Planning +£50,000 tax-free annually

Nobody likes paying tax, but our tax system offers legitimate opportunities to diminish tax payments. Clients can enjoy a substantial level of tax-free income and capital by taking advantage of the various allowances within the tax system…and it’s not that technical.

By carefully preparing and planning a multi-wrapper solution for clients with capital/disposable income to invest, we can help them achieve in excess of £50,000pa tax-free.

Personal Allowance - £12,570

Unless your client has Adjusted Net Income in excess of £100,000pa, the first £12,570 of taxable income will fall within the PA and, as such, will be tax free. Keeping salary within the PA is not an option for many, so most have to accept that earnings during their working lifetime (in excess of the PA) will be taxable. Unfortunately, non-savings income (earnings) in excess of £17,570 also prevents access to the starting rate of tax for savings.

However, many business owners have the potential of setting their own salary, deriving the balance of immediate required income from dividends and taking advantage of employer pension contributions for the balance of available profits. Managing profit extraction can make a considerable difference to the level of tax to be paid both now and in the future

On retirement, the use of a flexi-access drawdown pension allows pension income to be varied, or turned on and off, as individual need requires. Use of this flexibility of income to match a changing PA, when linked to the use of Pension Commencement Lump Sum (see below), offers a very tax efficient and flexible form of income. It goes without saying that the accumulation of a pension fund is extremely tax efficient, with tax-relief on pension contributions and tax-free growth of pension funds.

Recent Finance Acts have tightened down on the amount of contributions that can be made by high earners and those flexibly accessing their pension savings, via the Money Purchase Annual Allowance and the tapered Annual Allowance, but with the appropriate advice substantial contributions can still be achievable. Furthermore, the restrictions of the Lifetime Allowance may impact on the perceived tax efficiency of pensions.

Personal Savings 'Allowance' – up to £1,000

We can generate up to £1,000 (basic rate taxpayer) or £500 (higher rate taxpayer) of interest payments without any liability to income tax. This is available to all (except additional rate taxpayers), so will be available to ‘earners’, unlike the starting rate of tax (see below). Perhaps investments, such as OEICs (where the fund has more than 60% invested in assets generating interest), are worth considering if this allowance is to be fully utilised.

Starting rate of tax – up to £5,000

Those with non-savings (earned) income in excess of £17,570 need not concern themselves with the starting rate of tax. However, if your client does not need to work, derives, income mainly from investments, can vary income as required or have non-savings income under £17,570, this is for them.

If any taxable savings income falls within the first £5,000 of the basic rate band, your client will not be liable to pay any tax on it, as the starting rate for savings income is 0%. As well as standard deposit accounts, interest-producing OEICs and chargeable gains on insurance bonds fall into this category. 

The starting rate of tax is restricted by non-savings taxable income so that none of the band will be available if that income is above their personal allowance (and blind person’s allowance if claimed) plus the £5,000 starting rate. So the starting rate of tax is more of an advantage for people living off savings or who can vary their non-savings income, rather than people living off earnings. Dividend income is taxed after savings income and therefore, dividend income will not affect eligibility for the starting rate for savings.

But remember, those currently working are likely to cease work or retire, so accumulating savings or making an investment that can provide payment of interest, when non-saving income reduces, could be a sensible proposition.

Dividend nil rate – up to £500

The first £500 of dividend income is taxed at 0% regardless of your client’s current tax position. Based on the FTSE 100 average yield of 3.65% (as at 31/12/24), an investment of approximately £13,700 in OEICs would be required to generate this amount of dividend. So assuming that such an investment suits the risk profile, dividend-producing investments can be a useful tool in boosting the level of tax-free income irrespective of current tax position.

CGT Annual Exempt Amount – up to £3,000

We know that we can realise gains on investments up to the value of £3,000pa and not be liable to CGT. This could be from the same investments generating the dividends and interest mentioned above. The capital released with the gain would also boost “income”.

Now up to +£22,070 but it need not stop there

If we include the tax-free Pension Commencement Lump sum from unvested pension funds, the 5% pa tax deferred allowance for investment bonds and the fact that clients can make tax-free withdrawals from ISAs, the sky’s the limit. 

Pension Commencement Lump Sum - Limits capped by Pension Law

Pension Commencement Lump Sum is a useful resource when trying to generate a tax free "income" stream for clients and this remains the case after the removal of the Lifetime Allowance. 

There is still an upper limit on the amount of pension commencement lump sum (PCLS or more commonly known as tax-free cash/ TFC) available to a member when they take benefits. 

In broad terms, it’s usually limited to the lower of:

• 25% of the value of the member’s uncrystallised pension rights being put into payment,
• the individual's available Lump Sum Allowance (LSA), and
• the individual's Lump Sum and Death Benefit Allowance (LSDBA).

Individual Savings Account - No limit

Although contributions to ISAs don’t enjoy the same tax advantages as pensions, the growth within the wrapper is identical. Any money withdrawn is tax-free, without any limitations.

Summary

Appropriate planning, use of a multi-wrapper approach to investment, and learning to speak fluent ‘taxation’ (and being able to translate it to a language that a client can understand) can result in considerable tax wins for advisers’ clients.

In an environment where “sustainable income” is one of the financial planners key goals. Tax efficiency equals lower withdrawals equals capital lasting for longer!

In an overall planning scenario, the use of share investment plans, EIS, VCT etc. haven’t been considered. But availability and use of these (if appropriate) could expand the tax efficiency.

The ‘art’ of the adviser is to bring simplicity to the confusion.