Death benefits, SIPPs and the tax advantages – a case study

We’ve already looked this month at how death benefits are treated in a SIPP and the estate-planning advantages.

To help you to better understand some of the intricacies, we’ve put together a case study explaining what happens to SIPP (Self-Invested Personal Pension) benefits on death.

Showing you a real example of how SIPPs work on death

Mr and Mrs Jones have two SIPPs which hold the commercial property from which the family business operates. The assets in the SIPPs are owned on a 60/40 basis.

The property is worth £300,000 and there is no mortgage. They also have an investment portfolio within their SIPP valued at £100,000 each.

After taking their pension commencement lump sum and discussions with their financial adviser, they decide to take the rental proceeds received by the SIPP as income. The annual rental value is £25,000 meaning that Mr Jones is receiving £15,000 (60%) and Mrs Jones £10,000 (40%) drawdown income from their SIPPs. They are taking monthly income which is taxed at 20% as they are both basic rate taxpayers.

Note – it is not necessary to draw income from the SIPPs in line with the property ownership.

Mrs Jones passes away aged 67

She nominated Mr Jones as the sole beneficiary to her SIPP. Rather than take the benefits out of the SIPP as a lump sum, Mr Jones elects to retain these in the SIPPs.

What this means is that Mr Jones is now the sole beneficiary to the property and the rental income. At the next meeting with the adviser, it is decided to stop income withdrawals from Mr Jones’ SIPP as he is now able to take benefits free from tax from Mrs Jones’ entitlement.

Upon Mrs Jones’ death, Mr Jones updates his death benefit nomination details for his SIPP. He nominates his son and daughter to be the equal beneficiaries to his SIPP, as well as the dependents/nominees/successors to the benefits originally held by Mrs Jones.

Both children work in the family business.

A few years later, Mr Jones dies aged 72

In accordance with the death benefit nominations completed after Mrs Jones’ death, Mr Jones’ SIPP and the benefits he held in respect of Mrs Jones’ original SIPP, are split equally between his two children.

Outside of the SIPP, the son (age 35) and daughter (age 32) are now made directors of the company. Their priority is to ensure that the business continues to have premises from which to operate.

When it comes to the payment of the death benefits, both children establish a SIPP into which their 50% entitlement to Mr and Mrs Jones’ SIPPs are paid.

Effectively, the son and daughter have each retained 50% of the property and investment portfolio within the tax-efficient pension wrapper.

However, both the son and daughter decide they would like to receive £1,000 per month from their SIPPs. As Mr Jones passed away before his 75th birthday, these withdrawals can be paid to the son and daughter tax-free.

Two years later the son decides that he would like to receive a £30,000 lump sum from the pension to put towards a new house purchase. Again, this can be deducted tax-free from either the nominated beneficiary or nominee benefits (from the non-property assets in the SIPP).

Points to consider

  • If Mrs Jones had died aged 76, then any income from her benefits would have been taxed at Mr Jones’ marginal rate. If this extra income had pushed him into a higher tax bracket, then it may have influenced his decision to continue these withdrawals.
  • Even if Mrs Jones had died at 76, Mr Jones still died aged at 72. Therefore, all the benefits would still have been available for the son and daughter to withdraw tax-free.
  • If Mr Jones had died after the age of 75, both the son and daughter would be taxed on withdrawals on from the SIPP at their marginal rate. Again, they may have both re-considered their monthly withdrawals (and the son may have reconsidered his £30,000 lump sum) if this was going to be taxed and/or impact the rate of tax they pay.

The need for advice remains

While the rules may have been simplified for death benefits, the need for advice still very much remains. Why take benefits from the tax-efficient environment of the SIPP to then form part of an estate which could be liable for IHT?

For example, as an adviser you might need to manage the withdrawal of income where this is taxed. A full withdrawal of the benefits within the SIPP could see your clients paying higher rates of tax than if this was spread over several tax years.

Your clients may also need advice on passing assets to beneficiaries or dependents. While parents’ SIPPs can be passed onto children and grandchildren to assist them with their own pension savings in the future, there are practical considerations.

For example, clients may want to pass commercial property within the SIPP to spouses or children tax free. Properties can ordinarily contribute significantly towards generating an IHT liability, but there is no such consideration in the SIPP. And, properties can continue to generate income for the SIPP which can be taken tax free.

This is particularly relevant where a family business operates from the building the SIPP owns. Here, the property can be passed down the line to future generations, without the need to liquidate the SIPP to pay out benefits on first or second death (as had previously been the case).

Another case study to illustrate death benefits and SIPPs

Here’s another example that highlights how SIPPs can help pass property to beneficiaries.

Three company directors each have a SIPP. They each own one third of the commercial property their business operates out of, as well as an investment portfolio.

One of the directors dies, nominating his spouse as the beneficiary. She decides that she doesn’t want to retain the share of the property and would rather have cash from the SIPP.

So, the initial payment to her was for the realised value of the investment portfolio. Over the future years, the remaining two directors’ SIPPs will purchase part of the property from the spouse’s SIPP, giving her the liquidity to receive cash lump sum death benefits and leaving the remaining two directors ownership of the property within their SIPPs.

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