Tax Efficient Options

A question about : Tax Efficient Options

I will have a pension pot of 500k to take when I turn 55 and this needs to last me ten years.
I want to take an income of 40k a year from this over those ten years in the most tax efficient way that I can.
Any ideas on this?

Best answers:

• Will you have other income ie still be working? Do you have a spouse?
  You will have 125K tax free, which you can put into S&S ISAs to provide tax free income, and cash into some of the best paying current accts.
  Then you can draw 37,500 per year over 10 years which would be taxable at 20% after your PA if you aren't working still. Which would mean tax paid of 5380 per annum.
  What will you live on from age 65?
• Use the TFLS entitlement to invest plenty into VCTs, EISs, and SEISs; then you can largely avoid tax on the tax-exposed part (at the cost of taking absurd levels of risk).
• If you're not bothered about taking a lump sum and reinvesting it in ISAs, 40k net of tax could alternatively be achieved by using UFPLS:
  - take Ј44700, of which first 25% (Ј11175) is tax free
  - the remaining Ј33525 is subject to tax of Ј4705 assuming personal allowance of Ј10k, leaving Ј28820
  - Ј28820+Ј11175 = Ј39995
• It appears that you can get your whole Ј40,000 income target completely tax free for all ten years.
  The most tax-efficient way is to take the full basic rate income tax band income each year and use VCT investing to get tax relief on it back. Do the VCT buying early in the tax year and HMRC will adjust your tax code so that your ongoing pension income gives you the tax relief. VCT tax relief is 30%, capped at the amount of income tax paid in the year. If you took Ј40,000 of taxable income you could eliminate the Ј8,000 basic rate income tax on the Ј30,000 of it by buying Ј26,666 of VCTs.
  VCT dividends are tax free and getting about 4% is easy enough, more readily available. You must repay the 30% tax relief if you sell within five years but you should plan on holding for 8-10 years to give more time for the companies being invested in to mature.
  You can use the tax free lump sum to fund living costs during the years where you're effectively deferring income for 5+ years inside the VCTs.
  You initial plan might then be:
  year 1: take Ј125,000 tax free lump sum. Also take Ј40,000 taxable income from the rest and invest Ј26,666 from the lump sum in VCTs. Assume Ј1,066 tax free VCT income, Ј8,000 VCT tax relief and Ј10,000 basic rate income, total Ј19,066 tax free income topped up to Ј40k by using Ј20,934 of lump sum. Lump sum remainder Ј125000 - 20934 = Ј104066. 75% remainder 375000 - 40000 = 335000, VCT assumed 26666.
  year 2: assume 3% real investment growth, lump sum now 107187, 75% pot now 345050. Same VCT routine, take Ј40k taxable income from the 75% pot, Ј26,666 VCT. Income now 2132 + 8000 + 10000 = 20132 topped up by Ј19868 from the lump sum. Lump sum remainder 87319, 75% remainder 305050, VCT 53332.
  year 3: after growth lump sum now 89938, 75% now 314201. Same 40k/26666 routine, total tax free income of 3199 + 8000 + 10000 = 21199 topped up by 18801 from the lump sum. Lump sum remainder 71137, 75% remainder 274201, VCT 79998.
  year 4: now 73271 and 282427. Income from 79998+26666 VCT at 4% = 4266 + 8000 + 10000 = 22226. Top up from lump sum 17774. Lump sum remainder 55497, 75% remainder 242427, VCT 106664.
  year 5: now 57161 and 249699. Income from 106664+26666 VCT at 4% = 5333 + 8000 + 10000 = 23333 topped up by 16666. Lump sum remainder 40495, 75% remainder 209699, VCT 133330. VCTs are 34.8% of total value.
  year 6: you could now start to draw money from VCTs but I won't do that, letting their percentage increase for a bit longer. Now 41709 and 215989. Income from 133330+26666 VCT = 6399 + 8000 + 10000 = 24399. Top up 15601. Lump sum remainder 26108, 75% 175989, VCT 159996. VCTs are 44.2% of total.
  year 7, this year the lump sum is just enough to lend the whole 26666 at the start of the tax year to be replaced by the 40k. It's the last year where this will be possible at the start of the year using the lump sum, in later years some VCT selling can be used instead. Now 26891 and 181268. income from 159996+26666 of VCT = 7466 + 8000 + 10000 = 25466 topped up by 14534. Lump sum remainder 15959, 75% 151268, VCT 186662. VCTs are 52.7% of total.
  So far you've paid approximately no income tax at all on your 40k a year of income.
  I haven't fully used the basic rate band, you should, to reduce the draw rate on your lump sum. That would probably let you do year 8 also with no income tax and no VCT selling. From year 9 on you'd need to start selling VCT investments to continue paying about no income tax while you draw the remainder of the pension pot.
  The percentage of total investments in VCTs gets higher than desirable and starting in the sixth year it would be useful to start selling some VCTs that have good sale values, to reduce the growth in this percentage. 10% is a fairly often mentioned sort of VCT maximum level and this goes to many times that. Many reasons for this but they invest in small companies so even with diversification across lots of VCTs the investments have significant loss potential if you were forced to sell, though you probably won't be. Also the potential for other losses rather than just volatility.
  While it's not strictly necessary you might also want to consider paying some income tax to reduce the VCT percentage growth. After the ten years you may well be able to continue deferring your income for at least five years to remain mostly or completely tax free for life, though do note that big caution about too much to be really desirable being in VCTs.
• Hmm. Very clever, but looks like a prime example of letting the tail (tax) wag the dog!
• [QUOTE=Triumph13;67687544]Hmm. Very clever, but looks like a prime example of letting the tail (tax) wag the dog![/QUOTE
  It seems to fit the OP's question; do you have an alternative equal or better plan ?
• Well, the question was about the most tax-efficient way, and this has no income tax or CGT at all... So long as micro company investing and the tie-in periods are acceptable it's a pretty neat way to go and the way I currently intend to do things myself.
• Thanks for the responses so far. In answer to some questions I do have a spouse and she will retire at the same time as me but will be unable to take her pensions at that age. She will get her pensions at 65 and I have another one that kicks in then too, hence I'm planning to spend the first one.
• What about:
  Take Ј50k pa as UFPLS. Put Ј3600 gross back into OP's pension and Ј3600 into spouse's (ie Ј7200 gross total, Ј5760 net).
  Ј12500 of the UFPLS tax free, next Ј10k tax free (personal allowance), tax relief on pension payments effectively means next Ј7200 tax free, so tax only paid on Ј20k, so about Ј4k tax pa. Net money out Ј38740pa.
  Though not sure if this would be caught by the recycling rules? It seems not as the contributions of Ј3600 are less than 30% of the Ј12500 tax free element of the UFPLS? Don't think recycling into someone else's pension (spouse) applies does it?
• I'm a big fan of VCT's having originally been sort of forced to buy my first Ј100k worth to avoid Ј30k tax on a severance payment in 2008 when I retired early. Since then I have saved tax on my pension each year with much smaller VCT investments. Dividends over the period of Ј66k have also been a pleasantly surprising tax-free return.
  My question/concern is whether I will be able to sell them if I need to and whether I should go on investing small amounts each year for tax saving purposes. With good returns so far I am not particularly inclined to sell yet. However, with currently about 20% in VCT's I am way over jamesd's 10% advised level. My IFA is naturally cautious!
  All thoughts greatly appreciated.
• It's down to personal comfort levels. I'd be comfortable with 20-30% personally but it's appropriate for me to mention a more commonly accepted level for those of more typical risk tolerances.
  You're fine at 20% as long as you're comfortable. By now you have the advantage that most of your initial VCT investments will have increased in value to the point where selling would be possible if desired, without a capital loss. There's really no need to change if you don't want to change and the VCTs you have are delivering as desired. However, given that you can sell, I suggest at least trying not to get to say 25% VCT investments. Which implies some light selling as you invest in new ones to eliminate your ongoing income tax level. You might, say, adopt a gradual selling plan with the objective of getting down to 10% over 15 years.
• If you are concerned about being tied in to what you perceive as a potentially illiquid investment, look at the limited life VCT's (e.g. Downing, Pembroke, Puma etc) - these are arranged to be dissolved in year 6 and all proceeds returned to the investors.
  Also if you want to sell after the five year period, the VCT managers will buy back your shares at NAV minus anything between 0% and 10%. Reading the Annual Reports I get shows that all of the ones I've invested in have purchased shares over the past year. Of course, things may change and they could refuse but that's part of the risk you accept with VCT's.
  I'm very happy with the way my VCT investment is going (now in the 6th year), I'm currently receiving Ј40k p.a. tax free dividends and the NAV's (even minus the average 7.5% for selling back to the managers) are 28% up on the original buy prices.
  I have a number of limited life VCT's, so although the overall exposure is 16% of my NAV it will reduce over the next few years. Looking forward, because having the tax free dividends reduces the need to draw on my pension I may well keep them indefinitely. Sadly, they are not IHT free but I will address that in the future with my overall tax planning.
  One last bonus if of course you can sell after five years (either getting the proceeds of a limited life wrap up or selling to the managers) and then buy more - you get another 30% tax relief and this is against any income, not just earned income like a pension contribution. So - for example - I could withdraw Ј100k from my pension and instead of paying the roughly Ј30k tax, I would sell VCT's and then repurchase having been charged around Ј7.5k instead of Ј30k.
  Of course, all of this depends on future Governments not meddling with the system but we have to work with what we know
• "Re-cycling" mature VCT's - I have come across a note in the Risk Factors section of Apollo appln form that this cannot be done within the same VCT without losing the tax benefit. Does that mean that all you VCT investors have an array in order to go on getting tax relief effectively from the same capital? I have tended to stick with the same provider (Apollo) because of good returns. To re-cycle my original (now 7-yr old) investment I therefore need a new VCT - any suggestions?