With the launch of the Government's website for silver surfers last week,
we can expect those of retirement age to become increasingly well informed
about their financial affairs. But tax planning concepts will probably need
a little help from financial advisers for some time to come.
Take the tax regime introduced with stakeholder in April. Who would have
believed it would bring a radical new dimension to retirement planning? The
simple fact that someone who has retired can carry on contributing £3,600
every year until age 75 changes the way many higher-net-worth clients, in
particular, may plan their post-retirement finances.
One example of the new possibilities for tax planning is income-drawdown
recycling. Let's take a client who retires at 60 and whose earnings were
£80,000 in any one of the five years preceding retirement. The new tax
rules say, if earnings prior to retirement could have justified
contributions over £3,600, higher contributions can be continued for a
further five tax years after earnings have ceased.
Furthermore, the higher contribution can be based on the highest earnings
in the cessation year (his last year with net relevant earnings) or any of
the five preceding tax years. These earnings are applied to calculate
maximum contributions in the break year (the first year of nil earnings)
and the subsequent four years.
Our client will have attained age 61 at the start of the break year so
he can contribute a sum of £32,000 a year for that year and the next four
years before contributions reduce to £3,600 until age 75.
As a wealthy individual, he does not currently need to look to his
personal pension for income purposes but the prospect of unlocking his
tax-free cash to repay a mortgage or purchase a retirement property or
other investment could have considerable appeal. So he takes the pension
fund of £711,110 which he has built up and effects a drawdown policy.
After taking his tax-free cash of £177,777, he is left with a residual
fund of £533,333. Taking a gilt yield of 4.75 per cent as an example, this
would deliver a maximum withdrawal of £41,600 gross based on income at 100
per cent of the limit set down by the Government Actuary's Department.
If the client does not actually require that level of income, the
flexibility of income drawdown would normally be used to take the minimum
35 per cent ofthe GAD limit, namely, £14,560 gross.
But now a new possibility opens up. Taking the maximum withdrawal of
£41,600, assuming he is liable for tax at 40 per cent on all this, the net
amount received would be £24,960. This is now reinvested as a personal
pension contribution and grossed up by the provider with basic-rate tax
relief of 22 per cent to become £32,000.
Having established basis year earnings of £80,000 prior to retirement, he
is able to make this contribution to a personal pension and can also claim
higher-rate tax relief of £5,760 through his tax return. He will, in
effect, have received income of £9,600 – the gross withdrawal less the
gross contribution – and paid tax of £3,840 on it.
Two key advantages emerge from this approach. First, the £32,000
contribution reduces the drawdown fund on which 35 per cent tax will be
payable on his death and builds up
a new phased retirement plan payable free of tax on his death. Second, the
new plan delivers 25 per cent of the fund as further tax-free cash when he
chooses to take benefits under it.
This example may be a little extreme and deal with very high levels of
contribution but it demonstrates a concept which can be used flexibly to
meet any particular client's needs. Of course, everyone can use the idea
for a gross contribution of up to £3,600 to age 75 if they do not need the
maximum income they could take from their drawdown contract.
It is worth remembering that this facility is available to existing
income-drawdown clients, at least at the £3,600 gross contribution level.
Clients whose first year with no earnings is 2001/02 (essentially those who
retired in the fiscal year 2000/01 or later) may also be able to use the
cessation rules to contribute more than £3,600 based on their highest
earnings in any fiscal year starting 1995/56. Earnings while a member of an
occupational scheme do not, of course, count but all other earnings do.
There is a general warning which needs to be applied when using the
five-year cessation rule. Any further earnings will immediately take the
client back to using the five-year presumption rule which applies when
people are building funds during employment. Contributions over £3,600 can
still be made based on earnings in a basis year but only for that year and
the five subsequent tax years. So the period may be less than can be
sustained using the cessation rule.
In other words, even small earnings in retirement may remove access to an
old basis year resulting in the planned drawdown recycling no longer
working at the planned contribution level.
Wealth management and tax planning opportunities in the grey market – or
for silver surfers – represent a hugely significant opportunity for
financial advisers, with income drawdown recycling just one new feature.