Making Allowances for a Tax Efficient Retirement

The key to unlocking a tax efficient retirement income for clients lies in ensuring that tax allowances have been maximised.

Paying less tax will mean their savings will last longer in retirement and potentially provide a greater legacy for their loved ones.

Optimising the use of allowances is an easy way to demonstrate the value you can add for clients when they reach retirement. Left to their own devices, they may overlook the tax effect of withdrawals and end up paying more tax for the same net income.

Allowances on offer

There are allowances of 26,700 up for grabs this year. From next April this will rise to over 33,000 with the addition of the new dividend and personal savings allowances, in addition to planned increases to existing allowances. Thats a tax free household income of more than 66,000 for a couple.

And of course, certain withdrawals may only be partially taxable. For example, pension income could include an element of tax free cash, and withdrawals from bonds or mutual funds will include a return of the original capital.

This means some clients could enjoy a very comfortable level of income, which could be well above 66,000 in retirement without paying any tax on their withdrawals. But this requires savings across a range of tax wrappers and the right advice on where and when to take their withdrawals from.

The challenge is to undo a lifetimes worth of hardwired retirement savings habits. And the key to achieving this is to demonstrate that an alternative retirement income strategy, using a range of tax wrappers, can provide a sustainable source of spendable income while securing the best possible legacy on death from unused funds.

To do this requires an understanding of the available allowances and how the different investment wrappers use those allowances. With tax allowances, its a case of use it or lose it. So wherever possible, it makes sense to use allowances to extract savings tax free – even if this means potentially withdrawing more than is needed to meet spending needs.

Maximising those allowances

Any excess withdrawals may be reinvested, potentially into more tax privileged investments such as pensions or ISAs, and even where investment into pensions or ISAs is not possible, crystallising gains and reinvesting back into similar investments can reset base costs leading to lower future tax charges.

1. Personal income tax allowance 

  • Income of up to 10,600 a year can be received free of income tax. The allowance is reduced once total income exceeds 100,000. 
  • Earned income, which would include pension income, will use the allowance first. The opportunity to take income from investments tax free should not be overlooked. So income up to the personal allowance should always be extracted.

2. Income tax savings rate band 

  • Savings income (including interest and offshore bond gains) of up to 5,000 can be taken tax free in addition to the personal allowance of 10,600. But the 5,000 allowance is reduced if earned income exceeds the personal allowance. So for example, if total pension income was more than 15,600, the savings rate band would be lost.
  • The savings rate band allows gains from offshore bonds to be extracted tax free. And unlike most other forms of savings income, the timing of gains from offshore bonds can be controlled to coincide with tax years when theres little or no other income. When combined with the personal allowance, it takes gains of up to 15,600 out each year. And, of course, the withdrawal will also include a return of some of the original capital which is not taxable.
  • But this amount will be reduced if there are fixed incomes such as state pension, DB pensions, annuities or interest from savings which cannot be stopped. So, where there are offshore bonds in the portfolio, deferring fixed pension incomes can create a window to extract offshore bond gains tax free.

3. CGT annual exemption

Capital withdrawals from mutual funds can be used to meet spending needs. Similar to offshore bonds, the withdrawal will be part gain and part return of original capital. Its only the gain element which is taxable.

The first 11,100 of capital gains can be taken each year tax free.

Withdrawing sufficient capital each year to use up, but not exceed, the CGT exemption can provide tax free withdrawals. The withdrawal will also include an amount of original capital which will remain tax free.

Any withdrawals in excess of income needs can be reinvested into:

  • Pensions – subject to available allowances etc
  • ISAs – subject to contributions limits
  • Back into mutual funds to crystallise the gains and reset base costs (beware the share matching rules and sale and repurchase within 30 days)

In years where the portfolio (or specific funds) has suffered a loss, these should be realised and repurchased through pension or ISA and losses carried forwarded to offset future capital gains. But where there are both gains and losses in the same tax year, the amount of loss to be carried forward first has to reduce the gains in the tax year to zero.

Tax planning in the new world

Pensions and retirement income are synonymous with one another. The first thing most clients will think about when considering their income in retirement will be their pension. But with the new pension freedoms, its not necessarily the first place they should turn to when deciding where to draw their retirement income from.

Its now time to start thinking of savings collectively, rather than as separate individual pots. Clients with savings across a variety of wrappers will need your help to devise the best possible strategy to meet their income needs in retirement.


Robertson Baxter is a full service whole of market Independent Financial Advice firm. We offer a Family Office approach to clients of high and ultra high net worth together with Trustees and Charities. Our holistic advice covers all areas of Pension, Investment, Protection and Estate Planning, serving clients across Yorkshire.


    More stories

    08 Oct 2015

    The Mail on Sunday – ‘Top Rated Advisers’

    Read more

    29 Sep 2015

    Is the Lifetime Allowance (LTA) charge a price worth paying?

    Read more