You are married. You and your partner are 60 and seven years away from state pension. You have at least one child. You own your own home with no mortgage worth £1,000,000. You also have combined uncrystalised pension pots of £933,333 and ISAs worth £766,667. Lucky you, with an estate worth £2.7m you are currently on the hook for £820,000 of IHT come April 2027. Yikes!
What next?
If either of you die before April 2027, you will be able to give that pension in its entirety to your children tax free and it would be outside your estate. However, let's hope that doesn't happen.
So let's plan for you both to be alive come April 2027.
It may be worth retiring and never returning to work. Especially if your pension pot is able to generate around £50k/annum plus.
Traditional financial advice, prior to the 2024 budget, would suggest that spending the ISAs ahead of the pension would be best as you won’t pay tax on any withdrawals. Your money remains in the pension to grow until you are 75 knowing that should you die before then your beneficiaries will get whatever is in the pension tax free. That has all changed with IHT being levied on pensions from April 2027. So your estate that previously benefitted from RNRB no longer does so as it is clawed back over £2m and disappears entirely once estate hits £2.7m.
This change illustrates the big problem with pensions; big sitting ducks that can easily be raided as experienced on 30th October 2024. By contrast ISAs can quickly and easily be closed/moved. Hence depleting an ISA isn’t ideal.
What to do?
The first thing to do is crystallise pensions and take tax free cash up to £268k (LSA - Lump Sum Allowance). You can do this all at one or in stages. With an annual ISA allowance of £20k, it would take 13 years to move it into ISAs, however you can open ISAs for your spouse and children, so it should be possible to do in 3-4 years.
Follow that with a total no-brainer taking £12,570/annum tax free from your pension until you receive state pension. Even if you just crystallise £80,000/annum, you can get £32,570 out tax free. It may trigger MPAA, however I guess you won’t be planning to add to your pension to have more money liable to IHT.
Taking another £37,700/annum, paying £7,400 income tax and giving the money to your beneficiaries would make a lot of sense. Hard to get money out of a pension paying less than 20% rate in many other circumstances, so probably best to just do it.
Taking another £50,000/annum, paying £20,000 in tax could also make sense even paying 40% income tax. Better than 60% IHT. May be worthwhile considering if the annual growth for your pension is between £50,000 and £100,000. Better to pay 40% on £50,000 now than getting caught paying 60% and 45% when the pot grows.
Any gifts from this pension income would considred excess income as long as it doesn’t impact your lifestyle and not liable to tax. You beneficiaries can put the money in ISAs where it can grow tax free and not be subject to tax on withdrawal.
Worth remembering state pension is also taxable income, so adjust as necessary when you receive state pension.
A married couple with children and a family home lose RNRB when estate is worth over £2m. A £700k pot would attract £420k IHT. 60% IHT. Ouch. Decreasing term life insurance written in trust from April 2027 to 75 can mitigate this.
Over 75 it gets worse as not only is IHT due on the pot, so is income tax for any beneficiary withdrawals. This can result in a 91% super death tax (60% IHT + 45% income tax). And life insurance gets very expensive.
Emigration should also be seriously considered. Portugal has no IHT. And other countries, like Ireland, have far lower IHT.
Conclusion
Ultimately, it is your call, but my opinion is taking taxed income from a SIPP is likely to be a preferable option to depleting your ISA to age 75.
