I am 67 and currently have a SIPP worth approximately £500,000. Because the favourable IHT regime is now ending I am now considering whether to reduce the amount in my SIPP and look at alternatives.

My understanding is that I can take 25% tax free from my SIPP at any point and then the remaining pot is taxed on withdrawal at marginal rates. 

We do not need the cash immediately as we have other resources to call on and our ISAs produce a regular income. But given the pending change in IHT treatment I am considering taking the 25% tax free and gifting at least some of it in the hope of surviving seven years. My wife and I could also shelter £80,000 in ISAs over two tax years. 

Simon

Rachel Vahey, AJ Bell Head of Public Policy, says:

In the Budget at the end of October, the chancellor proposed bringing pensions into inheritance tax (IHT). On the same day HMRC published a consultation on what the rules surrounding this could look like.

To be very clear, this is currently only a consultation, and not yet law. The final rules on how pension funds are treated on death stand a good chance of changing between now and April 2027, so it’s probably a good idea to hold fire on setting detailed plans into action until we get a clearer picture of the final rules.

Having said that it’s understandable some people will want to start thinking about their retirement and estate planning, and what action they could take.

HOW PENSION WITHDRAWALS CAN BE MADE

Generally, people can take up to 25% of their pension fund as a tax-free amount. They can withdraw the rest of it out through drawdown in any way they want – gradually as a regular income, in chunks over time, or all at once. When they take money out it will be taxed as income, so people should be aware that taking large amounts could push them into a higher tax bracket.

Alternatively, once they take a tax-free cash amount, people can choose to buy an annuity with the remaining fund. An annuity gives them a guaranteed income for as long as they live. But it doesn’t have to be just drawdown or annuity – pension savers can take a combination of both.

People don’t need to take all their tax-free cash at once either. They could take a slice of their pension pot at a time; take 25% of that amount as cash, and then move the rest into drawdown to take out when they want, or use it to buy an annuity, or take it all as a taxed ad-hoc lump sum.

Once people take money out of their pension (either tax free or taxed), if it remains with them, it will generally be in their estate when it comes to working out what (if any) inheritance tax applies. If their spouse or civil partner inherits this money, then it will be exempt from inheritance tax. Of course, it then falls into their spouse’s estate when they die, unless they spend it in the meantime.

If someone takes money out of their pension and invests it in their ISA, then it stays within their estate when working out inheritance tax – the same way as for a pension (if the proposals go ahead). The key difference is the timing of paying income tax and by whom. If the money is taken out of a pension and invested in an ISA, then the pension saver pays income tax at that point. If the money is kept within the pension, then the beneficiary pays income tax when they take it out – but only if the original pension saver died after age 75.

WHEN IT MIGHT MAKE SENSE FOR MONEY TO STAY PUT

If the person inheriting the money is not a spouse or civil partner, is a lower rate taxpayer than the original pension saver was, or the original pension saver dies before 75, it may make more sense to leave the money in the pension. Especially in the knowledge that it is being passed on to help that loved one attain a decent income in retirement.

Alternatively, there are ways to remove money out of someone’s estate. People can gift it outright to others.  HMRC’s rules allow people to give out gifts of up to £3,000 each year exempt from inheritance tax. Or small gifts of up to £250 each (although these small gifts cannot be given to people who receive all or part of the £3,000 gift).

Alternatively, people can make an unlimited gift to another which will escape inheritance tax if the giver of the gift survives for another seven years after making the transfer. If the giver dies in this period, then usually the full value of the gift will be included in their estate when working out inheritance tax, but taper relief will be available if the giver survived the gift by at least three years. 

Another way is for someone to make a regular gift to another out of their normal income. To meet the rules to be exempt from IHT the gift has to be part of the giver’s normal expenditure, it has to be made out of income, and it has to leave the giver with enough income to maintain their normal standard of living. This can be a useful exemption from IHT, but it’s also complicated, so care needs to be taken and appropriate paperwork kept. Again, it’s probably best to get expert help and advice in this area.

THE TRUSTS OPTION

Gifts can also be made to trusts, but there are complicated rules around setting up trusts, as well as additional costs, so it’s always best to get some expert help and advice on your options on how to set these up and how to invest trust money.

One final thing. As well as making outright gifts to family members, some people may want to pay the money into someone else’s SIPP or ISA. If they pay into a SIPP, then the pension holder should receive tax relief on the contribution and that will boost the overall value of their SIPP, and their income in retirement.

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