How to make the most of a windfall at retirement

Retirees coming into an inheritance or looking to downsize from a home that has appreciated massively over the decades have various options to consider for the surplus capital. Is there an argument for simply spending the lot? Should it be used to supplement retirement income? Or does it make financial sense to gift the money to younger family members?

‘With property prices increasing dramatically during baby boomers’ lifetimes, some retirees are sitting on very valuable homes,’ says Jane Steadman, a financial planning consultant at Brooks Macdonald. ‘Also, with life expectancy on the increase, “children” are often benefiting from an inheritance from their parents’ estates when they’re into their 60s and beyond.’

Spend it

The main reason for people downsizing in the first place is often to improve their quality of life, so there is certainly an argument for spending some of the capital. Likewise, a relatively small inheritance might allow you to spoil yourself in retirement with that dream holiday.

‘If there’s anything left unticked on your bucket list, this might be the last opportunity to fund it,’ says Anna Sofat, founder of London-based Addidi Wealth. This comes with one big caveat: that you have given serious consideration to your long-term needs – Sofat recommends assuming a lifespan of age 100.

Sophie Kilvert, a relationship manager at Seven Investment Management (7IM), says: ‘Dr Samuel Johnson famously said that “it is better to live rich than die rich”, but since no one has yet discovered how to predict life expectancy or the future direction of financial markets, this is a hard chestnut to crack.’

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A cash-flow analysis drawn up by a qualified financial planner should help you ascertain whether your cash remains surplus to requirements. ‘Often people may feel they have substantial funds at the time, but haven’t thought properly about what is really needed for a comfortable retirement or considered the future costs of nursing and social care,’ says Ammo Kambo, a chartered financial planner at Brewin Dolphin.

Save it

The top priority should be to ensure a secure lifestyle for you – both now and in the future. Alan Smith, chief executive of London-based Capital Asset Management, suggests the most important thing is to achieve complete clarity over the biggest question faced by those approaching retirement: ‘Do I have enough?’ This means establishing ‘whether I have enough money, assets, income to ensure that I can live out my retirement years doing the things I love to do – travel, spend time with family, hobbies, charity, fun – without fear of running out of money,’ he says.

Do you therefore need the capital to improve your income stream, meet long-term care costs or put aside for a rainy day?

In the case of the latter, this should remain in cash, but if you are looking to boost your retirement income or fund care costs, Sofat advocates investing the money to stand the best chance of achieving inflation-beating returns. Look to utilise all available tax breaks: the best option will depend on your age and personal circumstances, including whether you have started drawing your pension assets.

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‘Whilst Isas are an important tool, for older generations the pension is the foremost place for a windfall, assuming the lifetime allowance hasn’t been hit ,’ says Kilvert.

However, many retirees will find the ability to fund their pension severely restricted. If you have withdrawn more than your 25 per cent tax-free cash entitlement, you will have triggered the money purchase annual allowance (MPAA), which means you can contribute only £4,000 per year. Remember, too, that tax relief is only available on contributions worth up to 100 per cent of your earnings (up to £40,000 a year) – which will limit your ability to contribute tax-effectively if you’ve reduced your paid working hours or stopped completely (pension and investment income doesn’t count).

You can, however, carry forward unused pension allowances from the previous three tax years. Moreover, says Rebecca O’Keeffe, head of investment at Interactive Investor: ‘Even if you have fully retired, you will still be able to pay £3,600 into your pension every tax year and get 20 per cent tax relief.

You pay in £2,880 and your pension provider will claim tax relief of £720 for you. This could be an attractive option for some of your windfall.’ If flexibility is a priority, an Isa is a better call. Andrew McCulloch, a relationship manager at 7IM, gives the example of clients who downsized from a large family home to build a smaller home in the country and meet a retirement income shortfall of £10,000 per year. ‘The flexibility of an Isa is that they can build up a tax-free income stream, either by realising some capital gains or by taking the natural income from the Isa portfolio,’ he says.

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Each individual can contribute £20,000 per year to an Isa, which offers tax benefits on the way out, with no tax to pay on income or capital gains. ‘The ability to generate tax-efficient, non-declarable income is highly attractive, particularly as any income derived from your Isa doesn’t impact your personal allowances or the rate of tax you pay,’ says O’Keeffe.

Assets held outside an Isa can be progressively transferred into the Isa over the years. Any additional capital gains, up to the CGT allowance, could be realised as tax-free income.

Gift it

If you have sufficient funds to meet your needs throughout your lifetime, consider gifting some of your windfall to children or grandchildren.

Kambo points to the ‘transformative effect’ that transferring wealth while you are alive can have on your family’s life. Gifting money to a son, daughter or grandchild could help them onto the property ladder, for example. ‘The benefit of gifting the deposit for a house is that the funds are tied into the property and much harder to squander ,’ says Michael Robinson, an associate director of European Wealth Group.

Other options for putting capital to work include topping up a younger relative’s pension or paying into a junior Isa to give a child a financial head start. Pension assets are accessible from age 55, and junior Isa savings (you can contribute £4,260 per child in 2018/19) from age 18.

Gifting can also yield significant IHT benefits. ‘Many retired clients find it difficult to spend money on extravagances for their own lives,’ says Tamsin Caine, a chartered financial planner at Smart Financial Planning. ‘They often have inheritance tax to consider in their own estate, so an outright gift or gift into trust can be beneficial.’ 

Each year you can give away £3,000 free of IHT. Beyond that, gifts of any size fall outside your estate, provided you survive for seven years after making them. Should you die between three and seven years after making the gifts, the tax liability reduces on a sliding scale.

Steadman at Brooks Macdonald stresses that these must be ‘true’ gifts, where the donor no longer has any control over or benefit from them. Alternatively, a gift could be made via a trust. In this way you could retain the right to an income stream from the capital, for example, while being IHT efficient (see case study 1). If receiving an inheritance, another option is to bypass your estate by way of a deed of variation, which must be executed within two years of the death of the donor. A couple advised by Falkirk based Tom Munro Financial Solutions inherited £200,000 during retirement. ‘They are more than comfortable in their old age, so they redirected it to their three children,’ says founder Tom Munro. ‘This saved a whopping £80,000 in IHT.’

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