Unfortunately, my father died last year. I am due to inherit quite a large lump sum after probate. What can I do to make it work for me?
Philip 53, Shrewsbury
Inheritances are one of the two main ways people end up with large cash pots that aren’t invested tax-efficiently. The other is business sales. Once the new money has become normalised for you, the problems with having a large amount outside efficient tax wrappers will become clear. If your money is not in an Isa or pension, you are likely to be taxed on any income from interest or dividends.
Cumulatively, the effect is very significant. If you are invested for 40 years, for every £1 of income you can expect in retirement from a non-tax wrapped investment, you would receive £1.78 if you are a higher-rate tax pension saver with that money instead. Basic rate pension savers would receive £1.33 and Isa investors £1.25*. Getting the tax wrapper right makes a big difference – but how do you transfer a large lump sum into a tax efficient place when you have annual limits?
Pension investments benefit from a large exemption that could assist you. There is a measure, covered under carry-forward rules, that allows you to bring forward previous years’ unused pension contribution allowances into this year. So, if you have not used the maximum contribution of £40,000 a year for the last four tax years, it is possible to use up to that total amount in one year – meaning there is a potential for you to invest up to £160,000 in this tax year and get full tax relief.
This sounds great but there are severe limitations. The largest snag is that despite the fact you can catch up with unused limits, you are still limited by your earnings this year when claiming the relief. This means large sums can only really be invested this way by high earners.
Make sure to maximise pension contributions and use up allowances in your spouse’s name too.
Next in your list of priorities would be to maximise your Isa contributions. After pensions, this tax wrapper is the next most attractive. The current limit is £20,000 per person, per tax year – but the amounts you can invest will still add up quickly. For example, a couple combined could invest up to £80,000 this way by investing before and just after the tax year-end.
Many people place large lump sums into investment bonds. These are not the same as Government Bonds, like Gilts, but are a specialist tax wrapper that allow you to grow money free of tax and only pay tax when money is withdrawn – but beware, the rules are complicated.
*assumes you are a basic rate taxpayer in retirement
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— to inews.co.uk