M is planning what to do with his SIPP in advance of IHT changes announced for 2027. He would like some pointers to a good plan of action.
His first thought was that a one-way trip to Beachy Head in March 2027 would be good tax planning but would have an unfortunate down-side (excuse the pun). M has been married to W for 60 years and they are both in the second half of their 80s. Death does not seem imminent, but neither can expect to be around in 7 years. Where possible they share all their wealth. Daughters and adult grandchildren would be their main beneficiaries on second death.
Their combined wealth, and so the estate on second death, is about £2M, made up of the family home, W’s ISA, M’s ISA, an AIM portfolio, a BPR portfolio and a smaller amount in cash and a joint share portfolio. The £300K SIPP is not needed as an income source and will be added to the estate from 2027. Combined with reduction of RNRB for an estate over £2M, the effective marginal IHT rate for the SIPP would be 60%. When the daughters draw pensions from the SIPP, the remaining 40% of the SIPP is taxed again as their income.
M has suggested drawing what would be excess income from the SIPP, some at 20% IT and some at 40%. A broadly similar amount, after tax, could then be gifted as regular excess income by M into a discretionary Trust for the benefit of the family.
M must decide how fast to draw from the pension. Is there a risk that HMRC would treat large sums as gifts of capital to the Trust? There are various pointers. M has 20K unused 20% tax band. The Flexi-Access SIPP has a drawdown limit of £70K. M and W had an income stream until April 2023 that ceased on re-arrangement of capital. Allowing for inflation, they could replace this with £30K drawdown.
Conversion from Flexi-Access to Capped drawdown would allow faster withdrawal but could a small number of large gifts to the trust be perceived as individual lump sums rather than a pattern of regular gifts?
Income and gifts could be at quarterly intervals. Would a catch-up payment for the first three payments of YE 5April 2025 be sensible?
Combined with reduction of RNRB for an estate over £2M, the effective marginal IHT rate for the SIPP would be 60%. When the daughters draw pensions from the SIPP, the remaining 40% of the SIPP is taxed again as their income.
I think that 60% won’t be known for sure until after the end of the consultation on how the pension scheme administrators will have to pay the IHT. It could be higher since the sharing of the nil rate bands between the estate and pension may mean that the effective IHT on the SIPP is c30% (with the estate bearing the rest) and then the remaining c70% would be taxed as income.
I think the key question, that you’ve identified, is whether what comes out of the SIPP is income for IHT purposes or not. For me having a regular plan to take out the same amount (or the same amount increasing inflation) each year is helpful in showing that what is taken out as income. By way of contrast, deciding to take account out the full amount in a couple of one of payments stretches where the amounts would be income for IHT (although they would be income for IT).
In relation to whether large sums as “gifts of capital”, I think the issue is that HMRC might say that the gifts are not part of normal expenditure. So having contemporaneous evidence as to how this is, from the start, intended to be a long-terms regular pattern of gifting is helpful. Setting up a standing order to do this is also helpful evidence.
From one perspective, you’ve nothing to lose with a one off payment for the last three quarters. But equally, you could split the payments for the year into four, pay one on Monday, then the next three on 1 Feb, 1 Mar, 1 April and then reduce them a bit thereafter. No idea if that would, in practice, be better but I would be tempted to do that.
One other thing to remember is that there is no requirement to survive seven years for a gift to be effective for the tapering of the RNRB.
I’d suggest that no plans can be made until the legislation has at least been drafted, and even then not until it is in force. Currently, we don’t know what the IHT changes are, only that the government intends to subject pension funds to IHT. I wouldn’t feel comfortable telling a client to do anything that might advance income tax to the government ahead of the knowledge of the future rules.
Pension withdrawals are income in nature. It doesn’t matter how large or regular/irregular they are. The IHT exemption is related to normal expenditure out of income. What matters is meeting the rules and guidance concerning the creation of an established pattern of regular gifting (or intention of), from surplus income, without affecting the donor’s standard of living.
“Allowing for inflation, they could replace this with £30K drawdown.”
But if the main body of the SIPP is circa £300K and you’re proposing £30K drawdown, wouldn’t that imply the income element necessary to meet the conditions of the regulations requiring the gifts to come from Income and not Capital needs a 10% return on the SIPP? i.e. if you’re reducing the main capital of the SIPP, regardless of what you do with it afterwards, whether a trust etc or not, and regardless of the marginal rate you pay receiving it from the pension scheme, you’re giving away capital and not income surely?
Otherwise, wouldn’t everyone just cash in their SIPP’s, suffer 20% IT on them, and give them away, spread across a monthly standing order as fast as possible over whatever time they guess they have left?
Various areas can be considered prior to outcome of consultation and/or 06.Apr.27…
strip SIPP of any remaining tax free cash element (thereby reducing future IHT impact to a maximum 40% from 67%+).
draw a taxable income from the remaining crystallised SIPP within the (stringent) normal expenditure out of income rules and gift this to family able to make pension contributions (and receive tax relief), potentially negating any income tax impact on drawing, while further reducing IHT liabilities.
Gifting can still be effective, even if it fails the seven year rule - investing in an investment bond, with appropriate lives assured (next generation plus), within a trust can remove investment growth from day one, and provide tax efficient extraction via assignment thereafter, with minimal trust admin.
Whole of life policies, held in trust, covering the anticipated IHT on second death are an (expensive but useful) estate reducer, or could be funded via equity release (another estate reducer).
Many of the above need the input/services of a regulated financial adviser; as can be seen though, the potential for moving asset value within the generations with minimal contribution to the Exchequer is possible…it just needs some careful planning…
Happy to chat this through in more detail if it would be helpful.
Graham Harmer (Chartered Tax Adviser and Independent Financial Adviser)
01892 459490/0794 1235761 graham.harmer@harmerfsl.co.uk