MAXIMISING TAX-FREE SAVINGS ALLOWANCES IN · PDF fileADVERTISING FEATURE MAXIMISING TAX-FREE...
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ADVERTISING FEATURE MAXIMISING TAX-FREE SAVINGS ALLOWANCES IN RETIREMENT The 6th April 2015 represented perhaps the biggest adjustment to UK pension legislation since A-Day in 2006, bringing changes in both the way that pension income could be drawn as well as wholesale changes to the pension death benefit regime. JOHN HALEY TECHNICAL SALES MANAGER T he Pension Freedom regime created a more flexible environment in which to implement suitable retirement strategies. However, some individuals with investment wealth outside of their pension schemes seem to have reversed previous strategies in light of improved pension death benefits, deciding instead to preserve their defined contribution pension funds and de-cumulate using their non-pension investment wealth. Such strategies help to make use of the various allowances available, potentially decrease inheritance tax (IHT) liabilities and hopefully improve the resultant legacy passed on to family and loves ones. Our industry obviously pays much attention to diversification of assets to reduce and mitigate investment risk - but there is also an argument for diversification of tax wrappers. A mixed wrapper strategy can enable an individual to use valuable tax allowances when de-cumulating, as well as reducing risk connected with potential changes in legislation. However, in this article, I'd like to concentrate specifically on offshore bonds and ways to extract "income" tax efficiently when in retirement. Once an investment is made into an offshore bond it is fair to say that although tax relief is not received on entry, it grows in much the same way as a pension fund i.e. largely tax free with the exception of withholding tax on overseas investments. The challenge is then, of course, extracting the funds in a tax efficient way. The good news is that the list of allowances and reliefs that can potentially be utilised to reduce or mitigate income tax on gains from an offshore bond is considerable i.e. personal allowance, starting rate band for savings, personal savings allowance, top slicing relief and tax- free assignment (and also time apportionment relief for those who spend some time as non-UK resident whilst holding an investment bond). Compare this to income from a pension - only the personal allowance is potentially available. This is due to the simple fact that pension income is classed as non-savings income and taxable gains from offshore bonds are classed as savings income. The list of savings income allowances can total up to £17,500, within which gains could potentially be received tax free if a client's tax affairs are organised well. AS MORE INDIVIDUALS TRANSFER FROM DEFINED CONTRIBUTION SCHEME THEY MAY HAVt MORE OPPORTUNITY..... Let's consider an example: Michael is 67 and married with two adult children. He has a sizeable drawdown plan, investment in a wide range of gilts and corporate bonds, as well as an offshore bond that he invested £500,000 in ten years ago, which is now worth £1,000,000. He currently receives retirement income consisting of the following: State Pension £10,000 Drawdown £40,000 Interest/coupons £10,000 £60,000 Matching £47,500 net spendable income Michael's existing income tax position is shown in table A. Let's consider how his position could be made more tax efficient using surrenders from his existing offshore bond. As mentioned earlier, individuals can benefit from tax free allowances for savings income of up to £17,500 which consists of the personal allowance, the starting rate band for savings of £5,000 and the personal savings allowance of £1,000. However, Michael does not currently receive any of the £5,000 allowance as his non-savings income exceeds £16,500. Let's see how things change if the drawdown income is reduced to zero and the current net spendable income figure of £47,500 is met by encashing £31,111 of the offshore bond, which generates a gain of £15,555. As Michael's non-savings income has now reduced to £10,000, his £5,000 starting rate band for savings is now fully available. In addition, he is now a basic rate tax payer which means that his personal savings allowance increases to the full £1,000. The result is that his net spendable income of £47,500 has been maintained but his tax bill has reduced by 71.11% to £3,611! Maintaining existing tax bill but Increasing net spendable Income What if Michael were more interested in increasing his net spendable income to assist with other purchases he'd like to make in retirement, whilst keeping the original tax bill of £12,500? In order to achieve this, £119,000 of the offshore bond
Transcript of MAXIMISING TAX-FREE SAVINGS ALLOWANCES IN · PDF fileADVERTISING FEATURE MAXIMISING TAX-FREE...
ADVERTISING FEATURE
MAXIMISING TAX-FREE SAVINGS ALLOWANCES IN RETIREMENT
The 6th April 2015 represented perhaps the biggest adjustment to UK pension legislation since A-Day in 2006, bringing changes in both the way that pension income could be drawn as well as wholesale changes to the pension death benefit regime.
JOHN HALEY TECHNICAL SALES MANAGER
The Pension Freedom regime created a more flexible environment in which to implement suitable retirement
strategies. However, some individuals with investment wealth outside of their pension schemes seem to have reversed previous strategies in light of improved pension death benefits, deciding instead to preserve their defined contribution pension funds and de-cumulate using their non-pension investment wealth. Such strategies help to make use of the various allowances available, potentially decrease inheritance tax (IHT) liabilities and hopefully improve the resultant legacy passed on to family and loves ones.
Our industry obviously pays much attention to diversification of assets to reduce and mitigate investment risk - but there is also an argument for diversification of tax wrappers. A mixed wrapper strategy can enable an individual to use valuable tax allowances when de-cumulating, as well as reducing risk connected with potential changes in legislation. However, in this article, I'd like to concentrate specifically on offshore bonds and ways to extract "income" tax efficiently when in retirement.
Once an investment is made into an offshore bond it is fair to say that although tax relief is not received on entry, it grows in much the same way as a pension fund i.e. largely tax free with the exception of withholding tax on overseas investments. The challenge is then, of course, extracting the funds in a tax efficient way.
The good news is that the list of
allowances and reliefs that can potentially be utilised to reduce or mitigate income tax on gains from an offshore bond is considerable i.e. personal allowance, starting rate band for savings, personal savings allowance, top slicing relief and taxfree assignment (and also time apportionment relief for those who spend some time as non-UK resident whilst holding an investment bond). Compare this to income from a pension - only the personal allowance is potentially available.
This is due to the simple fact that pension income is classed as non-savings income and taxable gains from offshore bonds are classed as savings income. The list of savings income allowances can total up to £17,500, within which gains could potentially be received tax free if a client's tax affairs are organised well.
AS MORE INDIVIDUALS
TRANSFER FROM DEFINED
CONTRIBUTION SCHEME
.i THEY MAY
HAVt MORE OPPORTUNITY .....
Let's consider an example: Michael is 67 and married with two adult children. He has a sizeable drawdown plan, investment in a wide range of gilts and corporate bonds, as well as an offshore bond that he invested £500,000 in ten years ago, which is now worth £1,000,000.
He currently receives retirement income consisting of the following: State Pension £10,000 Drawdown £40,000 Interest/coupons £10,000
£60,000
Matching £47,500 net spendable income Michael's existing income tax position is shown in table A. Let's consider how his position could be made more tax efficient using surrenders from his existing offshore bond. As mentioned earlier, individuals can benefit from tax free allowances for savings income of up to £17,500 which consists of the personal allowance, the starting rate band for savings of £5,000 and the personal savings allowance of £1,000.
However, Michael does not currently receive any of the £5,000 allowance as his non-savings income exceeds £16,500. Let's see how things change if the drawdown income is reduced to zero and the current net spendable income figure of £47,500 is met by encashing £31,111 of the offshore bond, which generates a gain of £15,555.
As Michael's non-savings income has now reduced to £10,000, his £5,000 starting rate band for savings is now fully available. In addition, he is now a basic rate tax payer which means that his personal savings allowance increases to the full £1,000. The result is that his net spendable income of £47,500 has been maintained but his tax bill has reduced by 71.11% to £3 ,611!
Maintaining existing tax bill but Increasing net spendable Income What if Michael were more interested in increasing his net spendable income to assist with other purchases he'd like to make in retirement, whilst keeping the original tax bill of £12,500? In order to achieve this, £119,000 of the offshore bond
ADVERTISING FEATURE
State pension
Drawdown 40,000
Interest/Coupons 10,000
Total 50,000 10,000 60,000
Less personal allowance (11,500)
Total 38,500 10,000 48,500
33,500@20% (6,700)
5,000@40% (2,000)
500@0% (0)
9,500@40% (3,800)
Total tax on Income (12,500)
Net spendable income (60,000 -12,500) 47,500
Effective tax rate (12,500/60,000 x 100) 20.83%
Michael obviously benefits from his personal allowance but he is currently paying higher rate tax and therefore only benefits from a £500 personal savings allowance.
Interest/Coupons 10,000
Offshore bond gain *15,555
Total 10,000 25,555 35,555
Less personal allowance (10,000) (1,500)
Total o 24,055 24,055
5,000@0% o
1,000@0% o
2,500@20% (500)
15,555@20% (3,111)
Total tax on income (3,611)
Net spendable Income (51,111 - 3,611) 47,500
Effective tax rate (3,611151,111 x 100) 7.06%
*The top sliced gain of £1,555 does not push Michael over the higher rate threshold when combined withhis other income of £20,000.
Table C: Using a bond encashment to increase Michael's net spendable income but
maintain the £12,500 tax bill
Non-savings (£) I Savings(£) Total(£)
State pension 10,000
Interest/Coupons 10,000
Offshore bond gain 59,500
Total 10,000 69,500 79,500
Less personal allowance (10,000) '
(1,500) '
'
Total 0 '
68,000 68,000 '
5,000@0% ;
o
500@0% i o
3,000@20% ' (600)
59,500@20% ' (11,900)
Total tax on income (12,500) ;
Net spendable income (139,000 -12,500) I 126,500
Effective tax rate (12,500/139,000 x 100) 9.00%
I
I
I
needs to be surrendered, which will give rise to a gain of £59,500.
Top slicing relief allows Michael to have £79,500 of taxable income but have no higher rate tax liability. His total income, including the top sliced gain of £5,950, is £25,950 which is below the higher rate threshold - therefore no higher rate income tax payable. Note that even though he does not have a higher rate tax liability, the total of his income and bond gains means that he only benefits from £500 personal savings allowance.
Michael's net spendable income has increased in excess of 266% to £126,500 and his starting tax bill has not increased!
Summary Offshore bonds are one of many tax wrappers that can be used as part of a wider retirement strategy. All wrappers have their place for the right client, having their own set of tax allowances that can be used in different circumstances. However, where income levels can be managed in retirement, offshore bonds can clearly represent a highly efficient source of "income" as they are taxed as savings income.
The level of chargeable event following a segment surrender will depend upon the amount of growth achieved and the number of segments surrendered. However, chargeable events could also be created by making withdrawals in excess of the cumulative 5% allowance, to potentially make use of unused savings allowances.
This type of strategy can potentially save income tax or increase net spendable income levels. However care should be taken that: • adjusted net income does not exceed£100,000 when combined with thechargeable gain generated, as the personalallowance will be reduced, or worse,extinguished.• the higher rate threshold is not exceededwhen the top sliced gain is combined withother income.
As more individuals transfer from defined benefits to defined contribution schemes, they may have more opportunity to use the allowances available to them if they have a range of tax wrappers in place. In addition, where clients can draw income and capital from different tax wrappers in retirement, the pension fund may be depleted more slowly, meaning that the legacy for future generations is potentially increased.
Utlll<>Sf WEALTH SOLUTIONS
