Take Care | ISA and Pension Pots aren’t tax-free forever

Take Care | ISA and Pension Pots aren’t tax-free forever

It’s surprising just how many people with ISAs and pension funds automatically assume that their tax-free status extends to every conceivable personal tax that currently exists in the UK. Now, one of the country’s leading provider of tax services, Baker Tilly, has sounded the alarm and warned its clients using one or both of these tax-shelters to remain alert to the fact that the whole tax regime alters radically on the death of the holder.

It’s common knowledge that ISAs, which the Chancellor has recently boosted with a hike in the annual maximum subscription to £15,000, are free of Income Tax and of Capital Gains Tax (CGT). The same applies to funds held within recognised pension schemes. When they are old enough to take their pension, individuals can withdraw 25% of their pot tax-free and, following recent reforms, can withdraw additional sums provided they pay Income Tax on this additional money in the usual way. Either way, the choice is in the hands of the individual pensioner.

But professionals working in the tax services sector say that too many people fail to appreciate the way in which the taxman is waiting like the Sword of Damocles to descend on these tax-saving vehicles once the lifetime holder has passed away.

In the case of ISAs, the beneficiaries of the holder’s estate will have to come to terms with the fact that all future income and capital gains derived from the funds will be subject to Income Tax and CGT in the normal way. Equally worrying is the fact that, if the estate’s Inheritance Tax nil-rate band (currently £0 – £325,000 ) has already been used up by, for example, the value of a house, then the current IHT rate of 40 % would normally be applied to the value of any assets over and above this threshold – including funds held within ISAs.

When one considers how many people have been investing their full annual allowance into ISAs since they started in 1999, then it is not difficult to see how easy it is for them to accumulate funds in these vehicles worth well into six figures by the time they die. Paying 40% IHT on ISAs worth, say, £150,000 which benefactors and their beneficiaries both thought were totally tax-free might come as something of a shock.

They might also need to be prepared for a nasty surprise if the deceased had a pension fund and died before taking pension benefits and savings exceed the lifetime allowance (currently £1.25m) or the individual died aged over 75. Alternatively, they could be handed a tax bill where the individual dies after taking pension benefits and certain lump sums become payable. In both cases, the tax rate would be an eye-watering 55% based on tax calculators and estimators although tax services experts are expecting this to be reduced to a more “reasonable “ 40 % in the 2014 Autumn Statement.

Fortunately, there are ways in which holders of both ISAs and pension funds can take steps to mitigate these potential tax bombshells or even eliminate them altogether. Clearly the more flexible rules relating to pension fund withdrawals due to come into force in April 2015 could help matters as could some judicious diversification into certain IHT friendly investments which qualify for 100% business property relief (BPR) on death.

If you’re worried about issues surrounding tax on ISAs and pensions, or any tax related issue, Baker Tilly has a team dedicated to tax services that is here to help.

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