MKC Wealth financial planner Mark Dallas explains how we helped George make the most of his tax-free lump sum tax-efficiently and reorganise the assets he and Sheila had built up over the years so they could help their children financially and enjoy a comfortable retirement themselves.
George was given my phone number by a client I have been advising for years. We had a quick chat and he explained that he wanted to take his 25% cash from his pension pot while he could, as he was worried that Labour would win the next general election and bring back the Lifetime Allowance. He said his main concern was not paying too much tax and that he wanted to pass as much as possible on to his children.
Tax-free lump sum limit with Lifetime Allowance protection
He lives not far from me, in Berkshire, and we arranged to meet the following week and I found out more about him and his family and what he really wanted to achieve. It turned out that his pension pot was worth £1.8 million and that he had taken out individual Lifetime Allowance protection of £1.5 million. He was rather disappointed when I told him that the amount he could take tax-free was therefore 25% of £1.5 million not, as he thought, 25% of £1.8 million. Still, £375,000 is not a bad amount to land in your bank account without having to pay any tax on it.
I asked George whether he worked and where he and his wife’s income came from. He told me that he trained as an engineer and had had a good career with one of the big utility companies. He retired a couple of years ago and has delayed taking his pension as the couple don’t need the income. He is now 68.
Income from pension and rental properties
Sheila, his wife, is 65 and retired from her job as a head teacher five years ago. She has a good income from the Teachers’ Pension Scheme. They bought a small house not far from where they live and a modern flat in the town centre 10 years ago and they still have a few years left on their mortgages. The rental income from the properties combined with Sheila’s pension gives them more than enough to live on. Their children, John, who is 33 and lives in Peterborough, and Sarah, 30 and living in Bristol, are both in long-term relationships and Sheila is hoping to becoming a grandmother in the next couple of years.
They told me that they would like to help both their children buy a family home and, with house prices a touch lower, think that now is a good time to do this. They had a figure of £70,000 for each of their children. While they have enough income now, they are beginning to be concerned about how they will pay off their remaining mortgages, and in the longer-term pay for their care later in life. They also want to shelter as much as they can from tax – income and capital gains – before any possible reduction in the allowances.
I asked them the approximate value of their rental properties and whether they would consider selling them. Maybe, they said. I then went away, we did some calculations back in the office, and I went back to see them two weeks later. Here’s what we suggested.
Shelter tax-free cash in ISAs to use later, without worrying about tax
George, I said, should take his £375,000 tax-free cash now and give each of his children £70,000, leaving Sheila and him £235,000. They should then each use their full ISA allowance for this tax year, which would immediately shelter £40,000 from capital gains and income tax, and place the remaining £195,000 in a general investment account. On 6 April 2023 they should, I continued, move another £40,000 from this account into ISA funds, and continue doing this, legislation permitting, for the following four years. This should enable them to build up a nice pot that they can use in later years without having to worry about tax.
I told George that, having taken his tax-free cash, he could leave his pension as it is, with the potential to grow, or take an income from it which, I had worked out, would be roughly the equivalent to the rent they receive from their rental house. The house had gone up in value by around 60% since they bought it and they needed to think about how they would repay their mortgages, which were coming to an end in three and eight years respectively. After some discussion they agreed that it would be nice to be mortgage-free and that now seemed like a good time to sell, especially as the annual capital gains tax allowance is being reduce further as of 6 April 2023 and as George said, “Who knows what Labour would do to capital gains tax – they certainly wouldn’t reduce it!”
I suggested that George, rather than taking a regular monthly income from his pension, he should use what is known as drawdown to take money out as and when they need it, perhaps to fund their travels. This would give him the flexibility to manage his income in order to remain just below the higher rate income tax band.
More than enough income now with the flexibility to draw more if they want to
The net result of our recommendations is that George and Sheila will have slightly more income now, with both their pensions and the income from the small flat they will own outright, which gives them the freedom to travel without thinking about the cost (“Well, within reason,” said Sheila). They will be mortgage-free and have the option of either selling the rental flat if they so wish or should need more cash, or passing it on to their children (or grandchildren) in due course.
I also explained that they should think about reducing the possible inheritance tax bill their children would be left with when they eventually die. The threshold above which tax is payable hasn’t increased for years, I said, and neither party is likely to raise it substantially. They could, I said, in, say, ten years’ time, transfer their ISAs into funds that can help reduce inheritance tax yet remain within an ISA. As these types of funds tend to be riskier, it makes sense to make the transfer later, rather than invest in them now. I finished by reminding them that they should give any income over and above to their requirements to their children now, on a regular (perhaps quarterly or annual) basis, as giving away excess income doesn’t count towards inheritance tax and is therefore exempt from the seven year rule.
Please note that although this story is based on a real client, we have changed their name and aspects of their personal information to protect their privacy and identity.
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