Looking for advice

Twerly

Happy New Year to everyone. 

I hope someone can offer some advice, I am 60 in May and will stick to my plan of not renewing my current contract and finish just before my Birthday.  I am lucky and saved during my contracting years so have a few DC pots which will be about £780K by May, full SP at 67, plus a long term DC pot of around £180K which I will not cash in until I am 74, this gives a joint GAR of 86/100 that rises 3% p/a , at 74 my wife will receive full SP and a DB Pension . A Financial Advisor has told us to basically use my £780K to last until 74 at which time we will have a combined pension that is guaranteed sufficient to meet the comfortable retirement. Note - my wife is also giving up work this year, therefore the fund will meet both our needs.

What I am looking for is the most tax efficient method to maximise income from the DC pot of £780K  - Should I take the maximum tax free, invest 2 x £20K in ISA p/a , looked at purchasing a guaranteed fix term Annuity for the 14 / 15 years to 74, alternatively am I better only taking smaller tax free and using this over a longer period.  My risk profile is now lower as from my retirement planning the pot will more than cover myself and my wife's lifestyle.  I obviously want to minimise my HMRC tax liability, therefore understand the use of the tax free amount, also I get the full SP at 67.  I am going to get some financial advice Jan/Feb, however would value advice from this forum as sure there are other method of getting the best return/risk on the DC pots. 

Thanks in advance

El_Torro

Assuming you don't need a big lump sum when you retire (you don't say you do) then generally speaking it makes sense not to take the 25% tax free lump sump and instead get 25% tax free on any withdrawals you make. That way you could keep the majority of your pension invested and growing. You may want to keep some of your pension in cash, depending on when you want to access it. 

You mention putting some of the withdrawal in an ISA. I know some people who are doing this, I've never really crunched the numbers myself but it seems sound enough, since anything in an ISA won't be taxable. However you are paying tax up front by removing it from the pension so I'm not sure how much of a benefit this actually is. 

The important thing is to avoid (if you can) paying 40% tax on any withdrawals.

Whether or not to buy an annuity is a personal choice. If a guaranteed fixed term annuity for 15 years will comfortably cover your expenditure / outgoings then why not? You might be better off in drawdown with a sound withdrawal strategy, up to you if you think it's worth the hassle.

Twerly

Thanks for coming back.  You are correct we do not need the lump sum for any major life purchases, Defo want to avoid 40%, my concern like many approaching retirement is protecting my capital against sudden stock market shocks, hence the potential of 15 year guaranteed annuity, also know we could get more by a draw-down pension, this has benefit of potential growth, however also more risk. 

LHW99

A Financial Advisor has told us to basically use my £780K to last until 74

If you have a Financial Advisor (Independent I hope) what has he said about your questions? You are presumably paying him / her for advice?

You should also bear in mind that although there are many helpful and knowledgable people here, they will be offering opinions, and then it is up to you to consider and DYOR. Advice is not allowed.

jamesd

The most tax efficient approach for taxable money is probably the one I'm using: withdraw up to £53,870 taxable at basic rate by using £3,600 of gross pension contributions to raise your basic rate band.

To eliminate the income tax on this, buy Venture Capital Trusts. HMRC will repay 30% of the purchase price and they typically pay tax exempt dividends of 5%, 7.15% of your net purchase price, plus periodic special dividends. The normal buying increment for VCTs is £1,000. Income tax due on £41,300 at 20% is £8,260. £27,533 of VCT buy would cover this but £27,000 is what you can buy. That'll cover 20% on £40,500 so reduce your taxable income target to £53,070.

You have to hold VCTs for five years or repay the 30%. After that you can sell and reinvest. £27,000 gross for five years is £94,500 after the tax relief and that's a reasonable amount given your total assets.

What do you mean by a GAR of 86/100? GAR normally means guaranteed annuity rate but 8% would be a high GAR. They also often have set periods when the GAR can be used.

What sort of income could you use, including for things like around the world cruising? I'm asking because your income potential exceeds your 40% threshold ability to avoid tax with VCTs unless you take some taxed at 40% and buy 1.33 times that much in VCTs. Doable, of course, but it could really increase your total VCT holding.

For the 25% tax free money your annual requirement seems to be at least £20,000 to cover ISA reinvesting plus £27,000 to cover the VCT buys so you can spend the whole £53,070. In later years the VCT dividends will end up adding about 7,15% of the £94,500, so £6,757 extra tax exempt a year.

Using seven years to state pension age and ignoring growth this could get out £53,070 × 5 = £371,490 taxable and £329,000 tax free minus two years of VCT recycling so £275,000. The first pension pot of £780,000 has £585,000 taxable and £195,000 tax free so couldn't fully manage the tax free need on its own. The £180,00 pot could provide some of the shortfall and you might be willing to pay some 40% tax or not eliminate all of the 20%.

I don't know the DB income but £10,600 in state pension each is £21,200 as a start on matching the £53,070+£6,757=£59,827 a year, leaving £38,627 shortfall with £38,627. Ignoring the taxable/tax free difference you'd have £780,000 - £371,490 - £275,000 = £133,510 left in the first pot and the £180,000 in the second. £313,510 including the second. Assuming 15 more years and ignoring likely equity release that cuts the shortfall by £20,900 to £17,727. If the DB at least matches this the income should be sustainable for life.

Then there's the £140,000 in ISAs that could be drawn on to supplement the tax free need or income and the £135,000 gross in the VCTs.

More rigourously I'd use a safe withdrawal rate calculation set for this but the picture is clear enough anyway.

jamesd

I'll do a basic safe withdrawal rate calculation assuming you're willing to accept the variability of the Guyton-Klinger rules (guidelines, really). Those in the UK start at 5% of initial capital for a 30 year plan and usually increase with uncapped inflation but sometimes skip it or add extra increases depending on the investment times you live through. Around 0.2% deduction for a 40 year plan.

With £780,000 + £180,000 you have at least £960,000 starting capital. 5% of this is £48,000 for 30 years or 4.8% is £46,080 for 40. Given the state pension providing £21,200 and the DB it's clear that SWR calculations also support the sort of income level covered in my previous post, quite likely more.

jamesd

Term annuities tend not to be very efficient and given the SWR numbers that would have worked for the worst historic UK market performance perhaps you might forgo that?

Alternative approaches include the quite popular bond ladder approach, where you buy index-linked bonds maturing each year to provide required income.

A conventional and generally appropriate investment mix would be 60% equities and 40% bonds. 40% of £960,000 is £384,000 of bonds you could draw on during a prolonged equity downturn. Or you could mix some bond ladder, some bonds and some term annuity.

SWR calculation used historic returns. My first post used the far too pessimistic for reality no returns except VCT dividends for around 40 years one and mostly ignored the later VCT dividends.

Marcon

jamesd said:

To eliminate the income tax on this, buy Venture Capital Trusts. HMRC will repay 30% of the purchase price and they typically pay tax exempt dividends of 5%, 7.15% of your net purchase price, plus periodic special dividends. The normal buying increment for VCTs is £1,000. Income tax due on £41,300 at 20% is £8,260. £27,533 of VCT buy would cover this but £27,000 is what you can buy. That'll cover 20% on £40,500 so reduce your taxable income target to £53,070.

You have to hold VCTs for five years or repay the 30%. After that you can sell and reinvest. £27,000 gross for five years is £94,500 after the tax relief and that's a reasonable amount given your total assets.



Then there's the £140,000 in ISAs that could be drawn on to supplement the tax free need or income and the £135,000 gross in the VCTs.

VCTs have big tax advantages for a reason: they are high risk, especially if you are concerned about loss of capital. Do a bit of googling on 'are VCTs risky investments' and you'll get the picture.

I'm not sure any competent IFA would be quite so categoric about the above plan!

jamesd

VCTs are classed as high risk but for me they haven't delivered that. Perhaps because I've been concentrating on those doing mid to late stage funding, previously mostly asset backed. My own choices and experience suggests doing better from them than what I wrote. Just the tax relief and five years of 5% dividends on the purchase price gets out 55% of the capital.

The plan isn't particularly categoric. It just explains how VCTs can be used to deliver the tax saving objective, while using a moderately small amount of the money involved.

It's also worth remembering that VCTs have a risk of loss but the tax is a certainty of loss.

LHW99

One question, you say:

at 74 my wife will receive full SP and a DB Pension . A Financial Advisor has told us to basically use my £780K to last until 74 at which time we will have a combined pension that is guaranteed sufficient to meet the comfortable retirement.

Do you mean 74? That seems late to recieve SP and a DB.

Also, while I can appreciate the points jamesd makes, considering particularly:

VCTs are classed as high risk but for me they haven't delivered that. Perhaps because I've been concentrating on those doing mid to late stage funding, previously mostly asset backed. My own choices and experience suggests doing better from them than what I wrote.

As said above, VCT's need a good deal of "looking beneath the bonnet", in order to understand exactly what they invest in, how they expect to derive their returns etc.

If you have reached age 60, and need / want to use an (I)FA, VCT's could be a step too far.

Twerly

jamesd said:

The most tax efficient approach for taxable money is probably the one I'm using: withdraw up to £53,870 taxable at basic rate by using £3,600 of gross pension contributions to raise your basic rate band.

To eliminate the income tax on this, buy Venture Capital Trusts. HMRC will repay 30% of the purchase price and they typically pay tax exempt dividends of 5%, 7.15% of your net purchase price, plus periodic special dividends. The normal buying increment for VCTs is £1,000. Income tax due on £41,300 at 20% is £8,260. £27,533 of VCT buy would cover this but £27,000 is what you can buy. That'll cover 20% on £40,500 so reduce your taxable income target to £53,070.

You have to hold VCTs for five years or repay the 30%. After that you can sell and reinvest. £27,000 gross for five years is £94,500 after the tax relief and that's a reasonable amount given your total assets.

What do you mean by a GAR of 86/100? GAR normally means guaranteed annuity rate but 8% would be a high GAR. They also often have set periods when the GAR can be used.

What sort of income could you use, including for things like around the world cruising? I'm asking because your income potential exceeds your 40% threshold ability to avoid tax with VCTs unless you take some taxed at 40% and buy 1.33 times that much in VCTs. Doable, of course, but it could really increase your total VCT holding.

For the 25% tax free money your annual requirement seems to be at least £20,000 to cover ISA reinvesting plus £27,000 to cover the VCT buys so you can spend the whole £53,070. In later years the VCT dividends will end up adding about 7,15% of the £94,500, so £6,757 extra tax exempt a year.

Using seven years to state pension age and ignoring growth this could get out £53,070 × 5 = £371,490 taxable and £329,000 tax free minus two years of VCT recycling so £275,000. The first pension pot of £780,000 has £585,000 taxable and £195,000 tax free so couldn't fully manage the tax free need on its own. The £180,00 pot could provide some of the shortfall and you might be willing to pay some 40% tax or not eliminate all of the 20%.

I don't know the DB income but £10,600 in state pension each is £21,200 as a start on matching the £53,070+£6,757=£59,827 a year, leaving £38,627 shortfall with £38,627. Ignoring the taxable/tax free difference you'd have £780,000 - £371,490 - £275,000 = £133,510 left in the first pot and the £180,000 in the second. £313,510 including the second. Assuming 15 more years and ignoring likely equity release that cuts the shortfall by £20,900 to £17,727. If the DB at least matches this the income should be sustainable for life.

Then there's the £140,000 in ISAs that could be drawn on to supplement the tax free need or income and the £135,000 gross in the VCTs.

More rigourously I'd use a safe withdrawal rate calculation set for this but the picture is clear enough anyway.

Hi James, thanks very much for your detailed response, I will read this slowly and take notes. The GAR is extremely generous, taken out back around 1990, I can take upto 75 , the  rate I quoted is for 74 and is over 8.3% joint life and rises with inflation.   Adding this to both SP and my wifes DB of around 10K at 2024 levels is around 46K /pa (this will grow as all the pensions should continue to grow) As said I will ready you response carefully as there is lots to review and understand.