We all require an income to enable us to live our lives and hopefully enjoy some niceties too. How you generate this income can have a marked effect of the amount of tax you pay. This blog introduces some ideas and opportunities that you may have previously overlooked.

This blog does not constitute individual financial advice or investment recommendations.

1. ISAs

Individual Savings Accounts (ISAs) are accounts where any income or gains generated, are free from income and capital gains taxes. The main constraint is that you can only contribute up to £20,000 per tax year, per adult and therefore to build an ISA of notable value, will take time. If you can build an ISA pot and invest such that it generates an income, for example, a couple with £200,000 in ISAs, assuming an income generation of 4%, you could receive an extra £8,000 tax free of income, each year.

2. Pensions

There are many different types of pensions, which is beyond the scope of this blog. If you are fortunate enough to have a defined benefit pension, one that pays you an income for the rest of your life, there’s typically little you can do, other than enjoy the income it generates.

If, like the majority of the population, you have a defined contribution pension (i.e. a pot of money), then depending on the terms of the pension, you may have the opportunity to access it in a variety of ways, including:

• The option to take tax-free cash (typically 25% of the value of the pot) is a potential opportunity to take money from the pension tax free, but can have consequences, for example, that’s a one-off withdrawal and not an income
• Tailored drawdown could be an option to consider, depending on the value of other income you receive
  • this option allows you to take an income, of which 25% is tax free with the balance being taxable at your marginal rate of income tax
• You can elect to take an income from your pension, which would be taxed like any other income – however, depending on the terms of your pension, it is possible to adjust the value of the income paid, such that you don’t pay more tax than is necessary. i.e. you’re not committing yourself to an income for life.

3. GIAs

General Investment Accounts (GIAs) are accounts allowing you to invest your cash. Tax rules at present are such that each adult has a £2,000 dividend tax free allowance per tax year, meaning any dividends up to this level are free from income tax.

Dividends received more than £2,000 are taxable at your marginal rate, which for many retirees will be at 8.75%. Any gains within a GIA are free from capital gains tax when they are below the annual CGT allowance of £12,300 per adult. Above this any gains are taxable at 10 or 20% depending on your other income.

A couple (no need to be married) could have £4,000 per tax year of tax free dividends and gains of up to £24,600 before they pay any tax. Using a £200,000 joint GIA, with an income generated of 4% (£8,000), as a mix of dividends and interest, may result in an effective tax rate of just 5% on that income.

4. VCTs

Venture capital trusts (VCTs) are higher risk investment opportunities and ordinarily something for individuals who have otherwise exhausted ISAs and pensions plus have a higher income tax liability. This is unlikely to be the case for most retirees, but in the years up to retirement, if you are paying higher rates of income tax, you could consider investing in VCTs, where you will save income tax at 30% of the invested value and any future dividends are free from income tax.

VCTs are higher risk and your capital value may well fall as well as gain.

5. Are you a business owner?

If you have a limited company with retained profits and no expectation of a trade sale, then you could consider investing some of the cash within the company structure. Any gains and dividends are subject to corporation tax, currently at 19%.

Withdrawals from the company in the form of salary or dividends will be taxable at your marginal rate but as a controlling director and shareholder, you have the flexibility to make such withdrawals when circumstances suit.

Planning opportunities

If you’re part of a couple (irrespective of legal status), it typically makes sense to use the income tax allowances you both have available.

Instead of one partner with an income of £90,000 paying tax at 40% (i.e. higher rate), it would be more tax efficient for both of you to have an income of £45,000 (£90,000 combined) but with both paying tax at 20%.

To make this scenario come to life, you need to plan and build various pots of money, and use allowances you both have, across many years.

Income generation outcome

If in retirement, you could have income coming from a variety of sources, including:

• A defined benefit pension
• State pension
• ISAs
• Personal pensions
• General investment accounts
• A limited company

This would provide you with mix of guaranteed and flexible income streams. The flexibility of some of those pots can be used to boost your income for that dream holiday or car, for example.

If you want to talk about your financial planning and income requirements, we’d love to hear from you. Book a free, no obligation meeting here (https://calendly.com/wattamkirbymee)

Thanks for reading.