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Canada Life Article - Retirement planning

Retirement Planning – Pensions and International bonds

 

With the introduction of the tapered annual allowance and the reduced lifetime allowance, retirement planning is somewhat limited for higher earners or those with generous final salary benefits or well-funded SIPPs with no further scope to fund their pensions.

In considering employee remuneration, employers have found themselves left with the difficult dilemma of how to provide additional benefits. In particular whether to pay additional bonuses, dividends or continue funding contributions into a pension. Were those employees with pension pots in excess of £1m, intending to apply for Individual Protection 2016 and have their employer continue to contribute, from a tax perspective it may still be the most tax-efficient option when compared to other forms of remuneration.

However, where the tapered annual allowance is causing the problem, this might not be so simple. Any payment made in excess of the reduced annual allowance would result in a tax charge on the individual at their highest marginal rate, regardless of the fact that it is the employer who has made the contribution. So essentially there is no tax relief on the excess over the annual allowance.

Though many of those restricted by the lifetime allowance may have large pension funds, those restricted by the tapered annual allowance may not have had time to have built up sufficient retirement provision. It might be the case that their fund has significantly reduced as of the result of a pension sharing order and again due to the annual allowance restrictions, will find it difficult to rebuild pension benefits in what may be a very limited time frame.

So what are the alternatives to pensions, when retirement planning is the main concern or objective?

One option is the international bond which can be a useful pension alternative for providing additional retirement funds while having many complementary features that sit well alongside a pension as part of a retirement strategy.

• Regular premiums can be made to a bond
• There is the benefit of gross roll-up within the bond
• A tax-efficient income can be taken (within the 5% limit)
• The bond can be wrapped within a trust for inheritance tax (IHT) purposes
• The bond does not suffer from any restrictions in terms of annual or lifetime limits

Obviously, there are other alternative investments to pensions other than international bonds and it may be the case that the client has a combination of non-pension assets, all of which can play a part in producing tax-efficient income in retirement. So it doesn’t have to be an ‘either or’ scenario and different products can complement each other.

 

At the accumulation stage

Where there is still scope to contribute to a pension, even if at a tapered amount, it may be prudent to fund up to the limit and make use of any unused carry forward from the previous three tax years. Some may find themselves in the fortunate position to have their employer making these contributions on their behalf, freeing up more of their personal capital to fund for additional retirement provision outside of a pension, for example, into an international bond.

 

At the decumulation stage

A mix of pensions and bonds close to and at retirement again can complement each other. As the bond has no age restrictions on withdrawals, it is possible to take tax-efficient payments (within the 5% limit) before, say, age 55, to act as a bridging income until retirement or to supplement reduced wages. Once the pension becomes available at age 55, it is possible to phase income payments, so that only the tax-free cash is used, providing additional tax-free income.

In addition to pension and bonds, other investments can also be brought into the mix and advantage can be made of the various allowances now available, for example the new savings and dividend allowances.

ISAs, unwrapped collectives, cash savings, indeed any solution, can encompass a myriad of products/wrappers as part of a holistic solution.

Victoria - Aged 52
 
Before 55
 
From 55
 • Sold her marketing business (still does occasional consultancy work)
• Looking to supplement her ad hoc earnings for next three years
• Looking to take a tax-efficient income from 55 onwards
• She has an international investment bond, where the initial investment was £360,000
• She has a SIPP worth £1.5 million (with Fixed Protection 2014)
• She also has a portfolio of collectives and cash savings, some of which are wrapped into ISAs
• Victoria can take a regular withdrawal from the bond in the form of 5% tax-deferred payments; and/or
• Take ad hoc withdrawals from the bond to supplement her consultancy earnings by making partial encashments, using the accumulated 5% tax-deferred facility.
 • She can take a tax-efficient income from her SIPP, phasing drawdown and using only tax-free cash to provide an income
• Continue taking regular and/or ad hoc withdrawals from the international investment bond

 
In those years with no consultancy earnings, she can take additional payments from either the pension drawdown or the international investment bond, keeping any income and realised gains within the personal allowance and still paying no income tax.

By utilising various income streams and making use of allowances she could provide a tax-efficient income in retirement as the table below illustrates.
 

Wrapper
 
Income
 
Tax
 Sipp (crystallising £60,000 a year)
£15,000 (tax-free cash)
 None (tax-free)
 International investment bond (within 5% of original value)
£18,000
 None (tax-deferred)
 Consultancy - salary/earnings
£11,000 (earnings)
 None (within personal allowance)
 Collectives/discretionary fund management
£5,000 (dividends)
 None (within dividend allowance)
 Cash savings
£6,000 (interest)
 None (within starting rate band and personal savings allowance for basic-rate taxpayer)
 Total
£55,000
  

 

As you can see in this example, it is possible for Victoria to produce as much as £55,000 without an immediate income tax liability by making use of various products and tax allowances.

The SIPP could produce £15,000 tax-free cash for 25 years, assuming a fund value of £1.5 million. The international investment bond could provide tax-deferred withdrawals of £18,000 for the next 20 years, based on an original investment of £360,000.
Even where there is no scope within the personal allowance or starting rate band to take other income completely tax-free, then providing it is within the basic rate band, the £1,000 savings allowance will still apply. This reduces to £500 once higher rate tax is payable.

By having a holistic investment strategy across all their investments they can use income producing funds with the bond, growth and income in the collectives, growth or guarantees within the pension, or indeed some other combination. EIS/VCTs could add further diversity to the mix, depending on the client’s overall tolerance to risk.

 

Retirement and Estate Planning

Although pension death benefits can in most cases be paid out free of IHT, international investment bonds can also be wrapped into trust to mitigate IHT.

The pension scheme can pay out a lump sum death benefit or provide a beneficiary’s drawdown, both of which can be paid either tax-free or subject to income tax at the beneficiary’s marginal rate of tax, depending on whether the date of death of the member occurs before age 75 or on or after that age. Where greater discretion or control is required, setting up a bypass trust for those benefits may be a considered option.

It is also possible to wrap international investment bonds up within a trust to make them tax efficient from an IHT perspective as well as providing access to the capital while the individual is alive. This could be achieved by using a flexible reversionary trust, for example, to provide access to capital for the client, while having the option to assign or appoint polices to the beneficiaries, so that subsequent realised gains are taxed at their marginal rates. There are other forms of trust, for example, a discounted gift trust, which can offer regular income payments, where flexibility is not such an issue or gift and loan trust, which can offer alternative forms of IHT-efficient solutions.

In conclusion, clients should still consider maximising pension contributions where possible, even if this is only within the reduced tapered annual limit each tax year, as well as making full use of the ISA allowances. Beyond that, international investment bonds can offer an alternative with some of the features inherent in pensions. Clients can make regular premiums, benefit from gross roll up within the bond, they offer portability and similar investment options such as unit-linked funds and access to platforms or discretionary fund managers (DFM). At retirement, clients can take tax efficient withdrawals, which can complement other forms of retirement income and have the ability to wrap their bonds up in trust as part of an IHT planning exercise.

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Canada Life Limited is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority.

Canada Life International Limited and CLI Institutional Limited are Isle of Man registered companies authorised and regulated by the Isle of Man Financial Services Authority.

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Stonehaven UK Limited and MGM Advantage Life Limited, trading as Canada Life, are subsidiaries of The Canada Life Group (U.K.) Limited. Stonehaven UK Ltd is authorised and regulated by the Financial Conduct Authority. MGM Advantage Life Limited is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority.