Tax efficient retirement income using all available allowances

By Sam Whybrow, Financial Planner
020 7490 7766


£50,000 + tax-free annual income! It’s possible.
The Finance Act 2016 (which received Royal Assent on 5 September 2016) has served to add further complexities to our tax system. On the bright side, these provide opportunities for clients to benefit. Using multiple taxwrappers and with considered financial planning, clients can take advantage of the various updated allowances. Through careful preparation and planning, a substantial level of tax-free income, in excess of £50,000pa per person, can be achieved.

Personal Allowance – £11,000pa tax free
Unless you have adjusted net income in excess of £100,000pa, the first £11,000 of taxable income falls within the Personal Allowance (PA) and will be tax free. On retirement, the use of a flexi-access drawdown pension allows income to be varied, or turned on and off, as required. This is very tax efficient and flexible.

Company owners who have the potential to set their own salary can derive the balance
of immediately required income from dividends while taking advantage of employer pension contributions for the balance of available profits. Managing profit extraction can significantly influence the level of tax due.

Personal Savings Allowance (PSA) up to £1,000pa tax free
It is now possible to receive up to £1,000 (basic rate taxpayer) or £500 (higher rate taxpayer) of interest payments without any liability to income tax. This is available to all (except additional rate taxpayers). However, given the current level of interest rates offered by high street bank / building society accounts (approx. 0.25%), you'd need £400,000 invested to exceed this allowance (for a basic rate taxpayer), so perhaps alternative investments, such as interest producing unit trusts/Open Ended Investment Companies (OEICs), are worth considering.

Starting rate of tax – up to £5,000pa tax free
You can also get up to £5,000 of interest tax-free due to the starting rate for savings. The more you earn from other income (for example your salary or pension), the less your starting rate for savings will be. The 0% band is restricted by non-savings taxable income so that the band is reduced to nil if your nonsavings income exceeds your personal allowance (£11,000 for 2016/17) plus the £5,000 starting rate. The result, for 2016/17 is that if your other income is £16,000 or more, then you won’t be eligible for the starting rate for savings.

If your other income is less than £16,000 then you may be eligible. However, if your nonsavings income exceeds £11,000, then, for every £1 of other income over the £11,000 Personal Allowance your starting rate for savings reduces by £1. Effectively your non-savings taxable income needs to be below £11,000 in the current tax year in order to make this work.

The starting rate of tax (0%) is advantageous for people living off savings rather than earnings. Accumulating savings or making an investment that can provide payment of interest, during retirement, when your non-savings income reduces, is sensible.

Dividend allowance – up to £5,000pa tax free
The new dividend allowance provides that the first £5,000 of dividend income is taxed at 0% regardless of your current tax position. Dividends are derived from the ownership of shares and can be via direct ownership or via an appropriate collective investment. Based on the FTSE 100 average yield of 3.76% (3 January 2017), an investment of approximately £132,979 in shares / unit trusts / OElCs would be required to generate this amount of dividend. Assuming that such an investment suits your risk profile, dividend producing investments can be a useful tool to boost tax-free income irrespective of your current tax position. Please note that the recent Budget has slashed this allowance from £5,000 to £2,000, effective from April 2018 which may result in a change to the amount recommended to be invested.

Capital Gains Tax (CGT) Annual Allowance up to £11,100pa tax free
If you realise gains on investments up to the value of £11,100pa they will not be liable to CGT. This could be the same share / unit trust /OEICs holding that's generating the dividends required to utilise the Dividend Allowance /Personal Allowance and / or the same unit trust /OElCs holding, generating the interest to exploit the Personal Savings Allowance.

That’s £33,100 of income tax free, but why stop there?
It’s possible to include the tax-free PensionCommencement Lump sum from unvested pension funds (if aged 55 plus), the 5% pa tax deferred allowance for investment bonds and tax-free withdrawals from ISAs.

Pension Commencement Lump Sum (PCLS) £? pa tax free
Up to 25% can usually be drawn tax free from defined contribution pensions up to the value of £1m. By phasing the PCLS over, say 20 years, this £250,000 could provide another £12,500pa tax free. You can also use the remaining pension fund value and withdraw an income to offset against the Personal Allowance.

Individual Savings Account – £? pa tax free
Any money drawn from an ISA is tax free. A cash ISA could yield around 1.5%pa (if fixed for 5 years) on an ISA holding of £300,000, which could provide a further £4,500 to bring your tax-free income up to £50,100. Alternatively investing in non-cash ISAs could mean targeting capital growth to fund tax free withdrawals. An ISA holding of £112,500 with a 4% investment return could produce the same £4,500.

Appropriate planning, using multiple tax wrappers, can result in considerable tax wins. We haven’t considered the use of EIS or VCT investments in this article but these could also be used, if appropriate, to boost the tax-free income that clients can generate. We have only considered planning for an individual in this article rather than as a couple. Using two sets of the same allowances may make this tax free income planning more achievable for some. The role of the adviser is to simplify the confusion and produce opportunity from change. If you are interested in generating tax-free income, please contact the LFWM team. Remember that some of these allowances will increase for next tax year.


Thank you to Les Cameron, Head of Technical at Prudential, for the content within this article.

This article is for information only and professional advice should be taken in advance of any changes to your financial affairs. HM Revenue & Customs’ practice and the law relating to taxation are complex and subject to individual circumstances and changes which cannot be foreseen. Tax advice and National Savings & Investments are not regulated by the Financial Conduct Authority. Lubbock Fine Wealth Management LLP is authorised and regulated by the Financial Conduct Authority.

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