When it comes down to it, retirement planning is essentially about one thing – ensuring you will have the income and lifestyle you desire once you finish working. While that may sound obvious, getting it right can be challenging.
If you are a high-net-worth individual (HNWI), a high level of annual income might be required for a retirement that could potentially span several decades. Add to the mix limits on common retirement vehicles such as pensions, and adequately planning for retirement becomes complex.
So how can HNWIs ensure they have sufficient funds to sustain their retirement ambitions?
Well, it has long been recognised that the sooner you start planning for your retirement, the more likely you are to achieve your goals. What hasn't received quite as much emphasis is the value of the more alternative options available and building a plan accordingly.
In order to do this, individuals need to first work out exactly what they want their retirement to look like. “Our first conversation with a client is about how much they'll need each year in retirement and how large their retirement 'pot' needs to be to achieve that," explains Nick Ritchie, senior director, Wealth Planning at RBC Wealth Management in the British Isles. “And then we'll look at how we get them there and what structures we'll use."
Adam Turner, associate director, Wealth Planning at RBC Wealth Management in the British Isles, stresses that this structuring is key. “Some clients might focus almost entirely on returns and hugely underestimate the impact of how the investments are structured and the effects of tax. Establishing these structures in an efficient way can make a significant difference to how far their money goes."
Thinking beyond the basics
Pensions and ISAs are typically seen as cornerstones of retirement planning because of their tax-related benefits. Broadly speaking, investments in both grow free from income tax and capital gains tax (CGT); while pensions benefit from tax relief on contributions and permit restricted tax-free lump sum withdrawals, all investments held in ISAs benefit from tax-free withdrawals.
“Factors such as this play a critical role in retirement planning," says Ritchie. “As much as ensuring enough money goes in, serious consideration needs to be given to how it's going to be taken out post-retirement and how to do so in the most tax-efficient manner."
For HNWIs, however, pensions and ISAs come with limitations – the latter has an annual allowance of £20,000, restricting the amount that can be invested tax-free.
For pensions, the standard annual allowance for tax relief is £40,000; but for anyone with an adjusted income exceeding £240,000, that allowance is reduced by £1 for every £2 over £240,000. If you had an adjusted income of £312,000 or more, for instance, you will have an annual tax-free allowance of just £4,000 (minimum allowance reduction).
What's more, the pension lifetime allowance – i.e., the total amount you can build up in a pension without incurring a tax charge – currently stands at £1,073,100.
Despite these limits, it's typically recommended for HNWIs to max out their contributions in order to make the most of the tax-related benefits – before introducing other alternatives to build a holistic retirement plan.
Two of the most effective alternatives are international bonds and venture capital trusts (VCTs).
Investing in international bonds can be a great way to complement other retirement structures, owing to their flexibility and potential tax advantages.
International bonds are similar to ISAs and pensions in that they act as a wrapper in which you can place a range of investments based on your return objective and attitude to risk.
Not only is there no upper limit on the amount you can invest, but tax typically isn't paid on investment growth while funds are retained within the wrapper.
From the perspective of retirement provision, you can withdraw up to five percent of the total amount paid into the bond with no immediate tax to pay. This is also cumulative; so if you take nothing in year one, you could withdraw 10 percent in year two.
It's important to note that tax may become liable later if a "chargeable gain" occurs, and chargeable gains are taxable at income tax rates. This can be offset by "top slicing" relief (i.e., spreading the gain over the number of years the bond has been held) or utilising personal allowances and the basic rate tax band where available.
Venture capital trusts
VCTs were introduced by the UK government to encourage investors to support smaller businesses and startups. To attract those investors, VCTs come with a number of compelling tax incentives which can help play a significant role in retirement planning.
As well as offering upfront income tax relief of 30 percent, any profits made from the sale of VCTs are free from capital gains tax. Turner also points out that when it comes to retirement income, dividends are tax-free, “which can provide an attractive, additional income stream."
Notably, the annual allowance for VCTs is £200,000, with no reduction for higher earners. “This is 10 times what you can put in an ISA," says Turner. “And that can really move the needle for clients when they realise how large a pot can be built."
While certainly a compelling proposition, it's important to state that VCTs are higher-risk investments and have lower liquidity. As such, they would have to fit your appetite for risk and complement your other holdings so that your risk exposure is managed.
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The bigger picture
With so much to consider when it comes to retirement planning, it's no wonder the recommendation is to start thinking about your strategy sooner rather than later.
For couples, there are additional considerations. If both individuals are retiring, structuring assets between them can ensure both sets of personal allowances are utilised, which can create significant tax savings over the years. For instance, married couples benefit from being able to make transfers of assets to each other with no immediate CGT.
There is also an additional option – holding investments that qualify for business relief. This is another government incentive to support smaller businesses and economic growth. While generally higher risk, such investments can form part of a diversified portfolio that can be used to fund retirement. Notably, they allow investors to retain control of the investments and are exempt from inheritance tax (IHT) after being held for two years.
This last point demonstrates the importance of factoring in succession, inheritance tax and gifting as part of your retirement planning. “Most modern pension funds sit outside of your estate for inheritance tax," says Turner. “So, for some families it often becomes more effective to preserve your pensions as a legacy to be passed on free from inheritance tax, using non-pension assets in retirement to drill down on first."
There are also gifting advantages built into international bonds. If not required for your own retirement, gifting segments of the bond can be an effective wealth transfer strategy, as they can be assigned to children and surrendered at their own tax rates, which will likely be lower.
“When you're planning for retirement, you don't want to end up with excess wealth so there's a huge inheritance tax bill after your death," says Ritchie. “You really need to factor this into your structuring at the outset."
By having a diverse range of structures in which you hold investments – including having cash reserves in place – you can reduce your risk exposure and build a tax efficient retirement pot. But what should you consider when you want to start using this money?
“Generally, you will want to start accessing retirement income from cash rather than investments," says Ritchie. “Because if you happen to draw on those investments in a declining market, it's far harder to recover any crystalised losses."
“At least annually, you should sit down and look at your income requirement for the year ahead, how you are drawing it at the moment and whether you are doing that in the most efficient way," says Ritchie. “And then make any necessary adjustments, so that your plans remain optimised."
With all of the above in mind, it's important to not only start planning for your retirement at the earliest opportunity, but to review your plans on a regular basis in case your circumstances, retirement goals or, indeed, regulations or broader global economic factors change.
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