Read the below case study based on tax mitigation:
Ryan and Emily are married couple in their early 30s, with two young children. Emily is an additional rate tax payer, while Ryan has no income. Historically they have been ‘savers’ rather than ‘spenders’ and have utilised their pension scheme contribution annual allowances when able to do so. Since the introduction of the tapered annual allowance in 2016, and because of her income position, the scope for pension contributions are now limited for Emily. Although contributions can still be made, albeit at a reduced level, the couple have started to consider what other options are viable to assist with their retirement planning.
Having reviewed their current financial position, it is clear Emily’s income comfortably meets their expenditure requirements, and they have a fairly high capacity for loss, in addition to a medium to high risk profile. Building wealth for retirement is a key objective of theirs, although given Emily’s income level, tax efficiency with saving is also high on the agenda.
Having met with a financial planner and explained their position, Ryan and Emily explore several financial planning options.
Given Emily is an additional rate taxpayer, she does not have the scope to contribute the full £40,000 per tax year into a pension scheme. As her income is above the ‘adjusted income’ threshold of £150,000, she is subject to the tapering of the annual allowance for pension contributions. Therefore, for each £2 of income above £150,000, her annual allowance will be reduced by £1 down to a minimum of £10,000.
Although tax relief will still be available on the contribution of £10,000 and £3,600 (gross), clearly this is not tax efficient as formerly the case prior to tapering.
As the couple are looking to build savings and under 40, contributing to a LISA secures a Government bonus of 25%, in addition to the tax benefits around income and growth within the wrapper. As the LISA limit is £4,000 per annum, using the remaining £16,000 per annum in a traditional ISA (cash or stocks and shares) provides the facility to build further wealth free of income tax and capital gains tax. There is a penalty applied of 25% on LISA withdrawals ahead of age 60, however there is still the £16,000 that can be accessed flexibly via the traditional ISA route.
Alongside making pension and ISA/LISA contributions, the couple’s adviser recommends Emily makes some investments into venture capital trusts (VCTs). This allows her to obtain income tax relief of 30% upon the initial investment amount, but also provides the facility to generate tax-free dividends, in addition to an exemption from any capital gains tax liability upon sale of the asset, once held for five years.
Although VCT investments are perceived as ‘higher risk’ combined with a more cautious approach to investment strategies within the pension scheme and ISAs, the adviser can provide a medium to high strategy, suited to Ryan and Emily’s risk profile. Additionally, spreading investments across a collection of VCT offerings provides diversification within the portfolio as well as benefiting from the input of various specialist fund managers.
Given their age, Ryan and Emily can afford to take a longer-term view with their overall investment strategy, meeting their objectives of achieving capital growth while maintaining tax efficiency.