Investment income projection

MJSW

oceanblue wrote:

You mentioned in an earlier post the possibility of posting calculations; I think this is an excellent idea.

Let's assume that brodev retired, aged 65, in the second week of April 2005. Let us also assume that his total income for 2005/2006 is £23,890.00. However, this income is produced in one of two ways:

1) £19,500.00 is from State Pension and Occupational Pension; the remaining £4,390.00 is generated by dividend income. How much income tax would be due?

2) £19,500.00 is from State Pension and Occupational Pension; the remaining £4,390.00 is generated by withdrawals from an investment bond. How much income tax would be due?

Is there a difference between the two amounts due?

What has caused this difference?

Indeed, excellent idea. (I'm assuming the dividend figure in this example is the gross figure rather rather than the net, althought it doesn't actually make any difference to the end result anyway in this particular example).

- Scenario 1, the tax due would be £2962.30 (£4895 @ 0%, £2090 + £4390 @ 10% & £12515 @ 22% less tax credit of £439).
- Scenario 2, the tax due would be £2479.40 (£7090 @ 0%, £2090 @ 10% & £10320 @ 22%). That assumes the investment bond withdrawals are within the 5% limit.

The difference is £482.90. The dividend income is £4390. The additional tax as a result of receiving those dividends is therefore precisely 11%, as I have stated from the outset. I trust you now agree that it isn't 33%, as stated by both yourself and dunstonh on numerous occasions.

"Using high yield shares in that case, would reduce the age allowance causing an equivalent tax rate of around 33%."

"I repeat that investing in a high yield portfolio could increase taxation making brodev an equivalent 33% tax payer."

"Effectively, therefore, some of your income could be taxed at an equivalent rate of 33% if you fall into this "Age Allowance Trap"."

"The reduction of the allowance causes an equivalent rate of 33%."

"This will lead to some income being caught in the "Age Allowance Trap", with an effective tax charge of 33%."

You then picked up on a potential ambiguity in dunstonh's post - and you have wilfully misunderstood this ever since.

In what way have I 'wilfully misunderstood' anything? And in what way is saying the additonal tax could be 33% "a potential ambiguity"? All these are statements quite simply WRONG. Plain and simple. It is 11% on dividend income!

oceanblue_3

"No the discussion was about the norwich union bond against a high yield stock portfolio..." Deemy, look at the original post, and then look at dunstonh's reply.

"An issue was made on nit picking one aspect i.e. tax on dividend income against drawing capital from the bond of 5%, as that is what i am presuming i.e. to draw cash from the bond your selling some units ? Unless I am mistaken and you want to better explain that aspect of the product ?" I have been referring to the overall suitability of certain solutions posted for brodev's situation. A portfolio of high-yielding shares could be suitable, but it has several characteristics which could make it unsuitable. In addition, the taxation of assets held in an investment bond is, in many respects, less favourable than that of shares - but, that should not be the main consideration.

"I mean if your selling units, then its best to compare against taking profits on stock capital gains, which is set against CGT." Well, I can't argue with that; however, in an investment bond, you're effectively allowing natural income to accumulate, as the dividends, property receipts, and gilt payments are not distributed. In a Distribution Bond, for example, there is no encashment of units - natural income is paid out.

"And as others have mentioned the commission is an important factor as its effects can reduce the gains anywhere from 33% to 50% !" What evidence do you have to demonstrate this?

MJSW says this..."In what way have I 'wilfully misunderstood' anything? And in what way is saying the additonal tax could be 33% "a potential ambiguity"? All these are statements quite simply WRONG. Plain and simple. It is 11% on dividend income!

I have never said that the "additional tax" could be 33%. Look at your calculation above; if we examine that part of the income which exceeds £19,500.00 - £4,390.00 - to what extent is its value affected by tax? For simplicity, I'm assuming that this is a gross dividend.

MJSW

oceanblue wrote:

I have never said that the "additional tax" could be 33%. Look at your calculation above; if we examine that part of the income which exceeds £19,500.00 - £4,390.00 - to what extent is its value affected by tax? For simplicity, I'm assuming that this is a gross dividend.

Well obviously its value is affected by 11%. The part the income which exceeds £19500 is entirely dividend income (dividends are the top slice of income), so the tax on the £4390 income itself is precisely zero. The only tax effect caused by that additional £4390 is the loss of the Age Allowance, which causes effective tax of 11% (as I have have just demonstrated by comparing the tax liability with and without the dividend income).

EdInvestor

oceanblue wrote:

"I mean if your selling units, then its best to compare against taking profits on stock capital gains, which is set against CGT." Well, I can't argue with that; however, in an investment bond, you're effectively allowing natural income to accumulate, as the dividends, property receipts, and gilt payments are not distributed. In a Distribution Bond, for example, there is no encashment of units - natural income is paid out.

Eh? On the one hand, you're saying the "natural income" is accumulating, on the other that it's paid out. Which is it?

Does the 5% annual payment to the investor come from the capital (in which case capital gains tax would be applicable) or the income? (in which case income tax would be applicable?)And while we're looking at these products, are the insurer's charges deducted from the capital, or from the income?



#Oh and BTW for most people, this discussion will be pretty academic, as their direct share portfolio will be held in an ISA and therefore not subject to any tax at all. Obviously 100k can be injected into an ISA quite quickly by a couple @14k a year. Nevertheless, it's very useful to know that the maximum impact the divi income would have have on your tax while you were doing that is only 11%

MJSW

Ed, I think you are not understanding how these bonds work or what they are. CGT isn't generally applicable to them (unless you buy them 'second hand'), and there is no Income Tax to the investor at the time of withdrawal if it not more than 5% (although there could potentially be some later). The underlying tax is on the income and gains is paid by the insurance company rather than the investor. There is usually only additional tax for the investor personally if the partial withdrawals exceed 5%pa cumulatively or on encashment, and that pushes them into higher rates (or if it affects their Age Allowance!)

As far as brodev is concerned, the tax discussion is pretty academic anyway, as he has already said that his wife has minimal income. If the portfolio of shares were acquired wholly (or possibly just partly) in her name, then there would be no additional Income Tax at all for either of them (although there may be other consequences of doing this).

oceanblue_3

MJSW, I note that you concur with the assertion that more tax would be due - thank you.

You also go on to say this..."The only tax effect caused by that additional £4390 is the loss of the Age Allowance, which causes effective tax of 11% ".

It has never been my contention that dividend income in excess of the Income Limit For Age Allowances of £19,500.00 would attract a higher tax charge on the dividends themselves. My point has always been that any income in excess of this limit would cause some of the income already taxed at 22% to suffer an additional tax burden. Your calculation puts this at £482.90; this is 22% of the Age Allowance of £2,195.00, or 11% of the additional income of £4,390.00. Beyond this point, there is nothing further to lose........unless both husband and wife breach the limit..........and they continue to do so for another 20 years......

I am also grateful that you have taken the time to attempt to disabuse Edinvestor of some of her misguided conceptions concerning Investment Bonds, and that you have intimated that there may well be some issues concerning the overall suitability of a portfolio of shares owned solely by one spouse.

EdInvestor

MJSW wrote:

Ed, I think you are not understanding how these bonds work

You're not wrong about that,MJSW, historically these bonds were mostly invested in With-profit funds and I defy anyone to explain exactly how WP works, even the FSA doesn't seem to have really figured it out yet.

CGT isn't generally applicable to them (unless you buy them 'second hand'), and there is no Income Tax to the investor at the time of withdrawal if it not more than 5% (although there could potentially be some later).The underlying tax on income and gains is paid by the insurer....

Right, that clarifies the tax aspect. What I also want to know is where the withdrawn money is coming from: the income earned by the invested capital within the bond, or the capital itself?

You see, I think it's a matter of some considerable concern that insurers mix up the income and capital so that investors can't see clearly what is happening to their capital and how much it is earning.Most of the people who buy these investment bonds think of them as like the savings bonds they are used to - they have it in their mind that the 5% withdrawal is the earnings on the capital invested in the bond, like interest on a savings bond, or for that matter the income distributions by an equity income fund - which are dividends earned by the shareholdings in the fund.

But it clearly doesn't work like that.And that's why they often get a severe shock when they go to cash in the bond and discover the withdrawals have been apparently been coming from their capital.Precipice bonds ( a different but related animal), were obviously the worst case in this area.

So I'm seeking clarity on the issue.It should be easier now, as WP is more or less out of the picture. What's under the bonnet?

oceanblue_3

Edinvestor says this..."Most of the people who buy these investment bonds think of them as like the savings bonds they are used to."

And I suppose you're going to supply empirical evidence to support this assertion?

She goes on to say this..."Precipice bonds ( a different but related animal), were obviously the worst case in this area." This is a vicious calumny: precipice bonds have absolutely nothing to do with Investment Bonds.

Edinvestor, [sotto voce].......I think MJSW was trying to tell you that you don't appear to know what you're talking about - it is testament to his percipience that he has seen this so quickly.........

dunstonh

You're not wrong about that,MJSW, historically these bonds were mostly invested in With-profit funds and I defy anyone to explain exactly how WP works, even the FSA doesn't seem to have really figured it out yet

So the choice of one fund on a bond means you should ignore the other 100 or so available? If you do not like with profits, do not choose it. With profits is a fund. Investments bonds are a product. You are comparing petrol against a car.

Right, that clarifies the tax aspect. What I also want to know is where the withdrawn money is coming from: the income earned by the invested capital within the bond, or the capital itself?

Its withdrawal of capital (upto 5% p.a.)

You see, I think it's a matter of some considerable concern that insurers mix up the income and capital so that investors can't see clearly what is happening to their capital and how much it is earning

If you set up a regular withdrawal from your bank account, you dont class that as income. Why should it be thought of any differently with a bond? I dont think you would find a single provider that calls it income. You will see it referred to as withdrawal.

Most of the people who buy these investment bonds think of them as like the savings bonds they are used to

Never come across anyone that has. In your professional capacity as a daily telegraph money section reader, how many clients have you found with that opinion?

they have it in their mind that the 5% withdrawal is the earnings on the capital invested in the bond, like interest on a savings bond, or for that matter the income distributions by an equity income fund - which are dividends earned by the shareholdings in the fund.

If someone choses not to know how a product works, then that is not the fault of the product. It comes with an manual.

Precipice bonds ( a different but related animal), were obviously the worst case in this area.

Next you will be comparing corporate bonds with James bond because they both have bond in the name.

So I'm seeking clarity on the issue.It should be easier now, as WP is more or less out of the picture. What's under the bonnet?

Unitised With profits invested with NU or Pru in the last 18 months have done very nicely. You do not eliminate a product because you personally do not like it. It still makes a very good fund for trusts where MVRs are never going to be an issue but capital security is. Those two providers also are MVR free after 5 years on their products if desired. Some people like the smoothed return on with profits and with the right tax wrapper and the right attitude to risk and goals, it is still a valid product.

Its not a product ideally suited to the sophisticated investor but its ideal when used in the right circumstances and, importantly, with the right provider.

cheerfulcat

dunstonh wrote:

Its withdrawal of capital (upto 5% p.a.)



If you set up a regular withdrawal from your bank account, you dont class that as income. Why should it be thought of any differently with a bond? I dont think you would find a single provider that calls it income. You will see it referred to as withdrawal.

This is disingenuous to say the least. The investment bond sold to me in a weak moment was sold on the basis that it would provide a "regular income". They are structured to provide a "regular income". The word "income" was used several times in relation to the regular withdrawals in the letter from the IFA ( example - " supplement your other income " ). The fact that the "income" is actually a withdrawal of capital would escape most people, especially those unfamiliar with the concept.

Yes, of course the providers are very careful not to use the word " income ". The same providers think that the opposite of a "gain" is not a "loss" but a "deficiency".

It is understandable that would-be investors are confused. To my mind there is deliberate obfuscation of the facts by providers and IFAs.

If someone choses not to know how a product works, then that is not the fault of the product. It comes with an manual.

The literature is almost unreadable so RTFM is not an option for most people.

Cheerfulcat