Diversify your investment structures, minimise your tax and optimise your retirement income

Up to pace with ‘asset allocation’? What about ‘asset location’? See how it could work for you.

Diversification – not putting all your eggs in one basket – is a pretty accepted concept when it comes to investing. But what about diversification when it comes to the structures through which you hold investments? Is it important?

Investment diversification is undoubtedly important – in particular, how your money is spread across different areas of the market (‘asset allocation’ we call it in the jargon). But how well your portfolio is invested matters less if you lose a chunk of your investment return to tax. Financial planning is all about meeting your objectives: securing a comfortable retirement, helping with the grandchildren’s school fees, minimising the amount of tax you pay. So finding a way to reduce how much you need to save and/or how much return you need to secure to meet these goals is key. That’s where the structures used to hold the investments come in and are relevant. Some refer to the use of different structures as ‘asset location’, as opposed to asset allocation.

How do you build up a range of different structures in your investments?

Many of us, and certainly our clients, will naturally build up a range of different structures driven by the tax advantages of saving through these. For example, pension contributions may be maximised each year, then ISA subscriptions, and then, perhaps, cash is directed to funds (OEICs and unit trusts) and maybe even to offshore bonds. Over time, a range of structures is built up to tax-efficiently hold the investments.

What are the advantages of building a spread of investment structures?

Holding a spread of structures can protect against adverse tax changes. Another major potential advantage of building up a spread of structures, and one which is less talked about, appears when it comes to taking money out of your portfolio, most commonly at retirement. This is because in the same way there are different allowances and rules when adding funds to structures, there are different tax treatments and allowances when money comes to be drawn from them, and having a range of different structures can allow you to minimise tax.

Can you give me an example of how I might benefit from the structures of my investments?

Let’s say you want net income of £100,000 in year 1 of your retirement and you have built up the following assets from which to draw that amount of money:

• Pension funds worth £1m
• ISAs worth £500,000
• OEICs worth £500,000, paying a dividend of £5,000 per annum
• An offshore bond worth £500,000

The obvious or traditional approach would be to start taking an income from the pension, drawing some tax-free cash and some taxable income, and, when combined with the dividend, this could provide the £100,000 net income. Tax paid to get to £100,000 would equate to around 20% of the gross amount, which is a pretty low rate, and is lower than you might think due to the use of the pension tax-free lump sum and the dividend allowance.

However, if instead you made withdrawals from the ISA, OEICs and offshore bond, using the Personal Allowance, Personal Savings Allowance, the Starting rate band, and the dividend allowance, the tax rate could be driven down to less than 1%, plus the pension fund is left to grow not only free of Income and Capital Gains Tax, but also Inheritance Tax.

Will this strategy apply to every scenario?

This is a relatively extreme scenario, and there are other pension considerations to factor in, but the point is that using different allowances from different structures can help to minimise the tax paid on your hard-earned savings, allowing you to enjoy a more comfortable retirement and/or pass on more funds to others in due course.

At Carbon, we advocate the building up of a sensible range of structures and in retirement, the regular consideration of the best way to derive the required income for the period ahead.

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Richard Wadsworth is a Director at Carbon and can be contacted at richard.wadsworth@carbonfinancial.co.uk

The value of investments and the income derived from them can fall as well as rise. You may not get back what you invest.

This communication is for general information only and is not intended to be individual advice. It represents our understanding of law and HM Revenue & Customs practice. You are recommended to seek competent professional advice before taking any action.

Tax and Estate Planning Services are not regulated by the Financial Conduct Authority.

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