75-year-old aims to minimise inheritance tax

ANONYMOUS PORTFOLIO: TOTAL VALUE £804,714

Source: Investors Chronicle

Chris Dillow, Investors Chronicle's economist, says:

You say you haven't found a cheap and straightforward way of reducing likely inheritance tax (IHT) liabilities. Common sense says we shouldn't be surprised by this. Imagine two identical assets and that the government then slaps a tax on one but not the other. The price of the taxed asset would then fall and that of the un-taxed one would rise, until expected returns on the two assets, after tax, were again identical. We should therefore expect assets that are free of IHT to be expensive - in terms of either poor returns (such as Aim stocks), high fees, or hassle and illiquidity.

You've simply rediscovered an ancient truth: you don't get owt for nowt.

There are simpler ways to reduce your IHT liability. One would be to get married and so benefit from the exemption of transfers between spouses: is your aversion to marriage really so strong that you don't want to try this? Another would be to start giving away some money now - either by taking advantage of the annual exemption or making bigger gifts and hoping you live another seven years to qualify for the potentially exempt transfer.

I mention these possibilities because you don't seem to need all of this portfolio for living expenses. You say you could get by on your pension income. But this portfolio should be able to generate an income of up to £40,000 a year without eating into your capital through either dividends or share sales; remember you can create your own dividends simply by selling shares. Doing so is often tax-advantageous; you've got a capital gains tax allowance, so use it.

I say £40,000 for a simple reason. The long-term real total return on equities - that is, price rises plus dividends after deducting inflation - has been around 5 per cent per year. With average luck, this could continue. And this means that you should, on average, be able to take out 5 per cent of your portfolio while leaving your capital intact in real terms.

However, the key words here are average and luck. This portfolio is well-diversified across equities. Your more speculative and higher-beta stocks, such as Rio Tinto (RIO), BHP Billiton (BLT) and some financials, are leavened with defensives such as Vodafone (VOD) and GlaxoSmithKline (GSK) and some corporate bonds. It does a good job of reducing stock-specific risk therefore. Unfortunately, though, such an equity-heavy portfolio cannot avoid taking on market risk. And this means that your objective of maintaining wealth might not be fulfilled.

We can, roughly, quantify this. If we assume an average real return of 5 per cent a year with a standard deviation of 15 percentage points - which is less than historic equity volatility to reflect your holdings of safer corporate bonds - then you have a roughly one-in-seven chance of losing 10 per cent or more over a 12-month period. And even over five years, you have around a one-in-seven chance of losing 5 per cent or more, after inflation. (I say one in seven because moderate losses are slightly less likely than a normal distribution would imply).

Whether these numbers strike you as a lot or not is a matter of taste. In truth, investors these days cannot be 100 per cent sure of maintaining their wealth simply because yields on inflation-proofed bonds are negative and all other assets carry some risk. The question, then, is: within which margins do you want to maintain wealth? If my estimation of the risk of a loss seems too much for you, consider shifting towards safer assets - although, remember, these entail a loss of expected return.

Lee Robertson, a chartered wealth manager and founding director of Investment Quorum, says:

You appear not to have quite enough income. You need to maximise your holdings in individual savings account (Isas) and these should be ideally geared towards income for greater tax efficiencies. For any growth stocks held outside Isas it would be possible to make use of your annual capital gains tax (CGT) allowance.

Turning to the portfolio and assuming that there is no, or very little, CGT restrictions then we would strongly recommend some restructuring. Basically, we would suggest that you take some of the risk out of the portfolio by selling some of the direct equities in favour of a more funds approach.

This would give you a wider diversification with a growth and income approach given your requirements are to maintain wealth, income, and "have a little fun with speculative purchases". With this in mind we suggest that you consider investments in the following: CF Woodford Equity Income Fund (GB00BLRZQC88), Henderson UK Equity Income & Growth Fund (GB0007494221), Artemis Global Income Fund (GB00B5ZX1M70) and Fundsmith Equity Fund GB00B4LPDJ14), which would assist this strategy. Then consider some themed investments such as Henderson Global Technology Fund (GB00B288CP83), Polar Capital Healthcare Opportunities Fund (IE00B28YJN35) and Guinness Global Energy Fund (IE00B6XV0016), which should give you some excitement while spreading your risk.

This could be financed through the sales of Accsys Technologies (AXS), GlaxoSmithKline (GSK), Kcom (KCOM), Micro Focus (MCRO), Verizon (VZC), Vodafone (VOD), TalkTalk Telecom (TALK), Coalfield Resources (CRES) and William Hill (WMH).

Although you wish to explore IHT planning opportunities we note your desire to maintain your wealth so we would urge caution over being too aggressive in your IHT planning. Assuming your priority is IHT planning over maintaining your wealth, we suggest you make use of the following options to mitigate some of your future IHT liabilities.

• Ensure you are using your annual gifts exemption of £3,000 - if you have not yet used it you can use two years in one go the first time. You can also use the small gifts exemption of £250 but not to the same individuals as who receive from the annual exemption of £3,000.

• You could potentially use the gifts from normal expenditure allowance but as we think you need all your pension income this might not be affordable as you appear to spend all your current income. HMRC only expects you to make use of this allowance if you have 10 per cent surplus income to expenditure.

• If you are using the above exemptions we advise keeping an historical record each tax year of the gifts so that these are easy to identify by your executors in the future.

• Make sure your will is up to date - but as an aside it might be worth considering putting in place lasting powers of attorney as this is quite complex and can take some time.

• Gifting is much more effective if you skip a generation to avoid the parental settlement rules. With parental trusts for minors, the child's income from the trust is deemed to be the income of the settlor for income tax purposes.

• With regards your queries of taking advantage of Business Property Relief, there are numerous products on the market to consider which make use of this relief. In our opinion, careful due diligence is required in the selection process. The difficulty for an investor is that you need to research the stocks that qualify at the time of investment but they also need to qualify at the date of death. HMRC also requires you to hold the stock for at least two years and they must be held at date of death - so there are some potential bear traps here if you go it alone. Also this is a high-risk strategy given your desire for income and to maintain wealth.

• You also might want to consider a discounted gift trust as this does give an immediate discount for IHT, is designed to provide income and a degree of capital control - but you should seek advice.