IHT on Pension vs ISA past 75

[nickfrog]

We will start drawing down in a couple of years so I am trying to devise a strategy to minimise future IHT.

So, between my wife and I let's say one of us will make it past 75 and that on death of the last survivor (of us 2!!) we have 1 child who is a 40% tax payer then and the overall estate is less than 2M and the current threshold/allowance/rates haven't changed (for simplicity).

Am I right to think that the child will pay no IHT at all on the first £1m (made up of ISA and house)? If so, what rate would they pay on moneys over that threshold? (for instance, if the house is worth £800k and the ISA pot still worth £400k).

How much tax would they pay on any balance of pension funds (which is outside the estate).

I am basically trying to understand whether we should spend the ISA or the pension money first or a blend of both.

Cheers. N.

[Mr Pointy]

My understanding is that's it's best to cash in/live off the ISA first as there are no IHT mitigation strategies for ISAs unlike pension funds.

[xeny]

Mr Pointy said:

My understanding is that's it's best to cash in/live off the ISA first as there are no IHT mitigation strategies for ISAs unlike pension funds.

That matches my understanding. Balancing that is the desire to use income tax allowance to withdraw from the pension tax free, while if you run an ISA all the way down, and then hit the pension harder you'll probably pay more income tax overall.

I've not calculated the trade offs to find out what the best option is for pension vs ISA sizes at different anticipated lifespan and estate sizes,

[btdk5]

Just leave them the house and spend the rest.

What was the point in sacrificing all that time to earn it?

[nickfrog]

btdk5 said:

Just leave them the house and spend the rest.

What was the point in sacrificing all that time to earn it?

That is the plan BUT difficult to predict when we'll die with great accuracy. If we blow everything before 70 and only rely on the State pension after that, it won't be very pleasant

[Carbon Sasquatch]

Anything in a SIPP is free of IHT - so any additional cash should be in there. It's considered outside of your estate, so can also be distributed much more quickly than waiting for probate.

If you die under 75, the beneficiaries also get it free of income tax. If you die over 75 then they will have to pay tax on it at their marginal rate at the point at which they chose to draw it. Alternatively they can get hammered by taking a lump sum.

The beneficiaries also do not have to wait until their retirement - they can start drawing it at any age.

[nickfrog]

Carbon Sasquatch said:

Anything in a SIPP is free of IHT - so any additional cash should be in there. It's considered outside of your estate, so can also be distributed much more quickly than waiting for probate.

If you die under 75, the beneficiaries also get it free of income tax. If you die over 75 then they will have to pay tax on it at their marginal rate at the point at which they chose to draw it. Alternatively they can get hammered by taking a lump sum.

The beneficiaries also do not have to wait until their retirement - they can start drawing it at any age.

Thank you so much. If after 75, I assume they don't even get any unused 25% tax free money either?

[Carbon Sasquatch]

I'm far from an expert, but am on the receiving end of part of my late fathers SIPP so have some understanding.

75 is a forced crystallisation event anyway, so as far as I know there isn't any tax free option left after that.

My father was over 75 so mine is taxable & separate from my own SIPP. My kids also inherited some & they are able to draw on theirs straight away, subject to income tax.

Edited by Carbon Sasquatch on Wednesday 27th October 18:43

[nickfrog]

^^^ sorry about loss.

I think it's a bit clearer in my mind now and I can see the benefits of drawing down on ISA first as in effect passing on a SIPP with no IHT is a bit like giving your kids an early retirement boost without the 25% tax free if they don't need the money now.

Although I am still not sure if any balance of ISA money within the £1M max inheritance threshold (as a couple) can be inherited tax free?

[NickCQ]

nickfrog said:

Although I am still not sure if any balance of ISA money within the £1M max inheritance threshold (as a couple) can be inherited tax free?

Unless you hold AIM stocks in you ISA, they have no special privileges under IHT. They count towards the non-property portion of the £1 mm threshold. For the recipient they are not tax-advantaged (i.e. cannot be contributed into their own ISAs beyond the £20k annual contribution threshold).

[nickfrog]

NickCQ said:

Unless you hold AIM stocks in you ISA, they have no special privileges under IHT. They count towards the non-property portion of the £1 mm threshold. For the recipient they are not tax-advantaged (i.e. cannot be contributed into their own ISAs beyond the £20k annual contribution threshold).

Thanks no we don't hold AIM stocks.

Looking at online calculators though it would appear that providing that the house is worth at least £350,000 then an entire estate worth up to £1M including ISA would currently attract £0 IHT to direct descendants.

And I guess it would be up to the kids to invest in GA first and progressively Bed and Isa £20k every year if they want to "convert" into ISA wrapped assets.

The challenge is to leave enough headroom on top of the value of the house (I assume the £1M rule won't keep up with house price inflation either, so I fear we might have zero headroom left) but that's where I would like to spend anything that tips them over the threshold, not that it's very easy to predict of course.

[LeoSayer]

Ongoing payments from income are outside of your estate immediately - subject to restrictions....

https://www.pruadviser.co.uk/knowledge-literature/...

[NickCQ]

nickfrog said:

The challenge is to leave enough headroom on top of the value of the house (I assume the £1M rule won't keep up with house price inflation either, so I fear we might have zero headroom left) but that's where I would like to spend anything that tips them over the threshold, not that it's very easy to predict of course.

You could always buy some AIM stocks, but IMHO that's the tax tail wagging the investment dog, so to speak.

[ChrisW.]

Carbon Sasquatch said:

I'm far from an expert, but am on the receiving end of part of my late fathers SIPP so have some understanding.

75 is a forced crystallisation event anyway, so as far as I know there isn't any tax free option left after that.

My father was over 75 so mine is taxable & separate from my own SIPP. My kids also inherited some & they are able to draw on theirs straight away, subject to income tax.

Edited by Carbon Sasquatch on Wednesday 27th October 18:43

But the children do also have their own tax allowances, so can draw income to use these so long as the SIPP is set up to include them.

[PistonHead007]

You can still draw tax free cash after 75 if you have lifetime allowance left to cover it. However, if you die after 75 having not used all your 25% tax free then the whole pot becomes subject to income tax based on the beneficiaries' marginal rate.

[Carbon Sasquatch]

ChrisW. said:

But the children do also have their own tax allowances, so can draw income to use these so long as the SIPP is set up to include them.

Agree - it depends on the age of your children as to whether they are likely to have any other income and therefore any unused allowance.