Whilst the choice of tax wrapper and products is by no means the starting point for creating your financial plan, there are few financial planning or retirement planning scenarios that do not utilise the tax benefits of ISAs and pensions. The choice of which vehicle can provide the best savings returns over time – the Pension Pot or the ISA – is a long talked about topic.
Standard Life recently published research which identified and compared tax and interest rate factors in relation to both options. With recent changes to rules governing inheritance, the research has also been updated to compare what can be passed on to family members on death and how tax efficient each method is.
The new ISA inheritability rules provide a surviving spouse or civil partner with an increased ISA allowance equal to the value of the deceased’s ISA at the time of their death. This allows the survivor to benefit from continued tax free investment returns on their spouse’s investments. But it doesn’t keep the ISA out of the spouse’s Inheritance tax (IHT) net. The fund could still suffer a 40% charge on the second death if total assets exceed the IHT nil rate band.
Pensions, on the other hand, are typically free of IHT. And there are new rules on how pension wealth can be inherited. Restrictions have been lifted on who can inherit a drawdown pension. From April, it will be possible to nominate anyone to receive a pension pot and for them to carry on taking an income from it. This applies even if they are below the normal pension age of 55, allowing children or grandchildren to have immediate access.
By keeping the money within the pension wrapper, they benefit from the same tax free investment returns as an inherited ISA. But unlike the ISA, it isn’t limited to spouses and civil partners but can apply to anyone the deceased wants to benefit from their pension. And it also means the funds don’t make their way into the beneficiary’s estate for IHT.
In addition, the rates of tax on inherited drawdown funds have fallen too. It no longer matters whether funds are crystallised or uncrystallised. The same rates will apply to both.
Should the scheme member die before age 75, any income drawdown by the beneficiaries will be tax free.
For deaths after age 75, income will be taxed at the beneficiary’s marginal income tax rate.
These rates will apply regardless of whether the fund is taken as an income or a lump sum, although for the 2015/16 tax year only, taking the whole fund as a lump sum on death post 75 will be taxed at 45% before reverting to the beneficiary’s marginal rate in April 2016.