How investors could generate a £40,000-per-year tax-free income

18th February 2015

Investors can earn up to £40,000 per year tax-free by making use of legitimate allowances, a financial advisory firm has shown.

In recent days the issue of tax avoidance by wealthy individuals has dominated the headlines, with fingers pointed at individual donors to each of the major political parties, said Tilney Bestinvest financial planning director David Smith.

While tax avoidance schemes are a form of aggressive financial planning which will typically try to exploit legal loopholes, this type of tax planning needs to be clearly distinguished from perfectly legitimate schemes, which allow people to invest in a tax efficient way using statutory tax allowances, explained Smith.

Many of these schemes are widely popular such as ISAs and pensions, although some – such as the annual Capital Gains Tax allowance – can be overlooked. In order to demonstrate the benefits of utilising HMRC recognised tax allowances, Smith has run calculations for a hypothetical case study, to demonstrate how  it is possible to earn £40,000 tax-free by making use of new and existing tax allowances.

David Smith said: “The new pensions legislation that will become effective on April 6th 2015 will allow more flexible access to pension savings for those aged 55 or above. The new pension legislation, coupled with existing tax laws and allowances, will enable those with sufficiently large investments to manage their income in such a way as to reduce, and possibly completely extinguish their potential exposure to Income Tax. In theory, it will be possible to generate just over £40,000 per annum without paying any tax at all.”

Assumptions used:

How to generate target income tax free:

Withdraw gross income from pension up to Personal Allowance £10,500
Additional tax-free cash from SIPP 25% £3,500
Surrender 10 segments from Bond (includes £5k gain) £15,000
Withdraw £8k capital gain from fund portfolio £8,000
Withdraw remaining income requirement from ISA £3,000
Total £40,000
Tax payable £0

David Smith added: “From the figures above, the benefits of what a little financial planning advice can achieve are clear. Indeed, utilising HMRC tax allowances should not be overlooked: if this same person was sitting with £800,000 in a bank account they could be looking at an income of only £14,800 per annum (net) which would have no prospect of capital appreciation.”

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