The Chancellor’s Budget speech in April 2014 was a major surprise to the pensions industry. His professed aim to give ‘freedom and choice’ to UK pension savers has opened up significant opportunities for clients. It has also given advisers and planners the best ever opportunity to demonstrate the value of their services in the most tangible way: through saving clients significant amounts of tax.
The Budget statement’s detailed projection forecasts these changes will net £8 billion more tax revenue by 2030, with £4billion by 2020. But why?
Let’s consider the wisdom of Spider-Man’s Uncle Ben: “With great power there must also come great responsibility”.[i] The changes give great power to individual taxpayers, but that doesn’t mean they will use it wisely, and the forecast £8 billion in tax will come from individuals who, through poor planning or none, will pay unnecessary tax.
We are also living longer. A recent report by JP Morgan[ii] showed that where a male and female couple who have both reached 65, they have a 94% chance of one of them surviving to age 80, and a 66% chance of one surviving to age 90. So two out of three 65 year old couples need an income solution for perhaps 25 years. That’s a huge ongoing advice opportunity, and effective tax planning is critical.
Consider the tax regime we work within:
|Area of change||2010/11||2012/13||2013/14||2014/15|
|Personal allowance||£6,475||£9,440||£10,000||£10,600 (individuals born post 05/04/38)|
|Savings & interests||
In 2015/16 every individual (born post 5th April 1938) will have a starting personal allowance of £10,600, an increase since 2010/11 of over 63%. Similarly, the savings rate band will increase to £5,000, with the tax rate reduced to 0% from April 2015. This figure is eroded once earned income exceeds personal allowance, but crucially, this rate applies to all UK taxpayers, irrespective of individual total wealth. For clients who can manage their earned income in decumulation to no more than the personal allowance, this could mean significantly reduced tax liabilities.
Mike is 70, has a self built portfolio of £650,000 and has never engaged with advice.
Share portfolio yield is 3% p.a. and he purchased his offshore bond in 2004 for £80,000, splitting it into 100 segments.
Mike wants £50,000 net ‘income’ in 2015/16. If this was all taxed as earned income, his tax liability would be £9,403.
There are of course any number of ways to drawdown on his overall assets, but one option is:
|State pension (2015/2016)||£6,029||£6,029|
|SIPP 'income' - via drawdown (PCLS cash only)||£5,500||£NIL|
|Bond (segment encashment)||£28,500||£9,500|
Tax on the state pension and dividends is straightforward, and the SIPP lump sum and ISA withdrawals are tax free. The bond encashment takes account of the overall increase in the value over 10 years from £80,000 to the current £120,000 – a gain of 50%. Consequently, where Mike encashes £28,500, his untaxed return of capital is £19,000, and the taxable gain is £9,500.
The key issue here relates to Mike’s offshore bond. Unlike onshore bond gains, offshore bond gains are taxed as savings income. This has a massive impact on Mike’s tax calculation, as his state pension takes up only £6,029 of his personal allowance of £10,600. This leaves a further £4,571 of personal allowance to use against his offshore bond gain, and the balance of that gain (£9,500 - £4,571 = £4,929) falls into the savings band (£5,000) – taxed from April 2015 at zero. Consequently, the only assets which are taxed are his dividends, at 10% on the gross dividend. The dividend tax credit covers this liability.
Mike’s overall tax liability is just £333, all of which is covered by the dividend tax credit. This represents an effective rate of tax of just 0.67%.
Clearly, this is a one year only solution, but it demonstrates the benefits of advice, and the need to have a long term decumulation strategy, frequently reviewed.
And don’t forget, every penny saved in tax is a penny which could remain growing in the fund, to ‘cascade down the generations’, potentially tax free under the new pension death benefit rules.
Mike’s tax bill could have been £9,403, but through careful planning was reduced to just £333. If we assume a 5% compound rate of return on that 1 year saving of £9,070, over 20 years (i.e. to when Mike is 90), that represents an additional potential fund value of £24,065. That feels like advice worth paying for, surely?
The new government guidance service Pension Wise will offer free, impartial guidance on different types of pensions and how much is available tax free, as well as other ‘at retirement’ options available. However, it won’t be tailored, be able to give a recommendation, cover all assets or tax interaction of wrappers, or address other family savings or inheritance. Also, perhaps most importantly, it won’t be regulated.
One can only hope that clients take heed of that other piece of American wisdom, from Donald Rumsfeld, and accept there are ‘unknown unknowns’. The ‘things you know that you don’t know’ can be worrying, but more impactful still can be the ‘things you don’t know you don’t know’ – particularly in a world as complex and fast changing as UK tax and pensions regulation. The answer, of course, is to turn to the professionals.
[i] Spider-Man, Marvel Comics
[ii]Report by JP Morgan - 2015 and the brave new world of retirement investing