Why not having all your eggs in one basket makes sense – but not for the reason you think.

Most people would think that when a financial adviser mentions the word diversification, they will be referring to investments, spreading risk that kind of thing. This is true, however this month I am going to talk about diversification of ‘product’.

People often ask me what is best, an ISA, a Pension, that kind of question. There is no categoric answer to this without knowing the context of why they are asking. It’s often apparent however they are thinking of investment returns, or possibly costs, but they are rarely thinking of the one key differential which is tax. That is why we often use the phrase ‘tax wrapper’, rather than product.

TAX STATUS Unit Trust Investment Bond (onshore) Pension ISA
General tax position/ reliefs when withdrawing money Income subject to Dividend allowance of £2,000 p.a.

 

Capital can be withdrawn subject to Capital Gains Tax Allowance of £12,300

Taxed while invested. Permitted to withdraw 5% of original investment without an immediate tax charge. 25% tax free, then any residual withdrawal is taxable but not, if within the Personal Allowance of £12,570. Proceeds are tax free when withdrawn.

This is not the most interesting of tables I’ll grant you, but when you start to add some figures to it, it becomes a little more exciting – well for me it does anyway! You can see that a reasonable ‘income’ can be provided from the Unit Trust and Pension as there are two decent tax allowances to use – the capital gains allowance and personal allowance within the income tax regime. The ISA is always the most tax efficient on withdrawal, therefore even more reason to keep a decent amount of capital in that, for the years of retirement when your personal allowance is used up by state pension and other pensions.

Graham is retiring early. He is 62 and has his ‘Work’ pension starting when he is 66 and his state pension starts one year later. He needs an income of £34,000 per annum for the next 4 years and this is required from his various tax wrappers which he has saved into for many years.

Value Unit Trust (£50k) Investment Bond (£60k) Pension (£140k) ISA (£150k)
Income £2k dividend,

£12k capital

5% of original £40k investment – £2k £16,750 withdrawal – 25% tax free, balance below personal allowance Withdraw £1,250
Any Tax to pay No No No No

 

So the income requirement (in orange) of £34,000 has been achieved and Graham will pay no income tax or capital gains tax. When he was employed an income of £34,000 would have meant income tax of about £4,280.

Author: Phil James, Grosvenor Consultancy Ltd

Please be aware that the above does not constitute financial advice. We recommend that you consider your existing investments, pensions and financial arrangements and then take advice. There are advantages and disadvantages to using all of these strategies and they depend on individual circumstances so don’t take action without seeking competent advice. Tax rules, rates and allowances are all subject to change. The Financial Conduct Authority does not regulate tax advice and some forms of offshore investments. The value of investments and the income from them can fall as well as rise and you may not get back the full amount you invested.

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