Tax Efficient Options

jim8888

I will have a pension pot of 500k to take when I turn 55 and this needs to last me ten years.
I want to take an income of 40k a year from this over those ten years in the most tax efficient way that I can.
Any ideas on this?

atush

Will you have other income ie still be working? Do you have a spouse?

You will have 125K tax free, which you can put into S&S ISAs to provide tax free income, and cash into some of the best paying current accts.

Then you can draw 37,500 per year over 10 years which would be taxable at 20% after your PA if you aren't working still. Which would mean tax paid of 5380 per annum.

What will you live on from age 65?

CLAPTON

jim8888 wrote: »

I will have a pension pot of 500k to take when I turn 55 and this needs to last me ten years.
I want to take an income of 40k a year from this over those ten years in the most tax efficient way that I can.
Any ideas on this?

is that 40k after tax or before tax

but with 25% tax free of 125,000 plus 9 lots of 10,000 (rising of course each years) that gives you at least 215,000 totally tax free over the 10 year period

kidmugsy

Use the TFLS entitlement to invest plenty into VCTs, EISs, and SEISs; then you can largely avoid tax on the tax-exposed part (at the cost of taking absurd levels of risk).

sandsy

If you're not bothered about taking a lump sum and reinvesting it in ISAs, 40k net of tax could alternatively be achieved by using UFPLS:
- take £44700, of which first 25% (£11175) is tax free
- the remaining £33525 is subject to tax of £4705 assuming personal allowance of £10k, leaving £28820
- £28820+£11175 = £39995

jamesd

It appears that you can get your whole £40,000 income target completely tax free for all ten years.

The most tax-efficient way is to take the full basic rate income tax band income each year and use VCT investing to get tax relief on it back. Do the VCT buying early in the tax year and HMRC will adjust your tax code so that your ongoing pension income gives you the tax relief. VCT tax relief is 30%, capped at the amount of income tax paid in the year. If you took £40,000 of taxable income you could eliminate the £8,000 basic rate income tax on the £30,000 of it by buying £26,666 of VCTs.

VCT dividends are tax free and getting about 4% is easy enough, more readily available. You must repay the 30% tax relief if you sell within five years but you should plan on holding for 8-10 years to give more time for the companies being invested in to mature.

You can use the tax free lump sum to fund living costs during the years where you're effectively deferring income for 5+ years inside the VCTs.

You initial plan might then be:

year 1: take £125,000 tax free lump sum. Also take £40,000 taxable income from the rest and invest £26,666 from the lump sum in VCTs. Assume £1,066 tax free VCT income, £8,000 VCT tax relief and £10,000 basic rate income, total £19,066 tax free income topped up to £40k by using £20,934 of lump sum. Lump sum remainder £125000 - 20934 = £104066. 75% remainder 375000 - 40000 = 335000, VCT assumed 26666.

year 2: assume 3% real investment growth, lump sum now 107187, 75% pot now 345050. Same VCT routine, take £40k taxable income from the 75% pot, £26,666 VCT. Income now 2132 + 8000 + 10000 = 20132 topped up by £19868 from the lump sum. Lump sum remainder 87319, 75% remainder 305050, VCT 53332.

year 3: after growth lump sum now 89938, 75% now 314201. Same 40k/26666 routine, total tax free income of 3199 + 8000 + 10000 = 21199 topped up by 18801 from the lump sum. Lump sum remainder 71137, 75% remainder 274201, VCT 79998.

year 4: now 73271 and 282427. Income from 79998+26666 VCT at 4% = 4266 + 8000 + 10000 = 22226. Top up from lump sum 17774. Lump sum remainder 55497, 75% remainder 242427, VCT 106664.

year 5: now 57161 and 249699. Income from 106664+26666 VCT at 4% = 5333 + 8000 + 10000 = 23333 topped up by 16666. Lump sum remainder 40495, 75% remainder 209699, VCT 133330. VCTs are 34.8% of total value.

year 6: you could now start to draw money from VCTs but I won't do that, letting their percentage increase for a bit longer. Now 41709 and 215989. Income from 133330+26666 VCT = 6399 + 8000 + 10000 = 24399. Top up 15601. Lump sum remainder 26108, 75% 175989, VCT 159996. VCTs are 44.2% of total.

year 7, this year the lump sum is just enough to lend the whole 26666 at the start of the tax year to be replaced by the 40k. It's the last year where this will be possible at the start of the year using the lump sum, in later years some VCT selling can be used instead. Now 26891 and 181268. income from 159996+26666 of VCT = 7466 + 8000 + 10000 = 25466 topped up by 14534. Lump sum remainder 15959, 75% 151268, VCT 186662. VCTs are 52.7% of total.

So far you've paid approximately no income tax at all on your 40k a year of income.

I haven't fully used the basic rate band, you should, to reduce the draw rate on your lump sum. That would probably let you do year 8 also with no income tax and no VCT selling. From year 9 on you'd need to start selling VCT investments to continue paying about no income tax while you draw the remainder of the pension pot.

The percentage of total investments in VCTs gets higher than desirable and starting in the sixth year it would be useful to start selling some VCTs that have good sale values, to reduce the growth in this percentage. 10% is a fairly often mentioned sort of VCT maximum level and this goes to many times that. Many reasons for this but they invest in small companies so even with diversification across lots of VCTs the investments have significant loss potential if you were forced to sell, though you probably won't be. Also the potential for other losses rather than just volatility.

While it's not strictly necessary you might also want to consider paying some income tax to reduce the VCT percentage growth. After the ten years you may well be able to continue deferring your income for at least five years to remain mostly or completely tax free for life, though do note that big caution about too much to be really desirable being in VCTs.

Triumph13

Hmm. Very clever, but looks like a prime example of letting the tail (tax) wag the dog!

mgdavid

Triumph13 wrote: »

Hmm. Very clever, but looks like a prime example of letting the tail (tax) wag the dog![/QUOTE

It seems to fit the OP's question; do you have an alternative equal or better plan ?

jamesd

Well, the question was about the most tax-efficient way, and this has no income tax or CGT at all... So long as micro company investing and the tie-in periods are acceptable it's a pretty neat way to go and the way I currently intend to do things myself.

jim8888

Thanks for the responses so far. In answer to some questions I do have a spouse and she will retire at the same time as me but will be unable to take her pensions at that age. She will get her pensions at 65 and I have another one that kicks in then too, hence I'm planning to spend the first one.

kangoora

jim8888 wrote: »

Thanks for the responses so far. In answer to some questions I do have a spouse and she will retire at the same time as me but will be unable to take her pensions at that age. She will get her pensions at 65 and I have another one that kicks in then too, hence I'm planning to spend the first one.

So, if you pop your clogs at 64.5 then your wife will presumably only get 50% of your existing pension and between you it looks like you will have spent £500k up to then. And vice versa.

I hope you both have a very good pension in your own rights and presumably no-one you wish to inherit anything. Fair play if you do.