John and Anne's Situation
John, aged 60, had enjoyed a successful career as an IT Analyst for a large firm based in London. He decided that he would like to take early retirement because he had grown tired of the daily commute, and wanted to spend more time with his wife Anne, but felt he still had much to give. John had always dreamed of setting up a consultancy business to try his hand at running his own company.
John has a Final Salary pension which will pay £20,000 pa from age 65
In addition, John has build up a Personal Pension fund of £400,000 with a previous employer
Both John and Anne have full entitlement to the State Pension when they reach State Pension age
John and Anne ideally wanted an income of £25,000 - £30,000 per year after tax at present
John expected his business to generate income straight away, but it was likely to be volatile initially
John ideally wanted £10,000 to buy the equipment he needs to run the business
Anne has already retired and has no income at present
Both John and Anne felt they had paid a lot of tax over the years, and wanted to be as tax efficient as possible
John was planning to run the business until age 65, at which time he would decide whether he wishes to continue or fully retire, depending on how much he enjoys being his own boss!
John and Anne's primary need was to generate £25,000 - £30,000 per year to support their lifestyle, with the ability to increase or decrease this depending upon how the business performed.
We suggested that John used his pension fund for "Phased Drawdown". In essence, this involves drawing an income directly from a pension pot in phases as required.
One major advantage of Drawdown is the ability to vary the income withdrawn. This really suited John, as it gave him the comfort that he could draw the level of income he required initially, with the ability to reduce and ultimately stop the drawings as the business took off.
It is possible to draw up to 25% of a Personal Pension fund as a tax free cash lump sum, John was entitled to take £100,000 from his pension fund with no tax (His fund was worth £400,000, so 400,000 x 25%=£100,000). However, it is not necessary to draw this all in one go.
We therefore suggested that in year 1, John should draw £10,000 from his pension as tax free cash, giving him the lump sum required to start his business. He should then draw £11,000 taxable income from his pension. Although this is taxable, there is no tax for John to pay as it utilised his Personal Allowance.
John's wife, Anne, had taken on the role as Book Keeper and Administrator, for which the business would pay her a salary of £8,000 pa; again this would be tax free as it was within Anne's tax free Personal Allowance, and at that level there would be no National Insurance for her or the business to pay.
As shareholders of the business, John and Anne could draw the profits by way of a £5,000 dividend in the first year. Again, this would be tax free as it would fall within their Dividend Allowance.
In simple terms, this meant John and Anne could generate their required income of almost £30,000 per year, without paying any income tax. The only tax payable would be by the company, on the profits of the business.
The arrangements could be reviewed after the first year, and with the Drawdown giving flexibility to increase or decrease the income to meet John and Anne's requirements.
John and Anne were delighted with the flexibility this arrangement provided, and this gave them the confidence to proceed with their plans knowing they had enough income available should the business not succeed.
Income Drawdown is a complex arrangement which carries a number of risks. It is important to ensure you are aware of and are comfortable with and able to take such risks before using Drawdown. There may be other options which are more suited to your circumstances and objectives.
This case study is designed as an example of a possible solution for this client. Although you may find yourself in a similar position, it is important to seek personalised advice to ensure the options you choose are wholly suitable for your circumstances. This case study should not be considered as a personal recommendation in any way. No liability shall be accepted for any action you may take based upon this case study.