NOVEMBER 2015 - Reviewing income; don't sleepwalk into unnecessary tax
When considering this blog and the changes that have been made to legislation recently I am reminded of a favourite phrase of a friend of mine; “trying to predict what changes politicians will make next is the equivalent of trying to herd cats.”
Not only did the Budget earlier this year facilitate changes to the way money flows into retirement savings, it also made changes to the way that allowances can be used to get your money out at the other end. It’s therefore important to remain vigilant and review the way in which you are funding retirement. By using multiple sources, and by reviewing the structure and making some simple but significant changes, there is now an opportunity to reduce or eliminate tax.
Now that a pension fund can potentially provide a tax-free lump sum for family members if death occurs before 75, since the payment will be outside the estate for IHT purposes, it is prudent to try and retain funds within this environment and to find another way to fund your desired lifestyle.
The broad principles to consider are to find a way to utilise your allowances and then to take money from the places that suffer the heaviest potential tax.
• If you have not fully used your personal allowance, consider structuring any investments which are not held in an ISA to be a balance between income-producing and dividend-producing funds.
• If this cannot be done and you have a private pension, consider utilising the new pension freedoms to your advantage. It is worth exploring the option of feeding out some of your tax-free cash in stages as this does not have any material impact on the death benefits. Alternatively, you can also use a combination of tax free cash and taxable income. If, for example, you have £4,500 of your Income tax personal allowance (due to the rest being used by a State Pension income of £6,100), that can give you a potential income of £6,000 without any income tax to pay.
• With the changes to the dividend allowance due on 6th April 2016, do you need to consider making changes to who holds investments in the household? If your portfolio has been held in one spouse’s name as the other was/is a Higher Rate taxpayer, should this be rebalanced to use the £5,000 allowance for both spouses? Also if there is a non-ISA portfolio yielding less than £5,000, again consider increasing those investments producing dividends. Conversely, if they are yielding higher than that, should they be adjusted down?
• It is now also an idea to consider taking the capital from general investments in order to utilise the Capital Gains Tax exemption rather than taking ISA income or pension income. Firstly, this spends money that is not in a tax-protected environment and secondly, it removes money that forms part of the Estate if there is an IHT issue. For example, if you have a portfolio that has grown from £80,000 to £120,000 over the years then you could potentially access a further £30,000 without paying Capital Gains Tax.
• The new Savings Allowance is also worth taking into account, although for many this might not apply. Can any of your cash holdings be structured to utilise the new allowance of £1,000 for Basic Rate taxpayers or £500 for Higher Rate taxpayers?
• If you hold onshore investment bonds – then consider utilising the 5% tax deferred return of capital as investment bonds suffer underlying tax.
If you consider the examples above and calculate what is possible: with a State Pension of £6,100, private pension of £6,000, dividends of £5,000, £1,000 of Savings income and making a capital withdrawal of £15,000, you would have given yourself an income of £33,100 without paying any tax.
Structured correctly, utilising multiple sources will mean your capital will go further because ultimately the amount of money you need to fund your lifestyle will be lower if you are taking it in a tax-efficient manner.
With all of the above, it is important to remember that planning and reviewing your arrangements are paramount. If you have any questions relating to the above or would like a further discussion you are welcome to contact us and we will be happy to help.