The number of retirees is rising rapidly; many investors have both taxable and non-taxable investments and recent budget changes have increased the financial options open to the recently retired. Significant extra value can be obtained by ensuring that post-retirement spending is undertaken as tax-efficiently as possible.
Let’s look at a hypothetical example. Consider a higher-rate taxpayer with a portfolio that is invested 60% in equities and 40% in bonds and split evenly between taxable and non-taxable investments. If this client wishes to withdraw 4% of the portfolio each year, the order in which he or she makes those withdrawals will have a big impact on the rate of tax they pay. This, in turn, will affect the long-term returns that the portfolio will generate.
Spend from taxable accounts first
For example, if our hypothetical client draws down the taxable portfolio first, an increasing proportion of the remaining portfolio will be tax-sheltered. Thanks to its favourable tax treatment, this remaining portfolio will subsequently grow faster than the starting portfolio, half of which was being taxed.
We have calculated that a higher-rate taxpayer with a £1m portfolio could achieve a 0.48% advantage in the internal rate of return over a 30-year retirement period by spending in this way, compared with another client who spends from both the taxable and tax-sheltered parts of the portfolio at the same rate. Although 0.48% a year is a small number, the magic of compounding means that over 30 years an extra return of over £150,000 is generated.
For clients who do have some tax liability and who wish to make withdrawals, sound advice can make a real difference. For example, a client with a £250,000 portfolio who is within the capital gains allowance and only has 20% of the portfolio in taxable accounts could still generate savings of 0.29% per annum by spending in a tax-efficient way.