Retirement planning for those restricted by the reduction in the lifetime allowance or limited by the tapered annual allowance can present both a challenge and an opportunity in terms of looking beyond pensions when planning for retirement.
The tapered annual allowance has, in effect, reduced the ability for many high earners to make substantial contributions to their pension plans. Anyone who has total adjusted income in excess of £150,000 will see their annual allowance reduce by £1 for every £2 of income up to a maximum reduction of £30,000 for income of £210,000 and over.
The lifetime allowance, which reduced from 6 April 2016 to £1m, has also effectively reduced the scope of wealthier clients, with large pension pots, to fund their pensions further for retirement. Some may have applied for Fixed Protection 2016 or had some previous from of protection where contributions are no longer possible without revoking their Fixed Protection.
What can these types of individuals do when further pension funding is no longer an option?
Retirement planning – building benefits at the accumulation phase
Well it makes sense for most clients to utilise whatever allowance is available to them as pensions can still be one of the most tax efficient forms of savings for retirement.
Beyond that, international bonds may be a suitable alternative or complementary to pensions for those looking to build benefits for retirement.
Some of the main features are:
- Some bonds can accept regular premiums
- Funds within a bond can benefit from gross roll up
- They can facilitate a tax efficient income (taking income within the 5% tax deferred limit)
- They can also be a tax efficient vehicle for wrapping the bond into a trust
- There are no annual or lifetime limits on the level that can be invested within a bond
Retirement income – taking benefits at the decumulation phase
Retirement is no longer a rigid event on a set date and many individuals retire in stages. This is where the bond can come into play, allowing individuals to a take a tax-efficient income prior to age 55, whereas pension benefits can only be paid from age 55 onwards. Again, an international bond can complement or act as an alternative to pensions and play a role as part of a wider holistic strategy, involving many different types of investment. By switching on different income streams and making full use of the various allowances available, a tax efficient income can be produced both pre-retirement, possibly in the years leading up to retirement, and then as a supplement to any pension income in the actual retirement years.
Example - Turning on the income taps for a tax efficient income
David, aged 50
- Sold his IT business, but still does occasional consultancy work
- Looking for a tax-efficient income;
- To supplement his earning for the next 5 years; and
- Provide flexibility from age 55 onwards
- He has an international bond with an initial investment of £400,000, which is now currently worth £500,000.
- He has a SIPP worth £1.25m (with Fixed Protection 2016)
- He also has a portfolio of collectives and cash savings, some of which are wrapped in ISAs
- He would like to take a tax efficient income between £55,000-£60,000.
Before age 55
- He can take regular withdrawals from the bond, using the 5% tax-deferred withdrawals; and/or
- Take ad hoc withdrawals from the bond to supplement his consultancy earnings, again using the accumulated 5% tax deferred facility
From age 55
- He can phase income from his SIPP, using only the tax-free cash to provide a tax efficient income.
- The bond can still be used to provide additional income to supplement the pension income in the form of regular and/or ad hoc withdrawals.
David could also make use of his various allowances and switch on income streams across his investments, providing him with a tax efficient income.
The SIPP could produce £15,625 tax-free income a year, where the strategy is to exhaust all the tax-free cash before David’s 75th birthday. The rationale being that any death benefit payable on or after age 75, would be taxable at his beneficiary’s marginal rates of income tax. The international investment bond could also provide tax-deferred withdrawals of £20,000 for the next 20 years to run alongside his SIPP income, based on the original £400,000 initial investment.
David is able to take as much as £57,625 without an immediate tax liability by making use of various types of investments, wrappers and tax allowances.
|Consultancy earnings||£11,000||None (within the personal allowance)|
|SIPP (phasing using only the TFC)||£15,625||None (tax-free)|
|International bond (within the 5% limit)||£20,000||None (tax deferred)|
|Collectives/Discretionary Fund Management (DFM)||£5,000||None (within the dividend allowance)|
|Cash savings||£6,000||None (within the starting rate band and personal savings allowance for basic rate taxpayer)|
If we assume that David had no scope within the personal allowance or starting rate band to take other income completely tax-free, then providing his income is within the basic rate band, the £1,000 savings allowance would still apply, although this would reduce to £500 once higher rate tax is payable.
Where clients face pension restrictions, either in terms of the tapered annual allowance or from reductions to the lifetime limits, this need not be the end of funding for retirement provision. International bonds can play their role as part of a holistic retirement income strategy.
In the accumulation phase, clients should be thinking about making the full use of all their available allowances and where these are fully used up or not available, international bonds can provide an alternative. In the decumulation phase, they can be used to provide a tax efficient income in addition to the various allowances available. Finally, beyond retirement, international bonds can be placed into a trust and depending on the type of trust used, for example a flexible reversionary trust, could still provide access to the settlor while having the ability to be assigned to beneficiary’s while the settlor is still alive and after the eventual death.
By switching on a variety of income taps the client can turn a drip into a stream!