UK tax efficiency in context of FIRE

[wycliffe19]

I have been thinking about how best to be tax efficient in a UK FIRE context. Setting out my thinking below, and would welcome others’ thoughts and experiences.

Situation is:

40s, married with kids

Total net worth = £2.9m consisting of

Pension (equity index funds) £0.4m
ISA (equity index funds) £0.6m
House (no mortgage) £1.2m
Total Sheltered = £2.2m

Non-ISA 'cash' £0.4m
Non-ISA equities (index funds) £0.3m
Total Unsheltered = £0.7m

£60k a year annual expenses burn rate. 4% rule on the net worth minus the house is 4% * (2.9 - 1.2) = £68k.

Drawdown plan = Unsheltered first, then ISAs, then 25% pension tax-free then pension. Those latter pension drawdowns will likely be at the basic rate of tax.

Approach to the unsheltered investments:

Non-ISA 'cash': Gilt ladder i.e. purchase short-dated gilts issued at some point during the low-rates era at e.g. 0.5% coupon but with around 4% effective yield when held to maturity. Maturities staggered to future drawdown needs. Interest received = £400k * 0.5% = £2k a year. Gilts are exempt from UK CGT so the ‘pull to par’ is not taxable. In practice some of this will be true cash to provide a buffer, so the interest earned will be a bit higher than £2k a year.

Non-ISA equities: Dividends received = 1.69% index fund dividend yield * £300k = about £5,070. There is CGT exposure here (charged at 10% in the basic rate band). Gradually fill 2 x ISA allowances with this over time.

Total resulting income on unsheltered investments is therefore £2,000 ish + £5,070 = £7,000 ish p.a. i.e. below one person’s Personal Allowance (£12.6k p.a.). Therefore tax payable is zero. There is some CGT exposure on top of this. If we choose to earn more income, there would of course likely be more tax.

Anything obvious that is being missed here / that others do?

[DrFfybes]

I've never really considreed my house value in any FIRE calc, because I have to live somewhere are am not intending to sell it.

As for the rest, it seems pretty similar to my approach. Given your age can you shelter some more assets other than the £40k into an ISA?

You might have some large outlays for the kids if/when they go to uni. Perhaps look at JISAs for them allowing you to shelter some assests you'd need to spend anyway.

Leaving the SIPP makes sense with current IHT rules, but they will probably change several times in your lifetime. So it might be more beneficial to part crystallise you SIPP first as your unsheltered assets dwindle, taking TFLS and some income to keep you under the 40% tax threshold along with the unsheltered Divis and whatever sales are permitted under future CGT rules. But as this is 10+ years away the Libe Dems could be in power by then [1] so I wouldn't plan in too much detail yet.

Paul
[1] I did say 'could'.

[Alaric]

Total resulting income on unsheltered investments is therefore £2,000 ish + £5,070 = £7,000 ish p.a. i.e. below one person’s Personal Allowance (£12.6k p.a.). Therefore tax payable is zero

When between allowed retirement age and State Pension age, there can be a case for taking amounts out of the SIPP up to the personal allowance.

[Lootman]

I've never really considered my house value in any FIRE calc, because I have to live somewhere are am not intending to sell it

He appears to know that as he said "4% rule on the net worth minus the house is 4% * (2.9 - 1.2) = £68k." Although the value of a home can be relevant if you are willing to downsize in the future.

The OP may care to not make too many changes solely for tax purposes right now as it looks like we are months away from a new government and the rules about pensions, ISAs, capital gains etc. could all change.

More generally a household net worth of £2,900,000 really ought to be enough for a couple to quit work even if, as apparently in this case, they are both only in their 40s and have children. Presumably they already made that determination if neither spouse works any more. There will also be two full state pensions assuming that they buy NICs as needed (or take some part-time work).

[SebsCat]

Drawdown plan = Unsheltered first, then ISAs, then 25% pension tax-free then pension. Those latter pension drawdowns will likely be at the basic rate of tax.

Obviously unsheltered first. After that, I think it gets more complicated. If you should exhaust your ISAs and then find you need a significant amount of cash (house repairs, etc) then you could end up paying a lot of tax to get it out of a pension. OTOH, it's better to keep the pension untouched if there's a chance you might die before 75 and / or you want to leave as much as possible to kids.

FWIW, what we've done / future plans are (I've got a DB pension that is in the "keep the lights on" range, wife has SIPP, no children so how much we leave to nephews & nieces is a factor but small in the scheme of things)
1) take maximum tax-free cash from wife's SIPP. Stuff as much as possible into ISAs and Premium Bonds. The rest is mostly in unsheltered cash but attracts little or no tax thanks to the starting rate for savings.
2) use cash and, only once the unsheltered cash is down to ~3 years expenses, start taking more from SIPP (obviously taking SIPP income up to wife's personal allowance level in the meantime). DB pension plus SIPP income and later on State Pensions should cover all regular future expenditure.
3) ISAs will remain largely a hedge against future care home needs but it's also there if we ever need a significant amount of cash.

This way, we should never have a marginal tax rate more than the basic rate. Overall tax level (*) should remain well below this.

* - we are both entirely comfortable with the fact that there will be a £500k+ inheritance tax bill when the second one of us dies. Someone's got to pay for the services we all use and are happy to defer our contribution until after we no longer need the money!

[kempiejon]

How much are you currently getting into tax sheltered investments annually? Hiving it away until 57 into the SIPP is all well and good but you might be able to RE before 57 so having plenty available outside the pension is handy. Another relevant point is the government can monkey with the tax treatment, limits and restrictions on tax free savings and there's an election coming. I didn't worry about my pension, preferring to save in ISAs and unsheltered but the tax rules changed so did my planning turning that plan on its head.

[Lootman]

Drawdown plan = Unsheltered first, then ISAs, then 25% pension tax-free then pension. Those latter pension drawdowns will likely be at the basic rate of tax.

Obviously unsheltered first. After that, I think it gets more complicated. If you should exhaust your ISAs and then find you need a significant amount of cash (house repairs, etc) then you could end up paying a lot of tax to get it out of a pension. OTOH, it's better to keep the pension untouched if there's a chance you might die before 75 and / or you want to leave as much as possible to kids.

Yes, one often under-estimated benefit of ISAs over any kind of pension is the ability to cash it out at any time, get the money within days, pay no tax on it and not even have to report it.

Pensions are forever captive to rules, changes and in most cases cannot ever be relocated beyond UK jurisdiction should that be desired.

I would always exhaust pensions before ISAs, under current rules anyway.

[TUK020]

Rather than think of unsheltered/ISA/pension as a sequence, you should think of this a taxed/tax free income - balance to manage level of tax paid.

You should be planning on taking at least your tax free allowance worth of pension (£12.5k) from the first moment you can, and then top up spending income as required from tax free sources. In later years, you should not be planning to take more than the basic rate's worth of pension (i.e. the first £50k), and keeping some ISA to top this up. When you get to state pension, you can dial back any SIP income.

JISAs for planning uni funds, support for property purchase etc for kids has already been mentioned.

[tjh290633]

In the next 20 years you could be moving £800k of that unsheltered investments into ISAs at least.

You might also like to contemplate using global investment trusts instead of index linked funds. ATST, FCIT and WTAN have all given a good TR over the last 20 years, approaching 10% per year, which implies doubling every 7 years. Better than the indices.

TJH

[EthicsGradient]

This may have been covered in another thread, but have both of you already taken early retirement, or are you contemplating it and trying to work out when it can be done low-risk? And does "40s" mean early, mid or late (same for both of you?) - it makes a fair difference for how long until you can withdraw pensions.

You will have, between you, a fair amount of income that could pay zero tax, from interest - it doesn't have to be just your float/emergency in savings rather than gilts, at least until you do start taking pension income. 2 PAs plus PSAs plus starting rate add up to 37k. Five year fixed-rate accounts are now about 4.5%, compared with a yield to maturity of 3.8%-3.9% for gilts over that time. Though I suppose if you did choose that, it'd mean that if either of you did take up paid work again, you'd pay income tax on it without being able to switch out of it. But if you used shorter fixed terms, you'd be able to put it into gilts if work did beckon.

[JohnB]

In the next 20 years you could be moving £800k of that unsheltered investments into ISAs at least.

You might also like to contemplate using global investment trusts instead of index linked funds. ATST, FCIT and WTAN have all given a good TR over the last 20 years, approaching 10% per year, which implies doubling every 7 years. Better than the indices.

TJH

I notice SMT is not on that list. Some investment trusts outperform the market, and get lots of attention, until they don't

But OP, its an art to keep tax under control, especially if your outgoings are around the HRT limit. ISAs are always good, but unsheltered with 10% rates can be attractive compared with SIPPs with 15-20% for a BRT taxpayer.

If you are still working I'd consider pumping your SIPP some more, salary sacrifice is your friend until you FIRE, but not too much, as I expect the lump sum will be stuck at £250k for years now.

Capital gains will be charging down the track at you, make sure you use your allowance every year.

And while planning tax is much easier than predicting the markets, predicting political change is really hard. Pensions have been a football, perhaps ISAs could be too

[xxd09]

Just some thoughts from an ancient retiree-21 years rtd-now 78
Disregard your house-we all need somewhere out of the wind and rain for all our lives
Get as much as you can in tax shelters ie ISAs and SIPPs/Pensions using your wife’s and your allowances
£100000 of a 60/40 portfolio should generate a safe £3000+ pa-rough guide to how much savings you will need-£2000000 ?
Unsheltered monies should be used up first for expenses as you are taxed on these funds
There are fine tunings to be done but the main principles are set out above
xxd09
Personally I have just used a global equities index tracker and a global bond index tracker hedged to the pound only as investment vehicles
Simple cheap and easy to understand-done the job for me -so far!

[Merrick]

How much are you currently getting into tax sheltered investments annually? Hiving it away until 57 into the SIPP is all well and good but you might be able to RE before 57 so having plenty available outside the pension is handy. Another relevant point is the government can monkey with the tax treatment, limits and restrictions on tax free savings and there's an election coming. I didn't worry about my pension, preferring to save in ISAs and unsheltered but the tax rules changed so did my planning turning that plan on its head.

It is important to explore expanding investments outside of tax-sheltered accounts, especially given prospective changes in taxation. Planning for early retirement demands flexibility and preparedness for unexpected policy changes. Diversified among several savings vehicles helps reduce the risks associated with legislative changes.

[DrFfybes]

How much are you currently getting into tax sheltered investments annually? Hiving it away until 57 into the SIPP is all well and good but you might be able to RE before 57 so having plenty available outside the pension is handy. Another relevant point is the government can monkey with the tax treatment, limits and restrictions on tax free savings and there's an election coming. I didn't worry about my pension, preferring to save in ISAs and unsheltered but the tax rules changed so did my planning turning that plan on its head.

It is important to explore expanding investments outside of tax-sheltered accounts, especially given prospective changes in taxation. Planning for early retirement demands flexibility and preparedness for unexpected policy changes. Diversified among several savings vehicles helps reduce the risks associated with legislative changes.

Care to come up with some examples or suggestions for how to do this?

[Gilgongo]

It is important to explore expanding investments outside of tax-sheltered accounts, especially given prospective changes in taxation

As an aside, I'm often surprised by how so much standard advice and information about retirement simply assumes you will have everything in a pension. Perhaps the FIRE thing is a lot more of a minority sport than I realise.

[kempiejon]

As an aside, I'm often surprised by how so much standard advice and information about retirement simply assumes you will have everything in a pension. Perhaps the FIRE thing is a lot more of a minority sport than I realise.

Quite, RE means be definition that you cannot use a pension with its time lock. And the trend is for that time to be pushed further back. A noticeable amount of the the online FIRE idea seems to be driven by people with extremist expenditure reduction, and a side line - like writing about ER.
I never really liked giving my time to an employer and wasn't suited to self employment so very early into my career I made a plan to take regular breaks and aim to leave before I could access my pensions so my provision was mostly made outside of pensions. When I draw my SIPP - where I gathered all my workplace pensions it'll be around 20% of my income. So if I can live without it I'll have an annual excess of income when I start taking my pensions. There's an element of spending investments down before pension age but the FI for me excludes SIPP and SP.

[genou]

As an aside, I'm often surprised by how so much standard advice and information about retirement simply assumes you will have everything in a pension. Perhaps the FIRE thing is a lot more of a minority sport than I realise.

How much does the average person have in savings UK?
25th percentile point £2,100
Median - 50th percentile point £12,500
75th percentile point £58,500
Average £76,301

That must exclude pension savings, but the average pension pot above age 55 is 37k. I'd guess that excludes DB pensions.

So the standard advice should probably concentrate on how to live on a state pension.

[Alaric]

That must exclude pension savings, but the average pension pot above age 55 is 37k. I'd guess that excludes DB pensions.

Such statistics shoiuld be treated with caution as many people will have DC funds from more than one employment. The notion of consolidating them all in one place is likely to be a minority interest.

[SoBo65]

Low coupon short dated GILTS are easy to buy, I use HL and only charge is standard dealing cost and small amount of accrued interest. I have invested with maturity each year over 2025 - 2030 (although there is no 2027, so have two holdings in 2026, Q1 and Q2). Gain is CGT tax free and only small amount of tax pay on the coupon.

[Lootman]

As an aside, I'm often surprised by how so much standard advice and information about retirement simply assumes you will have everything in a pension. Perhaps the FIRE thing is a lot more of a minority sport than I realise.

Quite, RE means be definition that you cannot use a pension with its time lock. And the trend is for that time to be pushed further back.

Yes, I have never been a fan of pensions. Too many rules and restrictions. Too much government interference and change. You pay income tax rates on investment income. And the whole idea of my money being fenced off beyond my control and forever subject to the whims of UK laws and taxes just irks me.

My original prejudice against them started in the 1970s and 1980s. Back then pensions were barely portable, and you were forced into annuities. Changing jobs was punished. Things have improved somewhat but even so I always avoided them unless my employer matched my contributions and I could control the investments. I have also deferred receiving any payouts for tax reasons. And I haven't even bothered inquiring about pension entitlements that I might have accrued prior to 1988.

I do not formally subscribe to FIRE but I realise that I followed some of its precepts and have successfully avoided both work and pensions for a quarter century now. And as a result my taxation is quite manageable relative to my financial position.