Higher Rate Tax Payers : Income Tax Now and Then versus CGT

ossian

Hello Fellow Money Savers,

The short sighted investor writes... :cool:

I thought I had a sensible pension strategy but am now unconvinced and more than a little confused having read the SIPP versus ISA thread I suspect my strategy is wrong. I suspect that I need to focus more on using my CGT allowance as the advice seams to be to keep your taxable income to a maximum of around £20k. Is this the best approach or is this only if you are going to slightly over 20k?

I'll give some background detail but it may be superfluous as we should stick to discussing the general point and not giving "advice". Feel free to skip anything and head straight to the bold text sorry if my approach is naive.

After years of focusing on my mortgage and investing in pubs (buying beer, wine, whisky) I had decided to focus on my pension with the strategy of "not paying higher rate tax". Which has led me to adopt this approach...

I am paying £1600 gross a month into pension funds as of this FY (and £250 to get 1/75ths of my salary at 65).

I have the following money purchase funds (including the SIPP I just started):

Company Scheme AVCs £4,806
European Investment PPP £15,967
SIPP £4,986 [just started]

The final salary arrangement has had the retirement age lifted and the rate of accumulation reduced however I have accumulated approximately 12% of final salary if I were to cash in at 60 (early) although if I wait to 65 this uplifts significantly. So if I stopped work tomorrow and cashed in early I would get about £6100.

I am planning on dumping the Personal Pension into the SIPP when the protected rights are up and building up enough AVCs to get the maximum lump sum (when I cash in the company scheme at 60 or 65) and building up enough SIPP to retire at 55 with around £20k per annum income reduced by the 25% lump sum again (which will be invested in a mixture of growth shares, ISAs, and tax free bonds.

I have also started fully subscribing to ISAs since last year.

However to cut to a chase, I am now concerned that I am making a mistake because of tax. Should I scale down the pension payments and build up shares in a trading account to get me capital gains (I will use the ISAs for dividend income in retirement) to tide me over from 55-65?

What strategy should a higher rate tax payer take to secure an early (55) retirement on as good an income as he can get? £24k or so would probably be really comfy if I could get that without working for the taxman (again). I like foreign holidays

I am 38 years old and have a fixed rate (5.85%) mortgage of £40k which will be paid off in 3 years time. My wife runs her own finances and is in a final salary pension and is considerably younger and better looking

All the best,
Ossian :beer:

EdInvestor

You don;t seem to have factored in your state pension, which is taxable income.Do you know how much it is likely to be?

daveyft

I'm is a similar position as a higher rate taxpayer and aiming to retire at a similar age. I've taken the approach eliminating my higher rate tax liability by putting it into a SIPP. I have done this on the basis that I'll get growth on the full pre-tax amount, when I retire I'll get 25% of the pot tax free and the remainder will only be taxed at the standard rate.

As edinvestor says, dont forget to factor in the state pension. I know you have to wait for it but it means you can afford to burn up some capital in the preceeding years to increase your income, safe in the knowledge that the state pension will replace the income you would have got from that capital. This can add thousands to your pre 65 pension income. Just be carefull you get the sums right!

ossian

EdInvestor wrote: »

You don;t seem to have factored in your state pension, which is taxable income.Do you know how much it is likely to be?

Hi EdInvestor,

I read a number of your posts on the ISA versus Pension thread, they were very informative.

I don't have a 2008 view yet however on the 1/1/2007 the view was ...

To Date...
Basic SP £1533.48/annum
Additional £151.32/annum
Total SP £1684.80/annum

Future (65)
Basic SP £4381/annum
Additional SP £151.32/annum
Total SP £4532.32/annum

I can claim SP at 65 (hmphh!)

Thank you DaveyFT,

The thing that I hadn't been taking into account is the tax changes over £20k. I need to understand the implications of them better.

Looks like the GAD tables limit the ability to draw down from a SIPP to about 6% per annum or have I misread them. So no chance of burning through capital over a few years.

I reckon I need to both max ISAs and get some capital invested outside ISAs. We probably need to think about how to get my wife some income before she can get her pension too maybe part time work will be the answer (she's 9 years younger but that's a secondary concern, the primary one is getting a plan for me at 55).

Thanks guys,
Ossian

EdInvestor

ossian wrote: »

The thing that I hadn't been taking into account is the tax changes over £20k. I need to understand the implications of them better.

Once your income gets to slightly under 22k, you start suffering from age allowance clawback, which means your high over 65 personal allowance (currently around 9k, and due to rise to 10k), gets clawed back at a penal rate until it reaches the level of the ordinary personal allowance, now around 6k. So you need to keep taxable income below the 22 k level.(Note that dividends on shares do not attract tax from basic rate taxpayers, but are counted for income as far as age allowance goes.)

Looks like the GAD tables limit the ability to draw down from a SIPP to about 6% per annum or have I misread them.

The rate is 120% of the annuity rate for your age,so higher than that.If your fund rises in value you can get your income uprated, annually if you like.Gilt yields also affect it and the amount allowed rises with age.

We probably need to think about how to get my wife some income before she can get her pension too.

Try to make sure your wife has taxable income of 10k a year at least, so she uses the age allowance in full - the income will be tax free.

ossian

Once my wife reaches retirement age her NHS pension should do the trick. However she fancies spending some of my retirement time with me when I stop at 55, I think part time working will do the trick as she will be 46 when I am 55.

I don't want to work beyond 55 as my family health history is poor... diabetes, cancer, and dementia appear regularly on one side and stroke on the other. I am in fine health so far though.

So if I aim for say £21,800 pension in todays money and build up maximum S&S ISA funds for an additional £5-6k of income per annum then I will be doing okay. To get the most out of CGT I probably need some investments outside rappers that don't pay dividends. Do funds that reinvest or DRIP type schemes for individual shares count as income? Meaning if I don't touch the income can it be converted to capital without becoming income taxable?

I'm thinking that I could fund holidays by using my CGT allowance each year.

Thanks,
Ossian

EdInvestor

Do funds that reinvest or DRIP type schemes for individual shares count as income?

Yes

Meaning if I don't touch the income can it be converted to capital without becoming income taxable?

No.

Put all these investments in an ISA, solves the problem.

daveyft

ossian wrote: »

Looks like the GAD tables limit the ability to draw down from a SIPP to about 6% per annum or have I misread them. So no chance of burning through capital over a few years.

As edinvester has already said there is the 120% rule. Also, you will be able to get 25% of your SIPP pot as tax free cash so you could use that at whatever rate you like!

ossian

daveyft wrote: »

As edinvester has already said there is the 120% rule. Also, you will be able to get 25% of your SIPP pot as tax free cash so you could use that at whatever rate you like!

Gilt index yield = 4.75%
Age=55
Gender=M => Table 1
=> £60

Assume £100,000 to simplify the maths...

(£100,000/1000)*£60=£6000 so a 6% return

However I believe I am being told that I can take a maximum of 120% of this so I could draw down 7.2% of the fund? Or have I misunderstood.

Thanks,
Ossian

EdInvestor

ossian wrote: »

However I believe I am being told that I can take a maximum of 120% of this so I could draw down 7.2% of the fund?

That's correct, so 7,200 p.a.