Grrrr...trying to optimise drawdown plans for tax efficiency is tricky!

jamesd

GazzaBloom said:

jamesd said:

It seems that you're destined to pay basic rate income tax eventually, unless you die first. Dying first seems unlikely so is it better thought of as when rather than if to pay the tax? ...

Yes, it is a case of when not if. That's what I need to work out, which route sees me paying the least income tax. Crystallise more to cover the one off spend at the start to avoid tax but accumulate more crystallised money that will be taxed over the £12,570 personal allowance when drawn in later years. Versus just paying the income tax in year one and keeping more uncrystallised for future years.

I'm sure one more go on the spreadsheet will reveal the answer, when I get time.

Let's consider that death timeline.

If you die after age 75 the beneficiaries of the pension are taxed as they withdraw it.
If you die before age 75 they aren't.

This is amenable to optimisation. You could try to keep taxable money in the pension, knowing that if you were to die before 75 it'll be transmuted to tax free. After 75 it's merely no difference.

However, there's a possible short term optimisation: our current Chancellor may reduce the basic rate of income tax in a few weeks and a quite likely Labour chancellor may be disinclined to retain that cut. If you share that opinion you might take the view that drawing taxable money to use your whole basic rate band while the rate is say 19% is worthwhile. Or not. The current Chancellor will tell us soon but the rest involves a crystal ball.

jamesd

michaels said:

jamesd said:

It seems that you're destined to pay basic rate income tax eventually, unless you die first. Dying first seems unlikely so is it better thought of as when rather than if to pay the tax?

I solved it for myself with VCT buying to largely eliminate the tax cost but that might not be right for you.

Any worked examples of using VCTs?
Lets suppose I am planning on taking £30k pa of taxable money from my pension every year for the rest of my life. 
So in 24/25 I pay 30k x 20% = 6k of tax and 24k of income.  I invest 20k in 'a VCT' in the same tax year and my income tax liability falls to zero so 30k from pension of which 20k is invested in VCT?
Next I receive dividend from the VCT for the next 5? years say 5% pa so 1k pa tax free
Finally after 5 years I can sell the VCT for whatever it is then worth say 10k which is also tax free.
And I have turned 24k of post tax income into 25k?

Is this correct?

Not really correct:

1. Selling VCTs which originally cost £20k for only £10k is unlikely. Though some money will be deducted by the promoter and others when you buy so you might get say 97.8% of your spend invested, that being a real number from one of mine. The full £20k gets the initial tax relief. At sell time, ignoring some likely growth the typical buyback policy is 5% so on £19,560 actually bought times 95% you'd get £18,582.

2. £30k of taxable pension of which say 97.8% of £20k is in the VCT, £19,560. £4k after VCT spend is in your bank account initially then HMRC adds the £6k tax refund leaving £10k in your bank.

So £30k taxable becomes £10k + £1k×5 + £18,582 = £33,582. Vs £24,000 plus whatever you make on it without VCT use.

This ignores special dividends after selling invested companies. In the Albion VCT case a few years ago this was around 30% of the total VCT value. So the effective later sale 5% haircut would be on only 70% of the amount purchased.

This also makes it fairly clear why VCT buying can be viewed as deferred income: instead of £24k spendable at the start you only have £10k. Add the personal allowance and you have 61.7% of what you could have initially. If you actually need to spend the money you have to cover that initial difference somehow.

PCLS can handle that nicely. On 30k taxable plus £12,570 personal allowance a 25% PCLS would be (£12,570 + £30,000) / 3 = £14,190. £14,190 + £12,570 + £10,000 delivers £36,760. Vs £12,570 + £24,000 = £36,570.

Of course that assumes no other need for that bit of PCLS.

For convenience I've stuck with 5% of £20,000 for dividends when it's really be 5% of £19,560.

jamesd

michaels said:

If I actually want to achieve a steady income should I draw max from pension in Y1 to stay in basic rate tax and put enough into the VXT to cover the tax liability and then similar in Y2 but taking into account the dividend income then gradually reducing amounts until I am at steady state with new pension drawings and VCT investments less dividends and sale proceeds?

Yes. But with the usual dividend plus equity sales caveats.

It's also worth mentioning that the dividend policy is typically 5% of NAV. As with any investment trust the NAV varies so you'll need some buffer. You may also find that five years comes at a down time and prefer to hold, so more buffer needed for that.

Of course that's not any different from the usual scheduled equity dividend yield and capital drawing mixture in its properties. VCTs are part of the equities percentage too and that's where bonds may come in, as usual.

I'm simply drawing at about max basic rate because what I don't spend gets saved or invested somewhere anyway.