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Blend ambition

Mixing tax wrappers demonstrates the value of good advice

Why is this so? First, in April 2011, we saw the publication of a new set of Government Actuary’s Department tables which, as a result of improving mortality, levelled down the GAD rates for most ages for both men and women.

Second, the maximum GAD of 120 per cent has been reduced to 100 per cent.

Third, we have seen a dramatic reduction in GAD interest rates, culminating in a December 2011 GAD interest rate of 2.5 per cent, the lowest on record.

One last ingredient to be added to this toxic mixture is the indifferent performance of equity markets over the last five years. There have been the usual ups and downs in market performance but inescapably the fact is that the UK market, as measured by the FTSE all share index, has been largely flat over the last five years. Indeed, the index over the last five years has produced a total return of 0.98 per cent.

These market and legislative pressures have therefore come together to create a perfect storm which for many people will be hard to navigate away from and demonstrates how dangerous it can be for clients to be too reliant upon one planning solution.

It also demonstrates how critical it is for clients, where achievable, to think laterally in terms of how they can save and accumulate wealth and how they can provide for an income in retirement. It is the case that clients need to reduce their exposure to solely one type of solution for retirement provision but also need to look across a range of potential tax wrapper solutions.

The idea of strategically blending differing tax wrappers is in itself nothing new but it is rarely appreciated by clients that with the right financial planning in place and with the appropriate advice sitting alongside it, how remarkably low the overall levels of taxation can be when an income is required.

The blending of various tax wrappers which face off against income tax and/or capital gains tax or indeed enjoy privileged tax status and pay no tax at all is critical. By showing clients the tax savings achievable, then “advice” becomes even more crucial and valued. This is perhaps best illustrated by way of a case study.

As with all case studies, some assumptions will be made. First, the tax rates for 2011/12 will be used, along with the more “typical” tax structures that clients may arguably look to hold. Due to space limitations, it is not possible to represent all tax wrappers available in the market and there are, of course, real tax advantages to be gained by using enterprise investment schemes and venture capital trusts.

However, let us imagine a client called George aged 60 who is seeking to retire. George has a net income requirement of £150,000 in the tax year 2012/13. After following financial advice, he has the below investment assets both wrapped and unwrapped. For the purposes of this example, assets such as George’s principal private residence have been ignored.

His assets include:

  • An uncrystallised self-invested personal pension valued at £800,000
  • An offshore investment bond with an original investment of £150,000 established with 150 segments 10 years ago. Each segment is therefore valued at outset at £1,000. The current value of the bond is £300,000. George has taken no withdrawals from the bond
  • Isas – assume that George has fully funded his Pep/Isa allowances and has built up a fund of £400,000
  • An investment portfolio man-aged by an external third-party discretionary manager in a range of collectives. The value of the portfolio is £300,000 and yields 2 per cent gross
  • George’s total net worth is £1,800,000.

George wishes to crystallise because of concerns over GAD rates and market timing, with £100,000 of his pension fund producing a pension commencement lump sum of £25,000 and based upon current GAD rates a gross taxable income of £4,200 per annum.

Offshore bond
George could utilise his 5 per cent per annum tax deferred entitlements and withdraw £75,000 from the bond without liability to tax.

Isa portfolio
George instructs his adviser to withdraw 5 per cent of the portfolio value which amounts to £20,000. This is free of income tax and CGT.

Collectives portfolio
George’s investment portfolio pays a “natural income” of £6,000 gross. Any shortfall in income can be made good by using George’s available CGT annual exemption by making a “part disposal” from his collec-tives portfolio of £19,800. Let’s say this results in a gain of £1,500 which is comfortably within George’s annual exemption and so no tax would be payable. The utili-sation of part disposals within a client’s CGT annual exemption can be an extremely tax-efficient way of producing a tax-free “income” in retirement.

So, running the numbers through, George’s total taxable income net of his personal allowance is £2,721 which is the dividend income from his collective port-folio and is accompanied by a non-reclai-mable 10 per cent tax credit which in turn satisfies George’s basic-rate liability.

Therefore, George’s total tax liability on his “income” of £150,000 is £272.50 and he would not have to complete a self-assessment form for the tax year 2012/13.

There are, of course, numerous strategies and tweaks that can be made to give George the income he requires. How-ever, what is illustrated here are the low levels of tax potentially payable simply due to the correct wrapper diversification.

Importantly, George can control the amount of tax he pays by switching on or off the income flows from a given wrapped or unwrapped investment as he feels appropriate.

This surely demonstrates quite clearly the impor-tance of advice, forward-thinking and planning for clients such as George to help them understand how various tax wrappers can work for them from a tax perspective and how they can be strategically blended to provide a happy as well as a tax-efficient retirement.

Andy Zanelli Head of technical sales Axa Wealth



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