Strategies for getting ready for retirement
Generating a constant and satisfying stream of income can be a complex task. In working life, the work to get paid cycle is straightforward. However, what happens when you reach retirement?
The current pandemic has and will present unchartered waters in the world of finance, which can worry those who are looking at or planning for retirement. However, with great advice, saving and planning, you can create a safety blanket and be ready for retirement by replacing the lost income.
How do I do this?
Is cash still king?
Use a bank account and simply withdraw the savings? Sure, this is fine; however, there needs to be a substantial level to cover you for several years, especially as life expectancy has increased over the last 20 years. According to the Office for National Statistics, females are on average living till age 82 years and males to age 79.
You could withdraw £20,000 capital on a sum of £300,000 for 15 years. Sound good? However, add a 5 per cent investment growth each year, and this longevity jumps to 25 years.
Yes, there are many different factors to consider when investing – risk tolerance, time frame and tax, to name a few. However, if used correctly, investments can provide you with a potential longevity boost.
So, if we are looking at investments and the boost they can give to your retirement pot, what types could be used to provide an income stream?
As safe as houses
A popular method for retirement is a buy-to-let house purchase, with the rent providing the income stream. Coupled with possible capital rises, a buy-to-let can seem like a win-win. Further, with a long-term tenant, a relatively stable return is generated, which can be in the region of a 2-11 per cent yield, depending on the geographical area.
However, changes to the rules around buy-to-lets, such as offsetting mortgage costs and stamp duty hikes, have reduced the attractiveness of such investments over the years. When added to a relatively high administrative burden of managing the property, income tax on rental receipts, capital gains on sales, potential tenant problems or void periods, maybe buy-to-let properties are no longer the panacea people once thought they were. Even if you can stomach the additional costs these issues can cause, there is also the lack of liquidity to consider.
If liquidity is a problem, what about the more ‘standard’ investments? Well, if these are the answer, we’re sorted, right? Let’s just throw our hard-earned lump sum at a fund manager and leave them to it! If they know to diversify between equities, bonds and fixed interest assets, we should have no trouble of meeting our income target, surely?
If only. Actually, investments can often appear confusing and abstract, especially when compared to the tangible nature of something like a house purchase. Not only is implementing a suitable investment strategy crucial for a client but also understanding the tax treatment is vital in determining the most appropriate structure for the client.
There are of course various structures available such as:
ISAs, for one, are extremely tax efficient and, given the right structure, can grow at an amazing rate.
The main advantages of an ISA are that they offer:
- a tax-free investment*
- tax-free growth*
- tax-free withdrawals*
*ISA’s are exempt from capital gains when the underlying investment is withdrawn plus income derived from the underlying investments is exempt from income tax.
This strategy can work exceptionally when used for income. Additionally, a wide array of investments can be used including equities, bonds and fixed interest. Therefore, ISAs can cater for most risk tolerances and needs. It must be noted the annual investment amount is a maximum of £20,000 per individual per tax year (2020-21 tax year).
If you’ve not heard, the pensions revolution is happening. Often seen as complex, archaic and boring structures, the introduction of relaxed income rules has thrust them firmly into the spotlight once more. The main perk to money purchase schemes via what is known as flexi-access drawdown being the ability to take as much income as needed at whatever point, with possible add ons, and favourable tax treatment within the fund and on death.
However, contribution allowances have fallen in recent years, plus withdrawals aside from the 25 per cent tax-free lump sum are taxed at an individual’s marginal rate, so there are again issues with what seems to be the perfect structure.
Something a bit different …
Outside of these ‘standard’ vehicles, we also have the more niche investments.
Venture capital trusts
Venture capital trusts offer a tax-free dividend on top of no capital gains tax on subsequent sale. They even offer 30 per cent income tax relief on investments up to £200,000 in any one tax year! Similar structures include Enterprise Investment Schemes and Seed Enterprise Investment Schemes, which can offer even more advantageous tax treatment.
However, it must be understood these investments are relatively higher risk. Therefore, investing all an individual’s savings into one is arguably not the most suitable advice.
With a large lump sum, investment bonds can provide for a very tax-efficient method of investment which there are advantageous tax treatments to consider. For onshore contracts, for example, the insurance company will suffer a 20 per cent tax treatment on investment income and realised gains within the bond. For offshore contracts, there will be little or no taxation within the bond incurred on its investments, which creates a multiplier effect as investment returns roll up gross.
For you, the investor, there are two major taxation benefits. Firstly, up to 5 per cent of the initial investment amount per annum can be withdrawn each year without liability to tax until a ‘chargeable event’ occurs. There is a distinct difference in choosing to hold the bond onshore or offshore as each one will have its own tax advantages therefore, when providing this advice to clients understanding their objectives and circumstances will assist in choosing the appropriate tax structure.
Secondly, these investments can be flexible enough to provide extra benefits when it comes to inheritance tax and trust planning.
As with all structures, there are issues (relative complexity) and although flexible, the tax treatment can be onerous if a very large lump sum is needed.
One investment to rule them all?
Hopefully I have made clear there are lots of investment structures you can use to generate an income and, indeed, the above examples only scratch the surface.
Each comes with their advantages and disadvantages and although there is no clear-cut winner, the above also show that by utilising a mixture – so, cherry picking structures to suit your objectives and needs – we can, together, create an easy-to-understand, tax-efficient portfolio that should get that income stream flowing pretty well.
Kieran Mehngar, consultant of Mattioli Woods plc.