How do I avoid double tax on my pension?

Q: I was saving my Self-Invested Personal Pension (SIPP) as a gift for my two children after my death. Would it now be better to slowly withdraw my SIPP and invest it in ISAs to avoid the double tax on my death?

A: It is generous of you to want to pass on your pension to your children. When you say “would it now be better”, you are referring to the fact that, from April 2027, most pensions will, for the first time, be counted as part of your estate for inheritance tax (IHT) purposes.

Until now, many retirees with surplus wealth have, like yourself, chosen to leave their pension untouched so it can be passed on tax-efficiently. Once the proposed changes come into force, that benefit is likely to be reduced for many people, meaning estate plans may need to be reconsidered.

As you suggest, inherited pension wealth could then be subject to both inheritance tax and, in some cases, income tax. Income tax may apply if the pension holder dies after the age of 75, with beneficiaries (i.e. those inheriting the pension) taxed at their marginal rate. If death occurs before age 75, income tax is not usually due.

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Where both taxes apply, the combined tax rate could exceed 60% in some cases.

If your estate is likely to incur IHT, withdrawing money from the SIPP gradually and moving it into an ISA could help to avoid your children having to pay income tax on those funds after your death.

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While ISAs form part of your estate for IHT purposes, withdrawals from them are tax-free.

However, what implications would this have for your own tax position? Could those withdrawals from your SIPP push you into a higher tax bracket?

Also, depending on the size of your SIPP, it may take a while to transfer the money into an ISA. You can only put up to £20,000 per year into an ISA - or up to £40,000 per year between you if you have a partner. What’s more, from next April, the Government is planning to limit how much you can save into a cash ISA to £12,000 per year (with an exemption for those aged over 65).

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Ideally, you would only withdraw enough to use that year’s ISA allowance. Otherwise, your money may sit outside the tax shelter of either an ISA or a pension.

Another question to consider is: if you’re sure you don’t need this money, could you gift some of it while you’re still alive?

That way, you get the benefit of seeing your children enjoy it. Plus, if your gift fits into one of HM Revenue & Customs’ (HMRC) gifting allowances, it should be immediately free of IHT.

For example, you can give away:

• Up to £3,000 each tax year using the IHT annual gifting allowance
•  Up to £5,000 to a child for their wedding (less for other people getting married)
• Up to £250 per person per tax year to as many people as you like (so long as you haven’t used any other gifting allowances on them)

If the gift doesn’t fit into any of the allowances, it may still be IHT-free if you survive for at least seven years after making it.

There are other allowances: you can read about them in more detail here

Of course, if you are likely to need the money, gifting is not advisable.

It may also be worth waiting until the rule change takes effect before making any final decision. It’s not pleasant to think about, but what if you were to die before the rule change in 2027?

If the money was left in the SIPP, it could be passed on IHT-free. Whereas if you had already started moving it into ISAs, that would no longer be the case.

Ultimately, whether or not it makes sense to withdraw the money from your SIPP and move it into ISAs will depend on a whole range of factors, including your health and spending needs, your IHT position and your tax bracket (as well as those of your children).

Please remember this article does not constitute financial advice. Pension and tax rules can change and their impact will depend on your individual circumstances. If you’re unsure about what’s right for you, you should speak to a qualified financial adviser.

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Important information - investors should note that the views expressed may no longer be current and may have already been acted upon. This information is not a personal recommendation for any particular investment. Tax treatment depends on individual circumstances and all tax rules may change in the future. Withdrawals from a pension product will not be possible until you reach age 55 (57 from 2028). If you are unsure about the suitability of an investment you should speak to one of Fidelity’s advisers or an authorised financial adviser of your choice.