The powerful combination of tax efficient planning and utilising allowances

After paying a lifetime of taxes and contributing to society, Derek’s main goal was to have a tax-efficient income in retirement and his target (net) income at this point in his retirement was £50,000.

 Derek’s assets are as follows:

Pension

Derek had always saved for his retirement and taken advice to pay as much in as he could during his working career. He had a and a balanced investment strategy. As he is over age 55, 25% (£200,000) of Derek’s pension can be taken as tax-free cash, and the remaining 75% (£600,000) of his pension can remain invested within the pension fund. He will only pay income tax at his marginal rate if and when he decides to draw income from the fund. At this stage Derek decides that he would like to take £20,000 per year of his tax-free cash over the next 10 years which takes him to age 72. 

 Buy-to-let property

 Derek invested into a buy-to-let when he sold his business. He understood that property is not a liquid asset and he has good long-term tenants. The rental income is £15,000 per annum. Income tax is chargeable on the rent received; however he is able to utilise his allowances. The first £1,000 of his income from property rental is tax-free (correct as of 2022/23 tax year). This is known as your ‘.’ He then utilises his ‘of £12,570 (correct as of 2022/23 tax year) and therefore his liability to income tax is £286 (£15,000 - £12,570 - £1,000 = £1,430 x 20%).

Individual Savings Account (ISA) portfolio

After taking advice nine years ago, Derek started to save in a managed investment portfolio ISA. ISAs are tax-exempt environments where assets can grow free of any taxes and no tax relief is given on the way in but is not taxed on the way out.

Derek started with £20,000 and continued to contribute the maximum allowance of £20,000 (per tax year) into his ISA each year. His ISA achieved an annualised gross return of 5% per year. Now in retirement he likes to take 5% (£12,500) per year as income. If his fund continues to achieve an annualised return of 5% then his capital is not eroded. There is no income or capital gains tax due when withdrawing funds from an ISA.

General Investment Account (GIA)

Unlike Derek’s ISA, his GIA is taxable. If he took income from the funds this would attract income tax, and on selling investments he may be liable to capital gains tax (CGT) if the gain in any tax year exceeds his annual allowance which is currently (ignoring any losses he may have made previously). This allowance is correct as of the 2022/23 tax year and will be changing 2023/24. His investment strategy is growth orientated. In this tax year he decides to take £7,500 from his GIA to supplement his income and there will be no CGT due.  

Venture Capital Trust (VCT)

Primarily, Derek implemented a VCT strategy so he could benefit from the 30% income tax relief on the amount he invested, again at the time he sold his business. He has held all of his VCT shares for more than five years which is the minimum period he must hold his shares to keep his income tax relief. His attention has now turned to the tax-free dividends that he receives from the VCT fund. Dividends are variable but he currently receives 5% which is £5,000 a year. In the future, all gains (if any) from selling his VCT shares are exempt from CGT.

Derek’s income tax position

Along with the tax efficient income, Derek likes the flexibility of being able to take more - or less - income if circumstances of life permit. The planning does not stop here for Derek as he could consider any of the following:

• Start taking state pension in four years’ time (measured against income tax).
• Start taking income from his pension (measured against income tax).
• Transfer £20,000 per year from the GIA into his ISA in the coming years and in effect moving his investments into a tax-exempt environment.
• Sell his buy-to-let property and implement another investment strategy.
• If Derek decided to sell his VCT shares and made a profit, the proceeds would not be liable for capital gains tax.
• Derek would also need to be mindful of is overall estate value and his inheritance tax liability.