Using tax wrappers and allowances at different life stages

To demonstrate how a variety of tax wrappers and allowances can be used, let’s consider how one individual (Kieran) might decide to invest at different stages of his life:

Age 25 – start of career, basic rate taxpayer.

At this point, Kieran is likely to be auto enrolled in a workplace pension. He might additionally save into a lifetime ISA (LISA) to raise a deposit for a first home, plus hold small amounts of savings in a cash ISA for emergencies.

Age 35 – Married with young children and a mortgage.

Still within a workplace scheme, Kieran may look to make additional pension contributions to avoid paying higher rate tax.

Depending on circumstances, he may now benefit from the Marriage Allowance, allowing his spouse to transfer £1,260 of her Personal Allowance to him.

At this point, he may invest in a stocks & shares ISA to build some additional savings that are accessible today.

Age 45 –Earnings have increased, higher rate taxpayer.

Kieran may now be making additional pension contributions to keep his income at £60,000 and avoid the High Income Child Benefit Charge.

Age 55 – Earnings increased further, mortgage is more affordable.

Depending on earnings, Kieran could now use pension contributions to reduce income to £100k and retain his personal allowance.

Kieran is now able to access his pension. He can therefore start moving tax-free cash of £20,000 a year into an equivalent stocks and shares ISA.

Within the ISA, the tax-free cash will remain growing in a tax-privileged wrapper, but without reference to the Lump Sum Allowance (LSA) of £268,275. This could otherwise limit the amount he is able to later withdraw tax-free.

Although both the pension and ISA will be assessed for inheritance tax on death, ISA money won’t attract additional income tax if he dies after age 75.

Taking tax-free cash is not a trigger event for the Money Purchase Annual Allowance (MPAA). It therefore will not affect his ability to maintain pension contributions at his current rate.

Age 65 – Retired, no mortgage and sizable assets within pension and ISAs. Substantial inheritance received.

Kieran may want to use much of his inheritance to help his children. The residual can be placed in investment bonds, ISAs and potentially GIAs.

At this point Kieran can use the full spectrum of tax wrappers and allowances to draw a tax-free retirement income:

• Personal Allowance - £12,570 of drawdown income taken from his pension each year.
• Starting Rate for Savings – £5,000 of tax-free interest received from non-ISA savings, as long as non-savings income doesn’t exceed his Personal Allowance.
• Personal Saving Allowance – Up to a further £1,000 of tax-free interest from non-ISA savings each year.
• Capital Gains Tax allowance – Can realise gains of up to £3,000 each year on GIA assets held outside of a pension or ISA.
• 5% tax deferred allowance – Kieran can withdraw up to 5% from his bond investments, each policy year, without incurring an immediate tax charge.
• Tax free lump sums – Any income shortfall can be topped up via further tax-free cash from his pension and tax-free withdrawals from his ISA.

Age 75 – Receiving state pension, estate and later life planning is important.

By this point, mitigating inheritance tax (IHT) is an increasing priority, but Kieran harbours concerns around running out of money and the potential high care costs sometimes incurred in later life.

• Pension – this is now subject to both IHT and income tax on death, so any remaining tax-free cash entitlement is taken.

Income needs are primarily financed from the pension and he may increase income further to take advantage of gifting exemptions such as ‘normal expenditure out of income’.

• Annuities – can be used to guarantee Kieran’s income needs and to potentially move pension assets out of the scope of IHT.
• ISA/GIAs – Kieran can use these for gifting, purchasing bonds or potentially changing investments to business relief qualifying assets.
• Bonds – new and existing bonds can be placed in trust or assigned to his children/grandchildren. Kieran may be interested in using settlor interested trusts (loan trusts, flexible reversionary trusts or discounted gift trusts) to ensure that he still has some future access to his money if needed.
• Equity Release – As part of his estate planning, he might also consider freeing up housing wealth via a lifetime mortgage or downsizing.

Age 85+ – Later life estate planning

If further estate planning is needed, any remaining ISA/GIA’s can be moved into business relief qualifying assets. This will reduce any IHT liability on the investments by 50% or 100%, once owned for 2 years.

Comment

Everyone is different, so the appropriate wrapper/allowance and when to use it will change depending on individual circumstances and preferences. In addition, protection products will continue to play an important role in these planning needs.

Although pensions will still form the bedrock of retirement saving for most, more people will need to consider alternatives going forward. More than ever, savers will require the benefits of good quality regulated financial advice.

Important information

Please note this is for general information only and is based on LV's understanding of the relevant legislation and regulations and may be subject to change.

The tax treatment of benefits depends on individual circumstances and may be subject to change in the future.

The use of this document is at your own risk, and the content should not be used for the provision of professional advice.

LV= accept no liability for any damages, losses or causes of action of any nature arising from your use of this document.