The Accidental Investor

The scenario of the clueless or accidental investor left with everything is surprisingly common, despite the legal and tax mine fields that have to be crossed first. Without looking very hard, we found three. While for some people, unexpectedly inheriting a portfolio worth several hundred thousand pounds would be a dream come true, for others it would be a shocking and unwelcome burden. But whatever their reaction, every accidental investor runs the risk of spilling large sums of money while they try to get to grips with managing their inheritance.

Typically, accidental investors will be the children of elderly parents, or wives who left the task of managing money to their husbands. The mistakes they make tend to be the same, whatever the size of the portfolio and whatever their age. By the investors' own admission they include: failing to pay attention to charges, to performance and to asset allocation, failing to do research, panic selling, buying the wrong shares through lack of understanding, missing the clues that point to a share price rise or fall and an inability to follow investment jargon. The risk of course is that by the time they have conquered steering the portfolio, it will already have been wrecked. Accidental investors face practical hindrances too. Often they are in the dark about exactly what is in the portfolio and why it’s there, while tracking down and managing paperwork can drag on for months.

To avoid all that, it makes sense to prepare family members for what lies ahead, and also to take precautions to minimise the tax that has to be be paid when assets are transferred.

First, your options for preparing your family include teaching your spouse or your children yourself or booking places on workshops run by stockbrokers for this purpose. You could try to awaken an interest by creating a starter portfolio for your children.

If your children have little interest in managing money, or are very young, the best solution might be to arrange for your assets to be locked away in a discretionary or accumulation trust. By doing this you will avoid inflicting wealth on young or unready shoulders, while ensuring the investments continue to be properly managed by you, another family member or a professional. Don’t knock the idea: trusts are no longer watertight when it comes to tax but they still offer a shield of protection that is unobtainable elsewhere. Running costs can be reasonable too.

Susan Spash at Blick Rothenberg is in no doubt that trusts “remain an effective way to ensure the wealth you have built up during your lifetime can be enjoyed by future generations”.

Trusts are handy for keeping family wealth safely out of reach of unscrupulous financial advisers. In exchange for that shelter, many people are willing to take the tax hit, which is a charge of 20 per cent on the value of assets above the inheritance tax threshold (currently £325,000) on trusts set up during your lifetime, and thereafter a 6 per cent charge every 10 years, again on assets above the nil rate band.

The tax is higher on trusts established after your death – these face the full IHT charge of 40 per cent (but only on assets above the nil rate band), and then the 10 yearly IHT rate of 6 per cent.

Ready or not

Without preparation, and in the absence of a trust set-up, the inheritor/inheritors will be left to get on with it. This tends to be the time when the biggest errors are made. Greg Davies, a behaviourial economist at Barclays, says inheritors often feel great anxiety initially, especially when there has been no preparation and there is a distinct lack of support. “There is a danger that drastic action might be taken such as selling off everything” but this could be a mistake. Guilt, and reluctance to dismantle something that a loved one built, is another common emotion. To avoid the risk of poor decision making, Mr Davies recommends that the inheritor postpones major decisions until they have a clearer understanding of what should be done, although in some cases the decision to sell off assets and shareholdings will be driven by circumstantial needs such as an inheritance tax bill or the existence of multiple inheritors. A group of inheritors will be far more likely to sell off assets so they can be divided equitably.

The inheritor needs to think about their financial personality: will they be comfortable and confident making financial decisions and dealing with tax returns?

Can they stomach big losses? “Ask yourself too how would you react to being told the stock market had fallen 40 per cent? Can you live with that? It’s important to understand the concept of risk and to understand that you need to be prepared to stay invested for the long term. Some people are stunned when their portfolio falls even though the market has also fallen,” says Paul Battersby, investment manager at Redmayne Bentley.

He recommends accidental investors ask themselves not: How do I manage this portfolio, but Should I have a portfolio?. Their first priority should be to pay off debts and mortgages. “Then think about the investment portfolio: what do you want from it; what risk do you want to take and how will you do it?”

If you are happy to accept the role of an investor, start thinking about the best way to use the funds at your disposal – your needs and risk profile may be very different to the portfolio’s creator’s. “Often there will be a need for rebalancing to suit the inheritor’s different circumstances and requirements but there may be reluctance to make those changes or to do any tampering. This can be costly, and, in fact, they might even be better off selling everything and reinvesting elsewhere,” says Mr Davies.

There will be practical issues to sort out too. You will have to arrange to have the shares transferred into your name (see An arduous and expensive journey through bureaucracy below) and you may be responsible for securing probate too.

Good websites for information on dealing with the practical side of things are:

http://www.hmrc.gov.uk/inheritancetax/intro/probate-process.html

http://www.ageuk.org.uk/money-matters/legal-issues/what-to-do-when-someone-dies/

Three accidental investors

Noreen

Noreen is a widow in her 70s who came to investing three years ago when she met a new partner, Mike, an experienced investor, and through him discovered a passion for shares. Encouraged by him, and with his guidance, she set about the task of moving her existing £100,000 portfolio out of a wealth manager’s in-house fund and into a mix of investment trusts and income producing shares. “I found the whole business enthralling and really enjoyed attending AGMs and discussing various companies. I was staggered how my capital grew in the first year and the amount of income it generated,” she says.

But not long after Noreen’s self-directed portfolio had been created, in a devastating twist of fate, Mike died. Without his help, she drifted dangerously. “I spoke to a friend who invests and followed one of his recommendations,” later kicking herself for not recognising that he had an appetite for high risk shares which didn’t match hers. “I lost £1,600 almost immediately, and have steered away from high risk companies since.” She concludes: “I’m happiest of all sticking with investment trusts, I hold on to good things for longer and I have learnt that it pays to do your research properly.”

Mary

Mary came into a lump sum of £95,000 when she was in her 50s, some of which she used to pay off a lump of mortgage. She had no experience of investing. “There was nothing like that in my family” but her science and maths background meant she was interested in the stockmarket and decided to use the money to create a portfolio. She struggled to find a course that would help her find her investment feet: “I completed a personal finance course on the Open University – it was a good foundation but it was nowhere near practical enough.” She took out a subscription to Investors Chronicle and read a number of books, including some on charting.

Her lack of knowledge was a handicap: “I used to buy shares and then sell as soon as they fell. I was often at a complete loss to know what to do. How do you decide when to sell?” On another occasion she held back from selling and deeply regretted it later when the holding eventually ended up totally worthless. “I learnt from that though.” She’s learnt too to clamp down on charges and, having realised she was with an expensive stockbroker, grabbed a lucky opportunity to switch when they made a change to their terms and offered a free exit.

“I understand more now about creating a balanced portfolio with a non volatile core. I am more careful. I’m smarter too about getting rid of stuff and more confident about my decisions”, she says. That strengthened confidence is reflected in firmly held sector views: “I deliberately avoid consumer facing sectors such as retailers. They always seem so terribly volatile to me and you can only make gains by buying at exactly the right time. Whereas I am perfectly happy with my Astrazeneca holding: it pays me a good dividend and I don’t expect it to outpace the market. I feel safe with dividend payers: I have a bird in the hand – if growth shares fall, you’ve got nothing.”

Susan

Susan, an investor in her early 50s, has managed an investment portfolio since inheriting £500,000 from her father just over three years ago. “It’s been a steep and scary learning curve,” she says, and admits that she made many costly errors in the first couple of years. “It was learning by doing.”

The money she inherited was in cash as her father, who held a deep rooted fear of financial crashes, had steered clear of investments. But Susan was determined to make the money grow and felt the stock market was the only sensible option for putting together a portfolio with serious growth prospects. It helped that she had worked as a marketing strategist for financial services companies and that her husband was an accountant with a strong knowledge of tax and was on hand to explain “alien concepts such as running yield”.

It wasn’t just what Susan calls her arrogance – the belief that she knew enough about investing to do it herself – that drove her to manage her own portfolio: there were also two disastrous encounters with financial advisers. Soon after inheriting the windfall, Susan wrote a long and detailed letter to a leading IFA spelling out everything the couple owned along with their aims and goals – “I wanted the adviser to know as much as possible beforehand to enable him to work out the best solutions” – and was bitterly disappointed when he spent the hour’s free advice trying to push us into the company’s own funds. “I wasn’t impressed, and thought I could do a much better job myself.” The couple’s only other visit to a financial adviser had been years earlier when the sole “appalling” recommendation had been “to put everything into a single fund which proved disastrous”. Articles in the fund management trade magazines her husband brought home detailing how advisers could cut the time spent on clients, by shuffling them into ready-made portfolios that would continue to deliver maximum rewards to the advisers, didn’t help.

Determined not to let financial advisers get away with pulling the wool over her eyes, Susan embarked on her DIY journey.

Her first big mistake was relying on performance tables and not realising how frequently they changed: being top performer one week didn’t mean being top performer for the rest of the year!

Her second error was failing to pay attention to the charges, taxes and commissions that were ripping chunks out of her profits on paper. “I soon realised charges were mostly incredibly high and not as stated on the tin,” while other “details” - such as the difference between inc and acc units and how and when gains were taxed - led to “lots of involuntary and costly churning” as holdings were rejigged into and out of Isas for maximum tax efficiency.

Eventually she settled on putting half into passive funds which she rarely touches, 10 per cent into cash, another portion into big global investment trusts with the remainder into shares of her choice. “I focus on shares where I can see value but I am not interested in buying the same shares that are held in the funds I own, so I might buy for example Irish shares that are listed on the London Stock Exchange.”

Her return to date in the three years since inheriting the money has been around 18 per cent: “I probably made 3 per cent in the first year, 4 in the second and the rest since then!”

The tax traps

If you’re now feeling inspired to talk to your spouse/children about how to manage money and/or a portfolio, there’s one other thing to consider: tax. Besides preparing your family for the future, you should be looking at ways of minimising the tax loss to your estate whether it’s transferred during your lifetime or after your death. How can you do this?

It is, in fact, perfectly possible to transfer whole share portfolios and other assets while paying only small or zero amounts of tax.

The first step you should take, if you haven’t already, is to draw up a will stating exactly how you wish to leave your assets. Doing this will not only rid your estate of the danger of intestacy, it will also bring into sharp focus the value of your assets and the concomitant tax liabilities.

Sorting out what happens after your death is just one half of the task though. The other half involves arranging your affairs during your lifetime (known as lifetime planning) using the invaluable weapons of your annual capital gains tax allowances and the nil rate inheritance tax band. In a nutshell, lifetime planning means passing on as much as you can to family while you are still alive and, fingers crossed, have at least seven more years on earth. You have to play strictly by the rules though, or the taxman will win.

The six main options

1. Give it all to your spouse.

A transfer to a spouse will be both CGT and IHT exempt whether done during your lifetime or on your death. This means your wealth can be passed on tax free and when your spouse dies, your unused nil rate band can then be called into play: this will allow an estate of up to £650,000 to be passed down free of inheritance tax.

2. Give it to your children and grandchildren and survive for seven years.

You can also transfer assets to anyone other than a spouse during your lifetime and if you survive for seven years afterwards, there will be no inheritance tax liability. The difficulties with this solution are: A. You may not be in a financially strong enough position to hand over the assets as you cannot benefit from the assets once you have gifted them. “Giving it away means exactly what it says,” says Mr Joyce. “Retain the use or benefit of the asset and you will be deemed not to have given it away.” B. You may wish to retain control of the assets and finally, C, there may capital gains tax to pay as a transfer to anyone other than a spouse or civil partner is treated like a sale, at the real market value. So if you originally bought the asset for £1 and it’s now worth £10, you will have a taxable gain of £9. You can use your annual CGT allowance to shelter up to £11,000 (in 2014/15) of gains in the year you make the transfer, with gains above that taxed at either 18 or 28 per cent. “But if you have losses lying around, of say £10,000, and haven’t used that year’s annual exempt allowance, you can transfer assets with built-in gains of £21,000,” says Mr Joyce.

Note that capital gains tax is payable at a top rate of 28 per cent, and only on the gain, compared to 40 per cent for IHT.

It’s also possible to sidestep a capital gains tax bill. You can use trusts to do this, says Julia Rosenbloom, associate director at Smith & Williamson – see solution 3 just below.

Or by making transfers from Isas rather than your regular portfolio, transfers can be made free of CGT.

3. Put the assets in trust

Instead of making a direct transfer to an individual, such as a son or daughter, you can place the assets in a trust. Although trusts come with costs and a tax sting in the tail, they offer a way round CGT bills and allow you, the donor, to retain control of the assets for example a share portfolio. There is an IHT risk but that is only encountered when the assets being transferred are worth more than £325,000.

“If the capital gains tax bill you face on a direct transfer is high, you could use a trust to defer any capital gains tax payable until an actual sale of the asset in question. It ensures the donor will not suffer a capital gains tax charge but, instead the donee (the trust) takes on the assets at cost price and then pays the capital gains tax when they sell it,” says Ms Rosenbloom.

The sting in the tail relates to IHT. If you put assets worth more than the nil rate band (£325,000 per person or £650,000 for a couple) into a trust set up during your lifetime, the lifetime inheritance tax charge of 20 per cent will be triggered. “The charge has to be paid usually within six months of the transfer,” says Ms Rosenbloom. That lifetime charge may be only half the rate of inheritance tax but nonetheless “it’s unattractive”. And just as with straight transfers, you will need to survive for seven years after to avoid paying up to an additional 20 per cent IHT. Plus every 10 years the trust will need to be assessed for inheritance tax again and all assets over the nil rate band of either £325,000 or £650,000 will be taxed at a rate of up to 6 per cent.

4. Use a Family Investment Company

Another solution could be to use a Family Investment Company. This has become popular as a succession tool says Ms Rosenbloom because there is no lifetime IHT charge on creation or at 10 year intervals, and because it allows parents to retain control of the assets. So how does the FIC work? You set up a company using a normal company structure with articles of association. Different classes of shares are issued - the parents taking shares with all the voting rights and no economic benefit, and the children being issued with shares which confer no voting rights and all the economic benefit. Cash or investments are transferred to the company – and there may be a CGT liability on transfers of assets. The gift of shares is effectively a lifetime transfer so after seven years the value will have passed to the children with no IHT liability. On the death of the parents, their shares which have no value, can be passed to their children or to other trustees. Because the shares are worthless, there is no IHT charge. Take an investor with a portfolio of £500,000 in shares. He transfers these into an FIC, and becomes both a shareholder and director in the company. He has total control over the investment activity, and because the corporate tax regime generally has lower rates than the personal one says Ms Rosenbloom, the returns are better while the assets are retained in the company. “In the right circumstances it can be ideal. Wealth can be passed on and control maintained.” One downside is that dividends paid to the children will be taxed – again.

5. Create a tax efficient portfolio of Aim shares

If the seven year exemption period is too long for you to contemplate, an alternative is to use an Aim portfolio where you need only survive for two years to secure relief from IHT.

You need to be clear that an Aim portfolio will generally be higher risk than a FTSE based one but it’s also worth considering that by investing in Aim shares you are ultimately saving 40 per cent in IHT so a £100,000 portfolio is instantly £40,000 “in profit” as it were. If the Aim share portfolio drops by 20 per cent, your estate is still better off. However this route might not be suitable if you’ve been relying on your investments for income.

At the end of the two year period, says Julia Rosenbloom, you can transfer the assets into a trust and there would be no 20 per cent IHT entry charge so this could be used as a mechanism to get greater value into a trust.

6. Give your income away

If you have significant earnings you can make gifts of income that is surplus to your requirements. There is no limit to the amount you can give but you must not give away income that you need and that you think you can replace by dipping into your savings. “This will be checked by HMRC after your death,” warns Mr Joyce who says the grant of probate forms will ask for details of your income and outgoings in the years preceding your death. If you are found to have given away income that was not surplus, it will be included in your estate after all.

An arduous and expensive journey through bureaucracy

Those of you who have had the unhappy experience of having to act as the executor of an estate will know that the DIY approach to probate can be rather arduous – especially if you also happen to be the bereaved. I have watched from the sidelines as my wife has attempted to grips with this grim task after the sad death of her mother last year – having coped admirably with the rump of a small but complicated estate, she handed me the final piece of the jigsaw to complete: the transfer of her mother's small share portfolio.

This is not in itself a complicated process. First notify the registrar of the bereavement via the dedicated teams they have in place to deal with such matters and send them the grant of representation to confirm your legal status as executor. Then simply fill in the stock transfer forms which can be downloaded from all registrars' websites and send off along with the related share certificates. The shareholder register will then be updated and new certificates issued.

This assumes, of course, that you have the certificates – which unfortunately we did not. Without them, the process can become an arduous round robin of correspondence with registrars and expensive charges to replace lost certificates. If you’ve lost the certificates for any holding you’ll need to obtain a Letter of Indemnity – depending on the value of the shares this will also need to be countersigned, which for the four certificated holdings my wife has inherited has cost in the region of £280 and a considerable amount of time and effort.

At least we had some paperwork that meant we at least knew the holdings existed – although we discovered this more by luck than judgement; having spotted a holding for National Grid it dawned on me that this could be one of three shares my wife’s mother owned as a result of the privatisation and subsequent demergers from British Gas. I wonder how we would have ever uncovered the holdings had someone without my knowledge of PLC history been on hand to advise.

I would encourage anyone with a share portfolio that they may pass on to their loved ones to make sure paperwork – including valuable share certificates – is kept up to date and in one place. And it isn’t even about the money - bereavement is difficult enough as it is without having to learn the language of bureaucracy of equity markets.

John Hughman

Valuing an estate for Inheritance Tax - worked example

The example below shows how the Inheritance Tax due from the deceased's estate is worked out.

Robert died leaving his estate to his daughter. The Inheritance Tax threshold for the 2014-15 tax year is £325,000.

Inheritance Tax is payable at a rate of either:

•40 per cent

•36 per cent, if 10 per cent or more of the net estate is left to charity

In this example, none of the estate is left to charity.

Value of Robert's assets:

•house = £300,000

•car = £7,500

•household goods = £2,000

•bank account = £19,000

•shares = £30,000

•Premium Bonds = £500

Total value = £359,000

Value of Robert's debts that can be deducted from the value of the estate:

•telephone bill = £55

•electricity bill = £45

•gas bill = £35

•funeral expenses = £865

Total deductions = £1,000

Net value of Robert's estate = £358,000

Inheritance Tax is due because the net value of the estate is above the Inheritance Tax threshold of £325,000. Inheritance Tax is payable at 40 per cent on the amount over the threshold:

•net value of Robert's estate = £358,000

•less threshold = £325,000

•amount subject to Inheritance Tax = £33,000

Inheritance Tax payable = £13,200 (£33, 000 x 0.4 (40%))

Interest is charged on any tax not paid by the due date, no matter what caused the delay in payment.

Source: HMRC