Heirs' income tax on inherited SIPPs

aroominyork

Is there any news (or existing threads) on whether heirs will pay income tax on SIPPs that have been subject to IHT after 2027? I recall hearing the government was considering steps to avoid double taxing.

UKTaxHelper

You remembered right. If the fund is caught by IHT and the beneficiary also pays income tax on it, there's a deduction for the IHT already paid, so the same slice isnt taxed twice. Only bites where death was at 75 or over.

aroominyork

So many questions... I'll start by asking whether the IHT paid on the total estate is applied to the SIPP on a pro rata basis. For example, £2m estate including £600k of SIPP. £1m IHT allowance so there is £400k IHT. Is £120k IHT deemed to be paid on the SIPP?

DRS1

Para 8.2 of this Note may answer your first question (I am not sure if that is the latest from HMRC on the subject)

Technical note: Inheritance Tax on pensions - GOV.UK

I am not sure it deals with your second question although there is some stuff on withholding notices which suggests that up to £300k of the SIPP could be held back for IHT .

aroominyork

8.2 Reducing taxable pension income: "How this is achieved for beneficiaries will depend on how the Inheritance Tax is paid but the overall effect should be consistent… Beneficiaries will need to work with HMRC to resolve their Income Tax position. Further guidance will be published in due course."

Does the Technical Note seem likely to answer anything for anyone?

UKTaxHelper

Yes, pro rata. Your 120k figure is right.

aroominyork

https://forums.moneysavingexpert.com/discussion/comment/82112192#Comment_82112192

So £120k IHT on the £600k SIPP in a £2m estate. Does that mean a basic rate taxpayer would pay no additional tax on withdrawals from an inherited SIPP if they don't creep into the higher rate band, and higher rate taxpayers would pay a marginal 20%?

DRS1

https://forums.moneysavingexpert.com/discussion/comment/82113704#Comment_82113704

I confess I do not understand what you have in mind here.

Are you thinking the beneficiary has taken an amount (eg £120k though it would have to be more if income tax is payable) out of the SIPP in order to pay the £120k IHT? If a beneficiary does that they will be paying a lot more than basic rate income tax on the withdrawal - 45% on some of it. Whether the beneficiary is a basic rate taxpayer will be determined by how much they draw from the SIPP won't it?

Or are you thinking the beneficiary has just paid the £120k IHT out of their share of the estate and only draws from the SIPP in small chunks to keep below the higher rate band? I suspect that is when the beneficiary is going to need to talk to HMRC to sort out their income tax on the SIPP withdrawals. Maybe there will be some reclaim mechanism or some jiggery pokery with the tax code.

Personally I would have thought most people would go for the third option which is the £120k IHT gets paid direct by the SIPP. Then there is no "burden" on the beneficiary and the income tax on the SIPP withdrawals will be the normal income tax (just applied to the SIPP net of the IHT paid).

One thing you have done is to convert the £ amount of the IHT into a percentage of the overall value of the SIPP. I doubt if that is how any "credit" for IHT paid would be done because then the credit would fluctuate along with the value of the SIPP. I suspect it would be a fixed amount of £120k "credit". But I am guessing there.

UKTaxHelper

Its not a credit against the tax, it comes off the taxable income. So £480k of the £600k is still taxable, whoever draws it.

aroominyork

Are you thinking the beneficiary has taken an amount (eg £120k though it would have to be more if income tax is payable) out of the SIPP in order to pay the £120k IHT?

No. I assume IHT is payable by the estate before any distribution - wouldn't it be? - so the SIPP element of the estate would see £480k of SIPP-wrapped assets pass to beneficiaries. Isn't that how it would work?

The reason for this we are recently retired and looking at which assets to use first for income, SIPP or ISA. Received wisdom used to be ISA but it has moved towards SIPP. But to assess it properly means understanding the tax implication on heirs; one is (currently) a higher rate taxpayer; the other is a French tax resident which raises a whole different set of issues which we are looking into.

UKTaxHelper

Only if the scheme pays it. The executors can settle the IHT from other estate assets instead and leave the £600k whole. Which way it gets funded changes your sums quite a bit.