SINCE THE GOVERNMENT’S
PENSION FREEDOMS RULES
CAME INTO EFFECT on 6th April
2015, many people have decided to
take full advantage of the flexibility this
allows. In essence, pension investors
now have full control over how to manage their retirement money and all
income limits
have been
removed.
As a
result, we are
often asked
how best to
structure one’s
investment portfolio given this new
pension freedom legislation.
Retirement income planning
considerations given new
pension flexibility
The new pension income flexibility
and greater inheritability of pension
wealth means that traditional thinking
on retirement income planning has
changed dramatically.
Much of the talk about these radical
pension changes focused on the fact
that unrestricted access to pension
savings could be a temptation too far for some. But stripping out the
fund in one go would mean an entire
retirement’s worth of income tax
liability would be taxed in a single tax
year, which would probably result in a
large and unwelcome income tax bill!
In addition, it would bring the value of
the pension back into the estate for the
purposes of Inheritance Tax.
However, with some careful financial
planning and awareness of the various
tax allowances it is entirely possible to
withdraw a highly tax-efficient income
in retirement.
In April 2016, the personal income
tax allowance is set to increase to
£11,000. In addition, it will be possible
to take a further £5,000 of “savings
income” tax-free. Then, of course,
there’s the annual Capital Gains Tax
(CGT) exemption which will stand at £11,100 in 2016/17. This means a
total of £27,600 of income and capital
gains each year can be taken tax-free
by just making full use of the available
exemptions.
However, if retirement income is
being provided from the pension alone
then £16,100 worth of tax allowances could be missed. That’s because the
savings band begins to be removed
once earned income (which would
include pension income) exceeds the
personal allowance and with regard
to the annual CGT exemption, if you
don’t use it in a year you cannot use it in the future.
It’s also important
to look at
what will
be available
to family
members on
death and that
means paying
attention to Inheritance Tax (IHT) and – in
particular – the current pension death
benefit rules.
To make the most of these allowances it
pays to have
saved across a range of
different
investment tax
wrappers after
maximising
your pension and ISA allowances
where possible.
Each tax wrapper has its own
particular tax characteristics. However,
having a combination of these
wrappers can provide flexible tax-
efficient income and estate-planning
solutions.
The ability to turn income on
and off as required can open up
much more tax-efficient income in
retirement. For example, stopping
pension income for a particular
tax year and replacing it by taking
withdrawals from other investments
can reduce the overall tax payable by
utilising allowances which, in turn, can
lead to reduced rates of tax.
Of course, it won’t be possible
to turn income on and off from all
pensions – such as state pension or final salary pensions. This could mean flexibility is needed, such as using the
years before these fixed retirement
incomes commence as a window of
opportunity to take income from other
investments.
New death benefit rules
Unlike most other assets, pension
funds are rarely subject to IHT and the
new death bene t rules have effectively scrapped the 55% tax charge on
drawdown death bene ts. There will be
more options for passing on pensions
as well, as each beneficiary will have
exactly the same death bene t options
from their inherited fund, allowing
pension wealth to cascade down several
generations while continuing to enjoy
the tax freedoms that the pension
wrapper will provide.
ISAs will work well alongside
pensions, and are probably the simplest
wrapper to understand. There is no
income tax or CGT when income or
funds are withdrawn. This, combined
with the fact that funds grow free of
tax, means they’re a popular investment
choice. However, on death, ISA funds
will usually form part of the estate and
where IHT is payable, this will leave
only 60% of the fund inheritable.
Capital withdrawals from Unit
Trusts and Investment
Funds
can also
supplement
income and
provided
gains don’t exceed the annual exemption (£11,100
for the 2016/17 tax year) this will
not be taxable. An investment fund
portfolio will form part of the estate
for IHT so withdrawing funds to meet income reduces the potential IHT bill
and may also help preserve pension
funds.
Investment bonds can also be used
with these other investments effectively
and – whether onshore or offshore
– they are unique in that income and
gains are rolled up within the fund
and only become taxable when a
withdrawal triggers a chargeable gain.
In addition, withdrawals of up to 5%
of the original capital can be taken
without an immediate tax charge.
This ability to defer and control
when income becomes taxable is a very
valuable tool for tax planning. Timing
withdrawals to coincide with tax
years when there’s little or no pension
income can result in gains falling within
the personal allowance and savings rate
band, meaning no tax is payable.
And with offshore bond gains
effectively taxed as savings income,
a non-taxpayer could have gains of
up to £16,000 which are completely
tax-free, thanks to the recent changes
to the savings rate band and personal
allowance.
I fully understand there is a lot
to consider within this article and I
appreciate this might all sound a little
complex when first considering your
options.
My advice would be to seek further
insight and support from a qualified
independent financial planner who
will be able to help you outline your
main objectives and put a financial plan
together to help you reach them.
