Summary
Timeline Planning's engine calculates the total tax required for a client to achieve their annual net planned spending.
The software takes into account all secure income sources like state pension and computes the full withdrawal needed from the portfolio.
Timeline's engine is designed to handle both gross-to-net and net-to-gross calculations accurately.
Introduction
Financial planning for retirement involves a multitude of factors, one of the most critical being how much you plan to spend. In this article, we'll delve into the intricacies of planned spending using Timeline's engine, focusing on both "net planned spending" and "gross planned spending."
What Does Net Planned Spending Mean?
Net planned spending refers to the amount of money you need to cover your expenses after all taxes have been accounted for. In other words, it's the amount you plan to spend in "take-home" terms. When you specify a net planned spending amount, Timeline's engine will calculate the gross amount you need to withdraw from your accounts, considering tax obligations, to meet your net spending needs.
What Does Gross Planned Spending Mean?
Gross planned spending, on the other hand, is the total amount you plan to withdraw from your accounts without accounting for taxes. It's the gross amount that you plan to spend. When you specify a gross planned spending amount, Timeline's engine will calculate the net amount you'll actually have for spending after tax obligations are met.
Net and gross planned spending use different tax bands and rates to provide accurate calculations.
The rest of this article will provide real-life examples to illustrate how Timeline models both net and gross planned spending, taking into account various income sources and tax implications.
Example 1: Gross planned spending
Initial Conditions:
John receives £11,502 from his State Pension.
He wants a total gross annual spending of £70,000.
To achieve his total gross annual spending of £70,000, John needs to withdraw an additional amount from his Flexi-Access Drawdown account. This amount is calculated as £70,000 (total gross annual spending) - £11,502 (State Pension) = £58,498.
Tax Calculation:
Personal Allowance:
Remaining personal allowance: £12,570 - £11,502 = £1,068.
Tax: £1,068 * 0% = £0.
Basic Rate Tax:
Taxable amount: £37,700 (maximum taxable amount in basic rate)
Tax: 20% * £37,700 = £7,540
Higher Rate Tax:
Remaining income: £50,498 (total income) - £37,700 (taxed at basic rate band) - £1,068 (taxed a personal allowance) = £19,730
Tax: 40% * £19,730 = £7,892.
Total Tax:
£0 (personal allowance) + £7,540 (basic rate tax) + £7,892 (higher rate tax) = £15,432.
Net Withdrawal:
£58,498 (gross withdrawal) - £15,432 (total tax) = £43,066.
Example 2: Net planned spending
Initial Conditions:
John receives £11,502 from his State Pension.
He needs a total net annual spending of £54,568.
To achieve his total net annual spending of £54,568, John needs to withdraw an additional amount from his Flexi-Access Drawdown account of net £43,066. This is because John already receives £11,502 tax free (because it is less than the personal allowance) from his state pension.
Timeline's engine will compute reverse net to gross rates and bands i.e. the required gross amount that needs to be withdrawn to meet the net withdrawal of £43,066. We tax the net amount of £43,066 using our net to gross reverse rates and bands as follows:
Tax Calculation:
Personal Allowance:
Remaining personal allowance: £12,570 - £11,502 = £1,068.
Tax: £1,068 * 0% = £0.
Total taxed withdrawal so far: £1,068.
Basic Rate Tax:
Taxable amount: £30,160 (maximum net taxable amount in basic rate)
Tax: 25% * £30,160 = £7,540.
Total taxed withdrawal so far: £1,068 + £30,160 = £31,228
Higher Rate Tax:
Remaining income: £43,066 (total net withdrawal) - £31,228 (already taxed withdrawal) = £11,838.
Tax: 66.67% * £11,838 = £7,892.
Total Tax:
£0 (personal allowance) + £7,540 (basic rate tax) + £7,892 (higher rate tax) = £15,432.
Gross Withdrawal:
£43,066 (net withdrawal) + £15,432 (total tax) = £58,498.
Gross planned spending:
£58,498 (gross withdrawal) + £11,502 (state pension) = £70,000.
Conclusion
Note that the results of examples 1 and 2 match perfectly. Timeline's engine has several tests in place to ensure that all the tax calculations are correct and all transitions from gross to net and to gross to net planned spending are validated. The issue with gross planned spending, is that it is not a representative figure of the amount of money a person may need to spend within a year. Naturally, this amount is thought of in net terms. Timeline's engine allows the selection of the desired net planned spending that the client needs in order to sustain their desired lifestyle. Then our modelling computes the tax that needs to be paid in order to achieve the desired net planned spending.