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Twin win

A dual approach to tax-efficient investment and withdrawls can pay off in the search for income

For many clients, the recent interest rate falls will result in a drop in income from savings and investments.

Volatility in equity markets has added another layer of complexity to advising clients. Although certain yields can appear attractive, there i a requirement to balance the income return with the short- term asset value movements and the associated risks of the underlying stock invested with that of the client risk profile.

In these unprecedented times, what options are there for those with existing investments and for those considering investing with future “with-drawal strategies” in mind?

In the current climate, returning to some core principles may present the adviser and the client with some alternative ideas.

Assuming a client’s pension and Isa portfolio is being used effectively, a UK-authorised investment fund (collective) and an insurance bond could be used to meet some income needs. Ensuring withdrawal strategies are tax-efficient can add value to the client by improving the net amount of income received.

Let us consider a client wanting to invest £500,000. If we look at a collective investment portfolio with a low to zero yield, then gains on withdrawals of capital will be subject to capital gains tax but will benefit from the individual’s annual exemption (£9,600 for 2008/09). The CGT part-disposal formula calculates how much of a withdrawal is treated as capital and how much is treated as gain.

It is worth remembering that a portfolio of 10 funds would need 10 calculations, even where all the funds are held on the same platform.

If the investment return was 6 per cent a year and the CGT annual exemption increased at 2 per cent a year, then a withdrawal of 5 per cent each year would not suffer tax until year 11.

If the same portfolio were held in a single-premium insurance bond, then the growth element for calculation would be irrelevant (assuming that there were sufficient funds to pay withdrawals) and a tax liability would not arise until year 21 if 5 per cent withdrawals were taken.

However, if the client were to invest in both a collective and a bond, we could create a withdrawal strategy which extends beyond 21 years.

For instance, consider investing £200,000 in the bond and £300,000 into the collective. If withdrawals remained at 5 per cent of the original investment and other assumptions remained cons-tant, we could extend the tax-efficient period until year 30.

This could be achieved by splitting the withdrawals as follows – £6,500 from the bond and £18,500 from the collective, £25,000 in total.

Due to the extended period of efficient bond withdrawals and the benefit of the escalating CGT annual exemption, this split between wrappers results in an excellent capital withdrawal strategy that supports or replaces other income.

Clearly, growth on the coll-ective exceeding the assump-tions will result in tax payable earlier than anticipated. However, planning and annual reviews will establish how, on a year on year basis, client’s objectives can be best fulfilled.

This strategy requires an annual review and may mean varying amounts are withdrawn from each investment year on year. This could even be advantageous for the collectives at the individual fund level. Ensuring the collectives that produce income and those that produce capital appreciation are held in the right wrapper will further benefit the tax efficiency of this strategy.

The impact of tax-efficient withdrawals is only one element of a planning strategy but demonstrating how different tax wrappers can work in tandem further underlines the value of advice.

Colin Jelley is head of tax and financial planning at Skandia


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