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Creating Tax-Efficient Savings and Investments | Client Scenario

To help you understand how you can manage your savings and investments in a tax efficient manner, we have put together a hypothetical case to walk you through it. Of course, everyone’s personal circumstances are different, so it’s best to talk to your adviser before making any changes.

At the beginning of May 2018 we were contacted by Jeff and Michelle, a married couple in their late 50s who have recently inherited £600,000 from Michelle’s mother and wanted advice on the best way to invest the money for future income, without incurring a large tax bill.

Both Jeff and Michelle are in good health, and they own their main residence outright, with no outstanding debts or liabilities. The couple had modest combined income needs in the region of £15,000 per annum and wanted to consider ceasing employment and taking early retirement, provided the income needs could be met from the inherited capital.

It should be noted that they retained suitable emergency cash funds and a Stocks & Shares ISA each in addition to the inherited capital, so they were happy to tie up the £600,000 in longer term investments to ensure their income needs can be met both now and in the future.

Despite having a combined Inheritance Tax allowance of £900,000 (£325,000 Nil Rate band each, plus £125,000 each Residence Nil Rate band, as they will leave their residence to their children) there will be an IHT liability on their estate following the inheritance from Michelle’s mother. However, a review with their adviser comes to the conclusion that it was not important at the current stage given their immediate retirement wishes. They will continue to review this at future meetings to ensure that it does not become an issue.

Having reviewed Jeff and Michelle’s circumstances the adviser provided the following recommendation a week later in May 2018:

  • Invest £20,000 into Michelle’s existing Stocks & Shares ISA for the current tax year (2018/19) as this allowance had not already been utilised (however, Jeff’s had been).
  • Invest £280,000 into a General Investment Account (GIA) held in joint names alongside the ISA. This can then be used to fund both Jeff and Michelle’s Stocks & Shares ISAs each year as the annual allowances become available on the 6th
  • Invest £300,000 into an Offshore Investment Bond held in joint names.

Topping up Michelle’s existing Stocks & Shares ISA will increase the funds held within the ISA wrapper, which removes the underlying assets from Income Tax and Capital Gains Tax (CGT), ensuring no tax will be due on future income or withdrawals. Please note ISAs do form part of the estate for IHT.

Opening a GIA alongside the ISA allows for the funds to be invested in line with Jeff and Michelle’s attitude to risk and provides a ready source of capital to maximise the ISA allowance each tax year (currently £20,000 for the 2018/19 tax year). Gains within the GIA are potentially subject to CGT on encashment. As each individual has an annual CGT allowance (currently £11,700 for the 2018/19 tax year) any gains realised on the account should be covered by this. Gains in excess of the annual allowance will be subject to tax.

Using the Offshore Investment Bond will provide Jeff and Michelle with a tax deferred income of up to 5% of the investment amount for the first 20 years. This is treated as a return of the original capital invested and based on an investment of £300,000 will provide a withdrawal of £15,000 per annum, which covers their annual income requirements. (Please note the level of income drawn may be reduced by charges if these are not covered externally from the Bond).

The Offshore Investment Bond allows for them to take control over the timing and amount of tax paid. While invested in the Bond, tax will not normally be paid on any growth. Tax is instead paid when withdrawals are made and is based on their circumstances at that time. An Offshore Bond was recommended in Jeff and Michelle’s circumstances as they would both be non-taxpayers once retired allowing for maximum flexibility for future withdrawals and tax. They will also both have their personal savings allowance of £5,000 which can be used to provide further tax efficiency.

Using three different investment structures allows for all of Jeff and Michelle’s investments to be held in a tax efficient manner and still provide them with the required annual income, without compromising both of their tax positions. If they were to fully invest the £600,000 into an Investment Bond the tax free ISA allowance each year would be left unused. Holding the funds in a GIA to ‘feed’ their ISAs also makes use of part of their annual CGT allowances. Jeff and Michelle retain maximum flexibility and access to both income and lump sums in the future.

This is a hypothetical situation to help you understand how a financial adviser might help you and it does not constitute specific financial advice or guidance. Taxation treatment depends on the individual circumstances of a client and is subject to change in the future.

If you would like more information please contact one of our highly qualified financial advisers. For more information on the subjects covered in this post, please see our Guide to Tax Efficient Savings and Investments.

Julie Mallett, Chartered Financial PlannerJulie Mallett APFS
Client Manager (Advisory)
Chartered Financial Planner