Pensions and retirement income are synonymous with one another. The first thing most clients will think about when considering their income in retirement will be their pension. But with the new pension freedoms it isn’t necessarily the first place they should turn to when deciding where to draw their retirement income from.
The familiar scenario of using the pension to provide income needs and other savings earmarked for other purposes, perhaps as a future inheritance for the kids or as a rainy day fund, requires a rethink.
Tax efficient income
It pays to make use of the available tax allowances when structuring retirement income. Up to £26,700 of income and capital gains can be taken tax free this year. For a retired couple that’s £53,400 a year without a penny in tax.
The personal income tax allowance increased to £10,600 from April. In addition, it is now possible to take a further £5,000 savings income tax free. Then, of course, there’s the annual CGT exemption which stands at £11,100.
The order in which funds are withdrawn in retirement can have significant impact on the tax allowances available and ultimately how much tax is payable. For example, the £5,000 tax-free savings rate band is lost if income from pensions exceeds £15,600.
Providing a legacy
This is where attention should turn to securing the greatest inheritable legacy for future generations. It may be a choice between withdrawing funds from an investment which is outside the IHT net and one on which would potentially attract a 40% tax charge on death.
Where to turn?
As a rule of thumb the order to withdraw funds will be the reverse order to the optimum way in which they are accumulated – last in first out. Using that philosophy means tax privileged savings are retained for the longest period and potentially preserves the greatest inheritance.
- Unit trusts/OEICs/Share Portfolios
Using withdrawals from a unit trust/OEIC or share portfolio to meet retirement income needs will result in a capital gain rather than an income tax liability. If the gain can be managed within the £11,100 annual CGT allowance then withdrawals will be tax free.
- ISAs
Keeping savings in a tax friendly wrapper such as an ISA makes sense. So typically it will be worth withdrawing other taxed funds up to the available allowances before touching the ISA.
NB. Those with excess income might want to consider investing in a portfolio of qualifying AIM (Alternative Investment Market) listed stocks in order to remove their ISA portfolio from their taxable estate for IHT
- Pensions
The new pension freedoms have turned conventional retirement income planning on its head. No longer should pension savings be the first thing clients turn to provide their income in retirement. Any clients with other savings in addition to their pension may be advised to withdraw income from other sources first and leave their pension until last.
The funds within the pension enjoy the same tax free gross roll up as the ISA. But, unlike other investments, pension savings are generally free of IHT. And the new death benefit rules provide greater choice on who and how pension wealth can be inherited.
The taxation of pension death benefits has changed for the better too. If a client dies pre 75 their pension can be passed on tax free. Post 75 their beneficiary will be able to draw an income which will be taxed at their marginal rate.
Summary
Having a range of different investment wrappers will increase the scope to utilise the tax free allowances. But that doesn’t necessarily mean spreading savings across wrappers is always the right thing to do. Pensions now enjoy such a privileged tax status that they should now be the first choice for life savings and the thing to keep hold of longest in retirement.
If you’d like to discuss our thoughts on investment strategies give the team a call on 01462 687337 or email info@provisio.co.uk.
Philip Bailey
This blog first appeared as an article in Light Blue Law, The Cambridge and District Law Society Newsletter
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