The move into retirement is stressful. Budgeting for your day-to-day needs while ensuring you leave enough behind for loved ones is a delicate balance. Add to this a life of leisure and the calls on your cash start adding up.
Michael Scott, whose name has been changed, faces all of these challenges. The 69-year-old wants an annual income of £70,000 so he and his wife, Julie, can enjoy their later years without tapping into his £900,000 pension.
He lives in Hertfordshire in the couple’s £1.5m home and earns £45,000 a year as a consultant, although this has fallen to half this amount during the pandemic – temporarily, he hopes. He also receives a £7,150 per year state pension.
There are no immediate plans to stop working given Mr Scott still “feels like a 30-year-old” but he has retirement in his sights. “My perfect goal is to leave the pension and the house to my kids and spend the rest,” he said.
The “rest” is sizeable and potentially enough to support his aims. Alongside the pension, there is £500,000 in an investment account and £200,000 in an Isa currently invested in a medium-risk fund with his wealth manager.
Mr Scott also has £250,000 in investment bonds, which pay him 5pc a year, as well as £30,000 in Premium Bonds and £155,000 in cash.
Even with £1.1m set aside to fund his retirement, the Premium Bonds and cash earn next to no interest. The bulk of the work will have to be done by his £500,000 investment account, where Mr Scott will have to pay capital gains tax when taking profits. So his £70,000 aim, especially when he stops working, will require careful planning.
Kim Barrett, managing director of Barretts Financial Solutions, said:
Given the state pension, Mr Scott needs his assets to produce £62,850 every year to reach his income goal of £70,000. A 5pc withdrawal rate from his bonds will provide another £12,500, reducing the target to £50,350.
There should be no problem generating the level of return he needs given the size of Mr Scott’s investments. For any balanced fund, an investment return of 5pc is not an unreasonable expectation. However, the adviser’s charge will need to be taken into account as well, leaving a 4pc return.
Mr Scott’s investment portfolio of £700,000 would provide £28,000 per year in returns on average, excluding any CGT or income tax, and reduces the remaining income target to £22,350. He should also sell some of his investment portfolio each year to take advantage of the CGT allowance of £12,300 and reinvest it within an Isa.
While Mr Scott feels comforted by having a large amount saved in cash, it is holding him back. He should keep a small cash sum for emergency spending – say, £15,000 – and invest the remaining £140,000. A 4pc return would provide an additional £5,600, bringing down his target income to £16,750.
For now, this is more than covered by his earnings. However, when Mr Scott stops working there will be more pressure for his investments to deliver.
At that time he could of course sell his assets to make up the difference. This would reduce the amount produced in investment returns, but given it is such a large pot there is a low risk of him running out of money. In the worst case scenario, he still has the £900,000 pension.
Neil Moles, chief executive of Progeny, said:
Mr Scott’s total estate is valued at £3,534,000, of which £2,634,000 will be included in inheritance tax calculations – the estate minus the £900,000 pension.
He and his wife can pool their nil-rate bands of £325,000 each plus the residence nil-rate band, as they are planning on passing their property to their two sons on death. This would usually provide an additional allowance of £350,000, or £175,000 each, but as the value of the taxable estate is over £2m this will be tapered down to £33,000.
Mr Scott should reduce the value of his taxable estate below £2m without allowing this to hurt his income target.
He could gift money into a discounted gift trust. This would allow him to benefit from an immediate reduction in the value of the estate, with the remainder falling out after seven years of the gift being made.
I would also look at assigning the investment bonds into a trust for the benefit of his sons. If they earn less, they may be able to withdraw the returns as income at a more favourable tax rate.
Mr Scott and his wife could also look to utilise their annual gift allowances of £3,000, carrying over the previous year’s if not used.
He should also consider that his pension is close to the lifetime allowance of £1,073,100. He could look to withdraw 25pc from the pension once the value nears the allowance threshold. This would bring a large amount of cash back into his estate for IHT purposes, but it could be gifted into trust, and should he survive seven years after making this gift, it will fall back out of his estate.
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If Mr Scott were to die after age 75, any withdrawals from the pension made by the beneficiaries will be liable to income tax at their marginal rate. This may therefore be another argument to crystallise the pension and gift the tax-free cash into a trust.