likely be based on amounts above a given figure.     If your pension is below that figure, then again, its something you don't worry about.   

Nick_Dr1

So taken from another thread, but this seems to say that taking capital from an ISA or indeed drawing down larger amounts from a DC pension is classed as income as long as it is a regular pattern. It doesn't actually matter where the money has come from in terms of dividends, capital etc.
https://techzone.abrdn.com/public/iht-est-plan/gift-surplus-pension
Indeed the IHT form does not make a distinction. The only entry is "pensions" and as mentioned earlier, once money makes it into a current account it is counted as income. There is no requirement to look back to see the source of that "income".

This is particularly relevant for ISAs as there is no income tax on ISAs but there is potentially IHT. For other income it depends on your marginal rate as to whether taking it to give it away is tax efficient.

May all change in the consultation going forward but currently that's the situation as I see it. 

EDIT Here's the quote form the link above for those interested.

What counts as 'income' from a flexible pension?

Flexi-access drawdown, (where there are no limits on what can be taken and withdrawals can be taken as combination of tax free cash and taxable income), gives significant scope to take withdrawals tax efficiently.

When it comes to gifting those withdrawals, the IHT rules also help here. The 'normal expenditure out of income' exemption doesn't use the income definition used for income tax purposes. As income is not defined in the IHT Act, it follows normal accountancy practice to determine what is income.

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.

Notepad_Phil

Nick_Dr1 said:

So taken from another thread, but this seems to say that taking capital from an ISA or indeed drawing down larger amounts from a DC pension is classed as income as long as it is a regular pattern. It doesn't actually matter where the money has come from in terms of dividends, capital etc.
https://techzone.abrdn.com/public/iht-est-plan/gift-surplus-pension
...

I'm not sure if you've mistyped or I'm misinterpreting you, but I'm pretty sure that taking the capital from an ISA is not classed as income and could actually reduce the amount you can count as excess income - as per the link "the amount of the gift which qualifies for the exemption may be limited if the client has to draw on other capital assets, such ISAs, bonds or OEICs, to supplement their lifestyle."

If you meant taking out the interest or dividends paid that year from the ISA, rather than the capital, then yes that appears to be okay to be counted as real income.

Nick_Dr1

Notepad_Phil said:

Nick_Dr1 said:

So taken from another thread, but this seems to say that taking capital from an ISA or indeed drawing down larger amounts from a DC pension is classed as income as long as it is a regular pattern. It doesn't actually matter where the money has come from in terms of dividends, capital etc.
https://techzone.abrdn.com/public/iht-est-plan/gift-surplus-pension
...

I'm not sure if you've mistyped or I'm misinterpreting you, but I'm pretty sure that taking the capital from an ISA is not classed as income and could actually reduce the amount you can count as excess income - as per the link "the amount of the gift which qualifies for the exemption may be limited if the client has to draw on other capital assets, such ISAs, bonds or OEICs, to supplement their lifestyle."

If you meant taking out the interest or dividends paid that year from the ISA, rather than the capital, then yes that appears to be okay to be counted as real income.

But if my normal lifestyle is covered by DB pension, then I don't think I am subsidising it with other drawings.
The whole thing looks like a mess and I'm sure will be clarified, but as it stands, I can give away excess income (indeed any money) regardless, via the 7 year rule, and as long as I give away enough to drop me below the IHT threshold it all becomes moot (after 7 years). If a consistent pattern is set up, I think it would be perfectly reasonable to assume that if a pattern is set up, those 7 years would qualify as excess income gifts, especially if its all come from DC funds.

I would like to see some confirmation that taking cash out of an ISA is seen as drawing on capital. If I take it all out then there is no CGT liability, and as previously identified, the source of income for IHT purposes does not need to be investigated once its in your current account, and it doesn't count as income under normal definitions anyway as there is no income tax liability either.

It seems to good to be true, so probably is. I'm not an accountant so I will accept I have a naïve view of it but I've already learned a lot from this discussion.

Madeinireland101

I think you need to think of it this way…

If you worked out the value of your estate for IHT and it came to £1.5m. Then the following year you did the same and it was £1.55m then as far as I see it you have £50k to give away. In other words as long as you aren’t reducing your estate (other than excluding Potential exempt gifts with the 7 year rule and the normal allowable £3k etc.) then you have maintained the capital value of your estate and not grown it with extra income or reduced it below the amount of the previous year - apart from those gifts mentioned.

This I must emphasize is not something I’ve seen accepted the HMRC but it works as a sensible guide in my mind.

Any views?

Notepad_Phil

[Deleted User] said:
...
The legislation looks at income, not inheritances received, capital received, unrealised gains, etc. It also looks at normal expenditure. It does not, for example, take account of the expenditure on a one-off holiday of a lifetime.

So if e.g. I bought a newish car or got a new kitchen or bathroom, which obviously most people would need to purchase from capital, then that would not prevent me from also gifting from excess income in that year (provided of course that I hadn't also needed to draw from capital for other more regular expenses)?

Madeinireland101

Notepad_Phil said:

[Deleted User] said:
...
The legislation looks at income, not inheritances received, capital received, unrealised gains, etc. It also looks at normal expenditure. It does not, for example, take account of the expenditure on a one-off holiday of a lifetime.

So if e.g. I bought a newish car or got a new kitchen or bathroom, which obviously most people would need to purchase from capital, then that would not prevent me from also gifting from excess income in that year (provided of course that I hadn't also needed to draw from capital for other more regular expenses)?

Thanks - More complicated than that - I would also like to understand this then in light of what you have said. You appear to be saying we don’t need to include in our expenses one off events (such as a dream holiday).

Nick_Dr1

[Deleted User] said:

Money taken out of an ISA is not income. Interest and dividends (but not capital gains) that arise in an ISA are income. 

Another way of looking at it is that it would be pointless to bother with the word 'income' in the legislation if you could just transfer money between two of your own bank accounts and create income. 

"When it comes to gifting those withdrawals, the IHT rules also help here. The 'normal expenditure out of income' exemption doesn't use the income definition used for income tax purposes. As income is not defined in the IHT Act, it follows normal accountancy practice to determine what is income. "(From the link previously mentioned)

So as you point out, it is pointless to bother with the word income, so they haven't. We have to think about normal accountancy practice when we define income. How does that relate to ISAs then? They are free of income tax and CGT.  

ader42

You’ve heard of the phrase “savings and income”? They are not the same are they? They are two different things. One is savings capital and one is income. 

ISAs contain savings not income. Individual Savings Accounts not Individual Income Accounts.

Interest on savings is income but the savings themselves are not. The savings are capital.

So you could (under this exemption) gift excess Savings Interest, but not the Savings. 

If you want to gift the savings you’ll have to put them into the pension wherein it will become income when taken out.