How to be tax efficient in your retirement

One of the main ways you can effectively plan for your retirement, and one that is recommended by financial experts, is to organise your finances in a tax efficient way. You may have plenty of objectives you want to achieve in your retirement, but it’s also just as important to ensure you have enough future income to enjoy the lifestyle you want.

Pensions are, of course, a great way to grow your wealth but, dependent on your circumstance, it may be unwise to exclusively stick to them. In fact, in some cases they can present significant challenges, especially to wealthier individuals who could feel the impact of the £1,073,100 lifetime allowance.

So, how can you be tax efficient when investing in your retirement? Read on to find out more.

What are tax wrappers?

‘Tax wrapper’ is an industry term that describes a specific product that your cash and investment can be held within – different wrappers have various tax treatments applied. Pensions are just one form of tax wrapper, but you should also explore other options to diversify your wealth effectively.

The way in which the different tax wrappers can be applied will depend on your goals and financial planning, and whether you’re at the stage of accumulating wealth or drawing on your assets.

Diversify your tax wrappers

One of the best ways to minimise the tax you pay on your retirement income, is through diversifying your tax wrappers. There are four core tax wrappers recommended by financial experts. The first is your pension, as previously mentioned, as well as the following three:

  • Individual Savings Accounts (ISA)
  • General Investment Account (GIA)
  • Offshore Bond

If all four are used in the right combination, you could see a considerable impact on your wealth.

Uses and benefits

As the aim is to diversify your tax wrappers, it’s understandable that they have varying uses and benefits.

With a Self-Invested Personal Pension (SIPP), the contributions are gross of all tax and all investment growth is free of Capital Gains Tax (CGT). You can access 25% of the pot completely tax free when you reach retirement age, and the rest is taxed as income in line with marginal income tax rate.

For an ISA, the contributions are net of tax, but once the money is in the ISA, the environment is tax free. Any withdrawals are also completely tax free.

GIAs are a fully taxable environment, liable to income tax and CGT at respective marginal rates. However, you can take advantage of your CGT allowance when accessing the money, withdrawing a significant amount, tax free. For the tax year 2021/22, the CGT allowance stands at £12,300. Any gains above this are taxed at the marginal CGT rate.

Finally, offshore bonds work in a way to defer tax. Contributions are net of income tax and national insurance. Each year, you can access 5% of your initial capital, with no immediate tax charge or CGT. However, any gains that are withdrawn are taxed as income in line with marginal rate.

Using four core tax wrappers

Let’s put this into practice and consider the example of a couple with £2,000,000 invested. By using the four tax wrappers successfully, they can access £90,000 a year in retirement, free of tax.

Collectively, they have structured their wealth in the tax wrappers, as follows:

  • SIPP: £750,000
  • ISA: £500,000
  • GIA: £500,000
  • Offshore bond: £250,000

Using the benefits of each tax wrapper, as explained above, they can withdraw:

  • 25% tax free cash from their pension and a further £25,170 tax free using their combined personal allowance
  • £27,760 from their ISAs without any tax implications
  • £24,600 from their GIA using their joint CGT allowance
  • £12,500 from their offshore bond (equal to 5% of their initial investment)

The ins and outs of tax wrappers can be quite complicated, especially when it comes to their uses and benefits. Therefore, it is always best to seek advice from a professional, financial adviser that can offer guidance on the most effective way to plan and invest for your retirement.

Disclaimer: Information is correct to the best of our understanding as at the date of publication. Nothing within this content is intended as, or can be relied upon, as financial advice. Capital is at risk. You may get back less than you invested.