ISA vs SIPP - impact of IHT change

poseidon1

As a singleton higher rate tax payer pensioner ( we do exsist), the proposed removal of the pension IHT exemption makes our parlous IHT position much worse.

 We singletons only ever had the long frozen NRB to shelter our estates ( no RNRBs for us), so our Sipps were the only means to pass on a reasonable benefit to nieces/nephews/siblings etc, and dodge the iht bullet for that unused pot.

To that end, my original plan was to continue to build an isa income generating pot, whilst taking modest UFPLSs each year to keep the Sipp reasonably static in value, and make the ISAs increasingly do the heavy lifting in producing tax  free retirement  income going forward.

With the sipp now facing up to 40% iht in future, I am now  thinking why not take the full 25% TFC up front, and steadily feed that into the isa's each year, parking the surplus in low coupon gilts and premium bonds in the interim.

 Makes no difference to my overall iht exposure, but I at least get more tax free income to deploy, rather than put up with permanent  life time 40% ( or higher)  income tax, with a 'nice' 40% IHT goodbye bonus deduction from the Sipp at end of life. 

'First World' problem, I know, but spare a little thought for the beleaguered fiscally penalised singletons out there.

bjorn_toby_wilde

Another thought I have is that it, if you were planning to pass a DC pension to dependants it makes less sense now to stick with “pension last” if it can be accessed at a lower tax rate.

Start accessing it earlier in retirement up to the higher rate tax limit and you pay 20% tax. Pass it to children to pay into their pensions up to their annual allowance.

gm0

bjorn_toby_wilde said:

gm0 said:

Or for age gated access flexibility. 

Sorry, I follow the rest, but what does that mean?

A pension once saved into cannot readily be accessed below the minimum pension age of 57 (and rising) - largely tracking State pension -10

A Stocks and Shares ISA with the same investments. And the same tax free gains.  Lacks the top up tax relief on the way in.  But can be accessed at any age.  So no age "gate" makes the ISA useful for different things.  As well as a place to hold savings for early retirement. Life throws the odd curve ball. So this flexibility can be very useful. 

Many come to the forum - in various financial troubles - saying "I'm desparate - can I empty my pension to do X".  And in many cases the answer is "no you can't and anyone who says they can help you is most likely a scammer trying to steal it"

Marcon

Juno_Moneta said:

So conventional wisdom has suggested in the past that we should build up as much as possible in our ISAs prior to retirement then live off of that as an income source when retirement starts - before drawing from our SIPPs which was taxable above the personal allowance. This would potentially leave more outside of IHT to leave our dependents. Great. 

But now that SIPPs are within our estates for inheritance tax purposes - the same as ISAs - I am questioning why I should continue to bother with my ISA?

Conventional wisdom in the past is usually based on the rules prevailing at the time. SIPPs are not yet within our estates for IHT and won't be until at least 2027 - and we all know just how well successive governments stick to the actions and timeframes they so confidently announce. 

Juno_Moneta said:

And further - isn’t the best course of action now to close my ISA and feed that money into my SIPP (over different tax years assuming ISA is > 60k right now) to benefit from pension contribution tax relief?

Are ISAs pointless for SIPP owners now - and if so will this lead to the unintended consequence of mass closures?

Feeding your SIPP might indeed be a better course of action for you, assuming that you have the necessary earned income to make the planned contributions, including any scope for carry forward - but not everyone has that luxury. You're overlooking those who save into an ISA because they can't save into a SIPP and get tax relief, either because they don't have sufficient earned income, or because they are already at least 75 years of age.

ader42

There’s bound to be plenty of people who will now cease putting any more in their SIPP and instead put it into ISAs or gift it to offspring asap.

After all, who wants to get 20 Tax Relief on the way in and then have to pay 40% inheritance tax on the way out?

After April 2027 if you put £80 in and get £20 tax relief = £100 into your SIPP, then you die and after £40 IHT it leaves £60 for the estate on the way out so you lose a quarter of the money as soon as you put it into your SIPP if you don’t spend it in retirement! This is no better than an ISA so you may as well use an ISA so you can access it at any age. 

Even if you manage to last long enough to get all your 25% tax free cash, it means you only get £25 TFC plus £45 net after IHT so you still lose 12.5% as soon as you put it in if you don’t live long enough to spend it! Putting money in a SIPP will for many be like burning tenners. 

In fact those with significant money in SIPPs are likely to start withdrawing it as fast as they can without paying more than 20% Income Tax.

I suspect it’s only going to be worth using pensions for the employer matched contributions and for the lucky few the higher rate tax relief (those in lower paid jobs get shafted again if they get caught by IHT). 

artyboy

ader42 said:

There’s bound to be plenty of people who will now cease putting any more in their SIPP and instead put it into ISAs or gift it to offspring asap.

After all, who wants to get 20 Tax Relief on the way in and then have to pay 40% inheritance tax on the way out?

After April 2027 if you put £80 in and get £20 tax relief = £100 into your SIPP, then you die and after £40 IHT it leaves £60 for the estate on the way out so you lose a quarter of the money as soon as you put it into your SIPP if you don’t spend it in retirement! This is no better than an ISA so you may as well use an ISA so you can access it at any age. 

Even if you manage to last long enough to get all your 25% tax free cash, it means you only get £25 TFC plus £45 net after IHT so you still lose 12.5% as soon as you put it in if you don’t live long enough to spend it! Putting money in a SIPP will for many be like burning tenners. 

In fact those with significant money in SIPPs are likely to start withdrawing it as fast as they can without paying more than 20% Income Tax.

I suspect it’s only going to be worth using pensions for the employer matched contributions and for the lucky few the higher rate tax relief (those in lower paid jobs get shafted again if they get caught by IHT). 

This! But realistically it needs to be HR relief PLUS employer matching for me in future otherwise I'm really not interested in making my pension any bigger - I'm already maxed out on TFLS so there's zero incremental benefit there.

ISA will get a lot more priority going forward. And let's buy the kids a house each for good measure. 

af1963

ader42 said:

After April 2027 if you put £80 in and get £20 tax relief = £100 into your SIPP, then you die and after £40 IHT it leaves £60 for the estate on the way out so you lose a quarter of the money as soon as you put it into your SIPP if you don’t spend it in retirement! This is no better than an ISA so you may as well use an ISA so you can access it at any age. 

Even if you manage to last long enough to get all your 25% tax free cash, it means you only get £25 TFC plus £45 net after IHT so you still lose 12.5% as soon as you put it in if you don’t live long enough to spend it! Putting money in a SIPP will for many be like burning tenners. 

If you put the same £80 into an ISA and then die, and if you are due to pay IHT ( a big "if"), you pay 40% and it leaves £48 for the estate.

af1963

Juno_Moneta said:

There are a ton of articles online suggesting the “ISA first” approach , eg from Brewin Dolphin:

” Should I draw from ISA or pension first?

These are discussing what you should do if you reach retirement already having money in both.

On current rules, putting new money into a SIPP beats putting it in an ISA - partly because it potentially shelters it from IHT, which it won't do after 2027. But it also benefits from the 25% tax free cash available ( £80 paid in to SIPP becomes £100 , £75 taxed at 20% leaving £60, plus a £25 tax free sum. Net amount available from SIPP is £85.  £80 paid into an ISA is just worth £80 )

There's no IHT advantage from putting £80 in an ISA and then spending it when you retire, rather than turning it into £85 in a SIPP and then spending the £85 when you retire.  It's been spent either way. You just got one more beer for your money if it was done via SIPP ...

ISA wins on flexible access at younger age though.

Triumph13

There is an extra wrinkle here with the way the IHT nil rate band gets allocated that makes it worth moving investments that you need to keep for income from SIPP to ISA if your beneficiaries are in the same tax band as you. 

At first glance it looks like it makes no difference, eg if both generations are 20% taxpayers leaving it in the SIPP would attract 40% IHT followed by 20% tax when they withdraw for a net 52%, whilst withdrawing first would be 20% income tax paid by you followed by the same 40% IHT.  The key difference though is that you get more value from your nil rate IHT band on the ISA route as it will be applied to money that has already been subject to income tax, rather than money that still has that to come.

If £100k of your nil rate band gets apportioned to the SIPP though, that means no inheritance tax on that £100k, but there is still the 20% tax to pay on withdrawal so that part of the nil rate band has effectively been reduced to £80k (£60k if beneficiary is a 40% payer.)  If you'd shifted the money to ISAs before death then you get the full value from your nil rate band.

Emmia

Juno_Moneta said:

Frankly I can’t be bothered. It seems obvious to me that building up a large ISA to delay accessing my SIPP is now a waste of time, but each to their own I guess. 

Fundamentally it depends when you want/expect to access the money you're putting away. 

Surely the goal should be building "savings" through both a pension, for the later years, and ISAs or other savings to deal with life's buffeting winds, that can be accessed earlier?

Piling everything into a pension ties up money someone might want/need earlier, for whatever non retirement reason, or to enable them to retire before the pension can be accessed.

Having a huge pension pot left when you've lived to a ripe old age, surely indicates those savings were not really for retirement, but at least partly as an IHT dodging ruse?

I do understand people want to minimise tax, but focusing on only one element of the ISA/Pension mix is also surely a bit tail wagging the dog?