Does the IHT taxing of SIPPs stop them being the last port of call for retirement spending?

aroominyork

Does the IHT taxing of SIPPs stop them being the last port of call for retirement spending?

You have £1m in SIPP and £1m in ISA. You need £100k pa to live on for five years before you die. How much is left in your estate?

Scenario 1

-          Take it all from SIPP

-          Withdraw £117,650. Pay tax of £117,650*25%*0% + £117,650*75%*20% = £17,650.

-          Net £100k withdrawn

-          Do that five times, withdrawing £588,250

-          Estate has £411,750 SIPP + £1m ISA = £1,411,750.

 

Scenario 2

-          Take it all from ISA

-          Withdraw £100,000. Pay no tax

-          Do that five times, withdrawing £500,000

-          Estate has £1m SIPP + £500k ISA = £1,500,000.

If that is right, the idea of spending from ISA before SIPP still makes sense, even if SIPPs are now subject to IHT.

Edit: is the answer that the SIPP transfers to the legatee with the unused tax-free lump sum in tact for his/her use?

Linton

Forgetting about what does or doesnt happen at 75..

If I havent misunderstood what you are saying...

Look at it from the beneficiaries point of view.  They would rather have the inheritance as an ISA because they dont have to pay income tax on it.  Money in an ISA is worth more than the same money in a SIPP.  So you cannot simply add the SIPP and ISA totals together.  For a fair comparison you need to account for the income tax paid by the beneficiary.

FIREDreamer

In Scenario 1, £12,570 is tax free, £37,700 is taxed at 20%, £49,730 is taxed at 40%, the next £25,140 is taxed at 60% (withdrawal of personal allowamce) and 45% thereafter.

If you want £100k clear, I think the calculation is more complicated and might need a goal seek in Excel to give the correct figure.

MK62

You also have to consider the implications of not dying.....however inconvenient that might be.....

Triumph13

The answer is that it is exceedingly complicated!  You need to consider the relative tax rates of the donor and the recipient, the dilution of the value of the NRB by using it on SIPP assets that will be subject to income tax, the value to the recipient of SIPP assets being received in a tax wrapper vs unwrapped from the ISA, etc, etc.

What you would definitely want to do in your scenario is take the full TFLS from the SIPP as otherwise that perk is lost.

Linton

Another factor to consider, assuming the objective of your SIPP is financing retirement rather than tax avoidance, is that the longer you delay taking money from your SIPP the more likely it is that you wont have time to withdraw the lot, or even enough to meet your needs, without paying higher rate tax. The situation is made worse by the benefits to the Government of fiscal drag of the tax bands.

We cover about 25% of our expenditure with tax free income from S&S ISAs initially financed from the TFLS. This % is likely to increase over time.

These considerations may lead to withdrawing the maximum money from SIPPs at basic rate as soon as you can. 

aroominyork

Triumph13 said:

The answer is that it is exceedingly complicated!  You need to consider the relative tax rates of the donor and the recipient, the dilution of the value of the NRB by using it on SIPP assets that will be subject to income tax, the value to the recipient of SIPP assets being received in a tax wrapper vs unwrapped from the ISA, etc, etc.

What you would definitely want to do in your scenario is take the full TFLS from the SIPP as otherwise that perk is lost.

This occured to me after posting. So I have a couple of questions:

- now that SIPPs are subject to IHT, does the legatee receive them as a cash sum (which they can spend without further tax implications) or does it remain within a SIPP? Since the assumption can be made that the legator's SIPP contributions were made net of tax and then grossed up, I expect the answer is the latter.

- And if the legatee receives the inheritance within a SIPP, is account taken - at the time the legatee makes withdrawals - of any tax-free withdrawals made by the legator? ie if no tax-free withdrawals were made by the legator, the legatee can take 25% tax free?

If the answer to the second question is No, then, as you say, it is more important than it was pre-budget to take lump sums early in your retirement (a euphamism for 'before you die'), and either spend them, transfer them to an ISA, or save them elsewhere (albeit with possible tax implications on the interest/capital gain).

ukdw

Despite the IHT issue I would personally still focus on income tax - and if possible avoid 40%.

So to fund £100k for 5 years, I would probably fund about £57k of it out of 25% tax free lump sum withdrawals, and the rest out of £50k taxable drawdowns - which would yield about £43k after tax.

Then some time in year 5 when the 25% tax free cash runs out I would start funding the £57k from the £1m ISA.

Ignoring growth then this would leave the pension at £500k and the ISA still pretty close to £1m after 5 years.

aroominyork

My OP was not meant to bring 40% tax into the issue. The numbers were illustrative only so divide them by two (or ten) and then consider it again. But I'd really appreciate an answer to last night's 9pm post about whether an unused TFLS gets passed to the legatee.

Grumpy_chap

aroominyork said:

I'd really appreciate an answer to last night's 9pm post about whether an unused TFLS gets passed to the legatee.

My understanding is that the TFLS option ceases when the pension holder becomes deceased.
The balance of the pension funds will be subject to IHT and then when drawn by the Beneficiaries will be subject to IT at the appropriate marginal rate.  No access to TFLS remains.
This is indicated here:
https://www.moneysavingexpert.com/news/2024/10/pensions-liable-inheritance-tax-2027/

MK62

aroominyork said:

My OP was not meant to bring 40% tax into the issue. The numbers were illustrative only so divide them by two (or ten) and then consider it again. But I'd really appreciate an answer to last night's 9pm post about whether an unused TFLS gets passed to the legatee.

This is where it starts to get complicated........have a read here and see if it clears the mist any..... https://adviser.royallondon.com/technical-central/pensions/death-benefits/pension-death-benefits/