Inheritance Tax

michaels

This is interesting, for those who having exceeded tfls ceiling and likely to save 40% tax on the way in and pay 40% on the way out, it did seem like ISA might be better than DC due to increased flexibility but it seems DC still seems to have an advantage over gifting form income.

Bostonerimus1

https://forums.moneysavingexpert.com/discussion/comment/82044352#Comment_82044352

An annuity payment will contain some part due to growth, some mortality credit and some return of the capital used to buy the annuity. If the annuity is purchased with money still inside a DC pension is the entire annuity payment classed as income for "excess income" purposes as the entire payment would be subject to income tax? I can see that if you buy an annuity with already taxed money then the return of capital component of the annuity payment would not be classed as income as it isn't taxed as such.

PS. diving down a few links in the HMRC manual I see that "purchased life annuities" are distinct from "retirement annuities" purchased with untaxed DC pension money.

DRS1

https://forums.moneysavingexpert.com/discussion/comment/82044392#Comment_82044392

Sorry I have now looked at the page linked by @poseidon1 and see I got hold of the wrong end of the stick. It is talking about the capital element of a purchased life annuity (ie the bit of the PLA payment which is not subject to income tax because it is treated as a return of your own money) and says that is not to be treated as income. They are not talking about the money you spend from your pension buying a pension annuity.

It is an interesting stance when you compare it to their approach to UFPLS where the whole UFPLS payment can be treated as income even though some of it is not subject to income tax.

Bostonerimus1

https://forums.moneysavingexpert.com/discussion/comment/82044396#Comment_82044396

The whole concept of the 25% TFLS always strikes me as a bit strange. Why should 25% of the money you save into a DC pension be tax free on the way in and the way out? Anyway just one of those quirks and I now see the logic between the "excess income" difference between a purchased life annuity and a retirement annuity.

ThreeScoreAndOn

Picking up the thread off my earlier reply, can DC drawdown be gifted under "normal expenditure out of income"?

Yes. Taxable pension drawdown counts as income in my opinion (HMRC is the one that counts though), same as a DB pension, State Pension or annuity. So Bostonerimus1's example works.

if DB + State Pension cover your ~£50k living costs, regular gifts funded from DC drawdown can qualify as out of surplus income becaue by definition it is surplus.

But keep in mind the 3 conditions

1. A regular pattern (or clear intention to be one) — not an ad-hoc withdraw-and-gift.
2. From recent income — HMRC looks at the year of the gift; income left to accumulate becomes capital after ~2 years also already mentioned. That's the ISA point: interest/dividends are income while fresh, but not once they've rolled up.
3. No drop in your standard of living.

Lots of stuff is changing from 06/04/2027 unused DC pots fall into the estate for IHT (now law). That's exactly why a regular, documented gift-from-pension-income strategy gets more attractive for a large pot, but only if set up properly from day one, records kept in shape are key so your executors don't have a hard time proving things when the time comes.

The thing I think that most people are finding hard now (mainly because it is new and upends a LOT of plans) is when to pass it to the next generation. It used to be easier because the pension was the way but now much more planning is needed… Give early and there is more exposure to sequence risk for yourself and less fun money avaliable, later more exposure to IHT. This is the very thing I am grappling with, my kids are in their 20's the money would be great now but maybe too early (thats my story and I am sticking to it) for them but it is still great for me and my wife.

NoMore

https://forums.moneysavingexpert.com/discussion/comment/82044627#Comment_82044627

Point 3 is the one that might trip a few people up, I expect some people think they can gift out of their pension income and then use their ISA's to top up the missing income. That wouldn't be allowed under gift from excess income, as you don't have excess income if you need capital to sustain your lifestyle.

Bostonerimus1

https://forums.moneysavingexpert.com/discussion/comment/82044709#Comment_82044709

I assume you would set up two separate streams of gifting. One usimg "excess income" from the DC pension and the other using the "7 year rule" from the ISA.

michaels

https://forums.moneysavingexpert.com/discussion/comment/82044709#Comment_82044709

All this makes the isa (and lisa) a bit useless as a retirement savings account alternative to a pension if you can't actually then use it for spending in retirement due to the potential inheritance implications.

For exampel I am maxin ghte basic rate tax band at the moment to avoid paying higher rate later with the surplus income being parked in an isa for later use when inflaiotn has further eroded the value of the tax thresholds but this atrategy will run into problems with gifting from income plans :(

NoMore

https://forums.moneysavingexpert.com/discussion/comment/82044855#Comment_82044855

That wasn't the point I was making, if you gift out of excess income, you can't also then use capital to replace the missing income for your lifestyle. It wasn't about using the 7 year rule to gift more from capital. It's just something people may fall in the trap of doing, without realising.

Bostonerimus1

I suppose the simplest approach would be to buy a retirement annuity and gift the excess income. This might mean some high income tax bills, but if you lived a long time your heirs would get a nice stream of extra income. For the well off, it might be a good way to help children out with housing costs and mitigate IHT, although at some level trusts come into the picture, but they are significantly more complicated and expensive to set up and administer.