Case Studies
Case study 1
Pay Less Tax on your Retirement Income
We all accept that having to pay Income Tax on what we earn is part of life, but when we retire it is somewhat galling to thing that we still have to pay Income Tax on our pensions and savings. However by planning in advance for retirement, there are several ways of minimising the tax we pay in retirement.
The solution is not to wait until the last couple of years before retirement and then decide what to do, but to plan ahead and utilise the annual tax allowances and limits available as much as possible.
Obviously most people are going to be in receipt of some form of pension which means that they cannot avoid paying some income tax. However we can help to minimise the amount that needs to be paid to the extent that a retired couple can generate an overall income of £57,800 with only £5,138 of Income Tax to pay before adding in any tax-free income from PEPs and ISAs.
A Case Study
A married couple who both have a full National Insurance contributions history either through the NI they have paid or through credits given whilst bringing up their family and have also both contributed to various pension schemes to the extent that they the husband has built up a fund of approximately £420,000 whilst the wife has an entitlement to a small company pension scheme of £1,500 per annum and a lump sum of £4,500.
In addition to these pensions they have built up £75,000 of savings in deposit accounts and other short to medium term investments and have £150,000 available from the sale of a business. They have also contributed to PEPs and ISAs over many years which have grown to a total value of £200,000 between them.
From the above figures we have been able to generate the following levels of income:
Pensions
Their state pensions are £7,400 for the husband (including his entitlement to the Second State Pension) and £4,400 for the wife.
The husband's pension fund produced a tax free sum of £105,000 and with the residual fund of £315,000, we are generating an annual income of £12,700 per annum - a return of 4% - with the residual growth remaining in the fund. This income will be adjusted each year to ensure that he maximises his personal tax allowances.
This means that the husband has an income of £20,100 per annum which is the threshold at which he keeps all of his age allowance and as a result only pays £2,570 per annum in Income Tax, giving him a net income of £17,530 per annum. The wife has total pension income of £5,900 and pays no Income Tax as it is under the age allowance threshold of £7,280 (available from age 65).
Capital Investments
The capital available for investment is £333,500 made up of the tax free lump sums from the pensions (£4,500 £105,000), the short term savings (£75,000) and the sale of the business (£150,000). In addition the PEPs and ISAs (£200,000) is already invested in a suitable place.
They wish to keep a reasonable sum on deposit for instant access which is held in a high interest deposit account in the wife's name as she hasn't used all of her tax allowances and interest of up to £1,380 can be paid gross. This allows them to keep up to £27,600 on deposit at 5% interest without paying any tax.
The residual balance of the fund (just over £300,000) can then be invested in a managed portfolio in a mixed spread of investments to generate growth throughout the year. The gains from the portfolio can then be taken out to supplement the income and are liable to Capital Gains Tax (CGT) if they exceed the annual exemption of £8,800. Therefore if they take gains of up to £17,600 from a joint holding there is no liability to CGT (just under 6% return).
The PEP and ISA holdings can be consolidated under one umbrella to simplify matters, invested in a mixed portfolio of fixed interest funds and high yielding shares. The natural dividends can then be paid out as tax free income and this will produce around £9,000 per annum (4.5% return).
Overall Income Position
Their total income from all the various sources is £55,360 with only £2,570 of income tax to pay, leaving net income of £52,790 per annum or £4,400 per month. The income stream is variable, but with over half of it being paid monthly, they can use the deposit account to regulate any peaks and troughs in their spending.