The freedom and choice regime has made pensions a significantly more valuable tool for both income and inheritance tax planning.
In some circumstances, where a client has continuing income after drawing tax free cash, they might wish to moderate drawdown from the pension vehicle so as to manage the income tax payable. This would result in funds being retained in the pension and an investment strategy planned accordingly.
Conversely, if an individual has substantial personal assets, they may wish to live from these, reducing their estate and potentially any IHT liability. Again, a suitable investment strategy can be put in place taking into account the likely date from which income may be required, if at all, from the pension.
Where an individual does not expect to live to age 75, drawing down on personal assets might make sense because it should be possible on their death to use the funds retained within the pension to pay out benefits free of any tax.
With careful planning and nomination of beneficiaries, even where death occurs on or after age 75, benefits can often be distributed with a lower overall tax charge than the 40 per cent applying to IHT.
Conventional platform based or insured pension vehicles, with access only to a number of regulated funds, provide a limited investment strategy. With full Sipps, however, a broader range of assets can be held, offering another dimension to income tax and IHT planning.
Let us look at two assets sometimes held in Sipps during the accumulation phase as examples.
Unquoted equity: Certain shares and securities in trading companies may qualify for IHT business property relief at either 50 per cent or 100 per cent. The 50 per cent relief is available for controlling interests in quoted trading companies but investments in unquoted trading entities, such as those found on Aim, can attract 100 per cent relief.
Investments (including farmed agricultural land) that have performed well during accumulation might then be swapped with other personal assets or cash (on arm’s length terms, of course) as the member reaches later life.
Farmed agricultural land: Agricultural land can also be exempt from IHT under the agricultural relief regime. This commonly includes land or pasture used to grow crops or to rear animals but can also include stud farms, trees that are harvested at least every 10 years, milk quotas associated with the land and even some farm buildings.
There are some ownership criteria which need to be met, though: the land must have been owned and occupied for at least two years if occupied by the owner, or seven years if occupied by someone else.
There are also circumstances where personal assets might be better moved from the member to their pension scheme.
Where the individual has a large personal estate that might give rise to IHT, they could draw down on the estate as outlined above. But if the estate is largely illiquid, perhaps being made up of a residential and commercial property portfolio, simply drawing on the rental income might not reduce the estate sufficiently quickly.
In such a situation, a Sipp could acquire all or part of a commercial property from the individual releasing cash to them (again, at an arm’s length value), which could be used for living expenses or to mitigate IHT through gifts to friends and family.
There are, of course, complicated calculations to take into account in this scenario, as the disposal of the commercial property is a change of beneficial owner and could give rise to a capital gains tax charge, depending upon the time held and increase in the value since original purchase. There may also be stamp duty land tax implications.
As with most tax planning, timing will be a critical issue. But the wide-ranging investment flexibilities of self-invested pensions provide an additional dimension when considering the taxation strategy of the wealthy.
Martin Tilley director of technical services at Dentons Pension Management