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

FIREDreamer

aroominyork said:

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-          Net £100k withdrawn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?

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.

In scenario 1, 40% and possibly some 60% tax will be paid on such a large withdrawal.

To avoid 40% tax, the maximum taxable withdrawal is £50,270 (less any taxable interest and dividends received).

Divide by 10 might work as an illustration. But you really need to take actual withdrawals and actual tax rates into account otherwise you might draw the wrong conclusions.

aroominyork

Grumpy_chap said:

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/

That would presumably mean the lump sum shuld be taken at the earliest opportunity (and spent, not moved into an ISA or other account which would be taxed to exactly the same amount on death) so long as it does not affect the tax banding?

Edit: But how different is that from the current rules? A legatee receives a SIPP (outside IHT). When the legatee spends from the SIPP is income tax treated differently depending on whether or not the legator had withdrawn some/all of the 25% tax-free lump sum?

MK62 said:

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/

Pre-budget article so I personally would not take anything from it.

AlanP_2

The IHT changes proposed in the budget do not affect the Income Tax treatment that the beneficiaries will be subject to (as far as we know but consultation and future budgets could change that).

Die before 75 they inherit and don't have to pay any IT on withdrawals, TFLS is irrelevant.

Dies after 75 and they have to pay IT at their marginal rated on withdrawals,TFLS is irrelevant.

AlanP_2

The pre-75 and post-75 age at death scenarios lead to the most optimal route after IHT becomes an issue in 2027 for the beneficiary of the DC pension (of someone who died under 75) to withdraw all of the DC money tax free ASAP before they pass away.

The age of the beneficiary compared to 75 would be a factor in this but the worst case is that the beneficiary dies after age 75 thus making what was a tax free pot subject to IT for whoever ends up benefiting.

ukdw

AlanP_2 said:

The pre-75 and post-75 age at death scenarios lead to the most optimal route after IHT becomes an issue in 2027 for the beneficiary of the DC pension (of someone who died under 75) to withdraw all of the DC money tax free ASAP before they pass away.

The age of the beneficiary compared to 75 would be a factor in this but the worst case is that the beneficiary dies after age 75 thus making what was a tax free pot subject to IT for whoever ends up benefiting.

I agree that age 75 becomes quite a big factor - as I guess in a fair number of cases the beneficiary will have to pay 40% tax to get access to most of the inherited pension, on top of the 40% IHT.   

If there is still plenty left in the pension at age 76 then it might be more tax efficient to start drawing down above the 20% tax band from age 76 onwards and gifting - so that only one lot of 40% tax ends up getting paid.   

aroominyork

AlanP_2 said:

The IHT changes proposed in the budget do not affect the Income Tax treatment that the beneficiaries will be subject to (as far as we know but consultation and future budgets could change that).

Die before 75 they inherit and don't have to pay any IT on withdrawals, TFLS is irrelevant.

Dies after 75 and they have to pay IT at their marginal rated on withdrawals,TFLS is irrelevant.

I'm still not clear (sorry...). Clearly TFLS is irrelevant if the legator dies before 75 because the legatee pays no tax on future withdrawals. But does a legatee have a TFLS to use on a pension inherited from an over 75 years old, or does the legatee pay IT at their marginal rate on all withdrawals, irrespective of whether or not the legator had utilised some or all of their TFLS? If the latter - the legatee gets no TFLS allowance on the inherited SIPP and must pay at marginal rate on all withdrawals - am I right in saying that TFLS is 'use it or lose it' and, as I said earlier, the lump sum should be taken at the earliest opportunity (and spent, not moved into an ISA or other account which would be taxed on death) so long as it does not affect the tax banding?

Sarahspangles

aroominyork said:

But does a legatee have a TFLS to use on a pension inherited from an over 75 years old, or does the legatee pay IT at their marginal rate on all withdrawals, irrespective of whether or not the legator had utilised some or all of their TFLS?

I don’t believe a beneficiary can currently inherit someone else’s lump sum allowance. I mean, it’s a number that was originally tied to a Lifetime Allowance, which implies it dies with the pensioner.

AlanP_2

AFAIK the TFLS option is only available against YOUR pension not an inherited one.

Triumph13

On post age 75 deaths the TFLS is indeed use it or lose it.  Entirely taxable at marginal rate.
Pre 75 the TFLS right is inherited - lump sums over the limit are taxable - but regular income taken from the pension is tax free, as long as you start within two years.

AlanP_2

Triumph13 said:

On post age 75 deaths the TFLS is indeed use it or lose it.  Entirely taxable at marginal rate.
Pre 75 the TFLS right is inherited - lump sums over the limit are taxable - but regular income taken from the pension is tax free, as long as you start within two years.

Does that mean that the inheritor of say a £200k pot from somebody who dies before the age of 75 cannot withdraw the full £200k tax free in one go?

If it does I certainly hadn't twigged that aspect.

TBH I wasn't aware of the 2 year rule either.  That seems a bit restrictive as I'm sure that the spouse of someone who passed away at say 40 and had their own income from employment wouldn't want to access the inherited pension at that stage in their life.