Heirs' income tax on inherited SIPPs

aroominyork

Being a bit thick here but if the tax rate is twice as much (40% instead of 20%) then you pay twice as much tax but that is not the same as double taxation. Double taxation is where the same amount is subject to IHT and IT.

That is what I am talking about, that you pay IHT on the original £1m and then 20%/40% on the remaining £600k. From the gross £1m SIPP you do not pay 100% IHT on £400k and 0% IHT on £600k; you pay 40% on all £1m.

So in your example a SIPP with £1m and an IHT bill of £400k (it probably wouldn't actually be that much but let's ignore that) there is no double taxation because the £400k only goes out to pay the IHT. There is no IT charge on the £400k

There is no double charge on the £400k – as I said, HMRC could not charge you income tax on money that is already in their coffers – but there is double tax on the remaining £600k, which is received by the beneficiary as £1m net of IHT.

But what if the beneficiary paid the £400k IHT?  In order to do so the beneficiary draws an amount from the SIPP. If that amount is subject to IT at 20% then he needs to draw £500k to get £400k net (I know on £400k it would be more than 20%). That is where there is double taxation because he has suffered IT on the £400k.

The remaining £500k would be subject to IT and at say 20% that would mean a net receipt by the beneficiary of £400k instead of £480k in your scenario. I think the legislation is trying to get the beneficiary back to the £480k from the £400k (not trying to get them back to £800k (which I think is where they might be if there was no IHT)).

What I do not understand is whether the new section is saying that the beneficiary won't be charged IT on the withdrawal to pay the IHT or that the beneficiary gets a credit on the subsequent withdrawals from the remaining £500k. I think it is the latter but I am not confident about that

I think that’s a red herring. Isn’t it best to assume the estate pays the tax in ways decided (if HMRC provides a choice) by the executor before the beneficiary comes into the picture?

DRS1

"but there is double tax on the remaining £600k, which is received by the beneficiary as £1m net of IHT".

Yes you get an income tax charge on that £600k. But that is deliberate. It is not what the "protection" is meant to protect you from. You (or your beneficiaries) are meant to pay that IT (which could be at 0/20/40 or 45%) as well as the IHT.

Isn’t it best to assume the estate pays the tax in ways decided (if HMRC provides a choice) by the executor before the beneficiary comes into the picture?

Personally I'd assume the SIPP pays it. If the estate pays then that is coming out of the beneficiaries' inheritance so I am not sure that it really leaves them out of the picture (and it raises issues if the estate and the SIPP go in different directions).

If the estate meets the SIPP's share of IHT then Subsection (3) will protect against the SIPP beneficiaries paying IT on the full £1million but they will still be paying IT on the £600k. So it is six of one and half a dozen of the other.

aroominyork

Yes you get an income tax charge on that £600k. But that is deliberate. It is not what the "protection" is meant to protect you from. You (or your beneficiaries) are meant to pay that IT (which could be at 0/20/40 or 45%) as well as the IHT.

And that's my point! AIUI, when Reeves said SIPPs would be assessed for IHT (and I agree they should be) there was pushback that, with beneficiaries being taxed on income if the testator died over 75, that would lead to double taxation. We were led to believe the point was accepted and a tax credit would apply. However, the situation seems to be that the SIPP is assessed for IHT and the net amount (£600k in my example) is then assessed for income tax; that is double taxation.

I understand the complexity from the govt's position. SIPP contributions benefit from tax relief with income tax subsequently paid on withdrawals. The argument is presumably "why should heirs keep the testator's tax relief without paying the income tax the testator him/herself would have paid on withdrawals?". I do not know what the answer is (nor do I understand the logic of tax-free vs. tax-paid withdrawals for heirs if the testator died under vs. over 75) but I am pointing out there seem to be smoke and mirrors in the 'solution' the govt proposes to avoid double taxation.

Yorkie1

If the estate meets the SIPP's share of IHT then Subsection (3) will protect against the SIPP beneficiaries paying IT on the full £1million but they will still be paying IT on the £600k. So it is six of one and half a dozen of the other.

I don't disagree. I'm just wondering how a beneficiary does their income tax return at a later date. Sounds horrendously complicated to have to decide whether the income they draw down from the pension falls within one part or the other?

SnowMan

https://forums.moneysavingexpert.com/discussion/comment/82129584#Comment_82129584

In the scenario the apportioned IHT is paid from the pension then the inheriting taxpayer (following a post age 75 death) simply puts the full gross pension amount withdrawn on their self-assessment form.

In the scenario that no IHT is paid from the pension and it is paid from the free estate, then for a post age 75 death a percentage, for example 10%, of each withdrawal will be income tax free to avoid IHT being paid on the inheritance tax amount itself. All the inheriting taxpayer then needs to do when filling in self-assessment is to put in this example 90% of the gross amount withdrawn on their self-assessment form. It's not really any different to someone while alive taking an UFPLS where usually 75% of the amount withdrawn is put on their tax return, other than that the percentage is individual specific. So provided you (and the provider) know the percentage i.e 10%, all is good. I presume the provider P60 will show a taxable amount figure and so the inheriting taxpayer doesn't have any work to do in any case.

We are awaiting detail in an autumn technical note on how this will actually work though and confirmation that the tax offset is a % rather than fixed amount.

DRS1

https://forums.moneysavingexpert.com/discussion/comment/82129421#Comment_82129421

I think the trouble is that the double taxation they were talking about was paying IHT on £1million and paying IT on £1million. So now you will only have the IT on £600k not the full £1million.

By introducing IHT on pensions they weren't trying to replace one tax with another - they were trying to ADD to your tax bill. You or your heirs paying more tax was the idea.

DRS1

Oh and the under 75 over 75 thing is I believe a hangover from some old rules about what you had to do at 75 (I could be wrong but buying an annuity perhaps). I think everyone expected that that might bite the dust at some point. Maybe it still will.

aroominyork

I realise this is a tax rise and, as I said, I see no reason for SIPPs to be excluded from IHT. But I do not see the logic in “you will only have the IT on £600k not the full £1million”. How could it be any other way? How could HMRC levy income tax on the £400k of IHT which is already into its coffers?

Dead_keen

How could it be any other way? How could HMRC levy income tax on the £400k of IHT which is already into its coffers?

If the pension scheme administrator is not allowed to pay the IHT (and instead it is the beneficiary or estate) that is what happens.

DRS1

https://forums.moneysavingexpert.com/discussion/comment/82129870#Comment_82129870

Well as @Dead_keen points out if the estate (or beneficiary) pays the SIPP related IHT out of other assets then the SIPP is left at £1million and when the beneficiary draws money out of that £1million IT will be payable (unless you died before 75) on the full value - up to £1million. That is what subsection (3) is saving your beneficiary from. Absent that subsection 400k of IHT doesn't magically disappear from the SIPP if the estate or the beneficiary has paid the IHT out of other assets even though 400k is in the coffers of HMRC.