Andy Zanelli discusses the importance of asset allocation within a tax wrapper.
As with any discussion there are two sides to be considered and the subject of wrapper allocation and tax is no exception. Some may feel that this is evidence of that famous saying, popularised by Mark Twain:
“Lies, damn lies and statistics”, while others may feel that this is a demonstration of the power of numbers. The other point worth making at the outset is that this is merely an example to provoke thought and not any sort of recommendation.
The beauty of the industry that we work in is that every client is unique and requires a thoughtful blend of advice to achieve their life goals. A question that has been rolling around in my mind recently is how much asset wealth could a client have that could produce a significant income level and not attract any higher rate tax?
As we all know there is no definitive answer, yet I think this question is underpinned by asset allocation not in a traditional investment sense when considering asset classes but at a tax wrapper level.
In the following example, I have made some assumptions so the figures are representative and purely illustrative, but the principles are the same.
I have stuck to the typical investment vehicles that most clients would be expected to hold and based the situation on tax rates for the 2011 to 2012 tax year:
• Property – house worth £500,000
• Pension – assumed to be an uncrystallised self invested personal pension (SIPP) with a value of £1m with no form of fund protection.
• Bond – assumed this is an onshore bond with an original investment of £250,000, with 250 segments, made from an inheritance ten years ago and now worth £500,000 – no previous withdrawals have been made.
• ISA – assumed that the client has made maximum use of the personal equity plan/instant savings account (PEP/ISA) allowances throughout the years and the value is now £500,000.
• OEIC – assumed the client has been saving £12,000 per annum for 20 years and a growth rate of approximately 6.5% per annum would give a value of £500,000.
Neatly (and a real benefit of using a fictional case study) this gives an asset wealth of £3m. The next step is to consider the income level that could be produced and the resulting tax liability.
•Pension – assuming the client is entitled to a full basic state pension then this gives a starter on the income of £5,312 per annum. If we then crystallised £100,000 of the SIPP this would produce £25,000 as a pension commencement lump sum and, assuming a gilt yield of 4% for a 65-year-old from the 2011 government actuary’s department (GAD) tables, a taxable income of £4,950.
• Bond – if we fully surrendered 13 segments this would provide £26,000. After running through the full encashment calculation (policy proceeds + previous withdrawals) - (previous chargeable amounts + the original premium) it would give a chargeable gain of £13,000 and a ‘top sliced gain’ (the gain divided by the number of years the bond has been in place) of £1,300.
• ISA – withdraw £25,000.
• OEIC – assuming that this is a portfolio of low-yielding funds that produce an annual income of 1% of the OEIC value then this would produce £5,000 of dividends. If we withdrew £25,000 of the capital and apply the formula above this would result in an amount of circa £12,900 as a gain of which £2,300 would be liable for capital gains tax (CGT) after the deduction of the annual exemption of £10,600.
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