Investing to pay mum's care home fees

CARE FEES PORTFOLIO

Chris Dillow, Investors Chronicle's economist, says:

You're right to expect care home costs to increase by more than inflation. The sector has low productivity growth, and such sectors usually see their relative prices increase over time; this is Baumol's cost disease.

However, with average luck, your portfolio should also increase by more than inflation; we should expect a real return of around 3 per cent per year. A least bad guess would be that the shortfall in care costs of £23,000 stays a little over 1 per cent of your portfolio. This is entirely sustainable.

What you have to worry about here is not so much care home inflation as the possibility that your portfolio falls in value.

This risk is mitigated by the fact that you have almost 40 per cent of your wealth in safe assets and that your shares have a defensive bias. But nevertheless, it exists. There's around a 10 per cent chance that this portfolio would fall 12 per cent or more even over a five-year period. This would not jeopardise the funding of your mother's care; even with above-inflation rises, this cost would be only around 1.5 per cent of the portfolio. But it would leave the beneficiaries worse off than they would otherwise be.

In this context, the trade-off between risk and return is especially acute. A few years ago, you could have fully insured yourself against the prospect of rising care home fees simply by holding index-linked gilts - which back then paid a positive real guaranteed return. Now, you cannot do this. With real yields negative, index-linked bonds don't protect you from above-inflation cost increases. This means you face a choice. More safe assets increase the chance of suffering a modest loss, because of their negative real return. But more equity exposure increases the chance of a larger loss - albeit that the compensation for this is a reasonable chance of positive returns.

NS&I 65+ Guaranteed Growth bonds, sales of which have been extended to May 2015, are pretty much the only assets which offer a highish safe return - which is why they are both so popular and widely regarded as a bribe. They would, therefore, help you to improve the risk-return trade-off.

Your portfolio's strong defensive bias, thanks to big weightings in utilities, GlaxoSmithKline and Royal Dutch Shell, means in the near term we should expect it to underperform a strongly rising market but outperform a falling one - probably by falling less; shares are only relatively defensive. Over the long-term, though, it could do a little better simply because history and international evidence tells us that defensive stocks tend to outperform on average. In this sense, you are right to avoid selling shares for tax reasons and because there's no great need to rebalance the portfolio.

I'm surprised you think the portfolio lacks diversification. The two investment trusts and M&G's funds give you general equity exposure. And your index-linked bonds give you protection against equity volatility. This is good diversification. Your father did a good job.

Mel Kenny, a chartered financial planner and later life adviser at Radcliffe & Newlands, says:

I am sure your father was very proud of his financial portfolio and I am sure you feel a great deal of responsibility to carry on his good work as an attorney, a role in which older sons and daughter increasingly find themselves.

The portfolio has a classic 60/40 growth/defensive split but lacks diversification in that the equity component of the portfolio is FTSE centric. While FTSE companies do have overseas exposure, the UK stock market represents just 8 per cent of global market capitilisation. If you take a look at leading global tracker funds, these are typically weighted by global capitalisation and would quickly give you greater diversification without having to sweat over individual stocks. I also note the expensive M&G Dividend fund is performing no better than the equivalent tracker which could be run at a lower cost.

NS&I Index-Linked Savings Certificates are a useful diversifier compared with traditional bonds given the latter's recent behaviour being similar to that of equities, contradicting their low-risk label. While we are in a very deflationary environment, index-linked certificates are still hard to come by so preserving these should not be overlooked as they can be retained and re-invested by beneficiaries of the estate, which would be especially valuable should inflation take off again.

Don't overlook NS&I 65+ Guaranteed Growth Bonds offering 2.8 per cent gross and 4 per cent gross over 1 and 3 years for any proceeds from your fixed-rate bonds.

As capital gains tax dies on the owner's death, there may in fact be fewer gains subject to tax sitting on the portfolio than you think. Only the shares your mother held before death would be sitting on a taxable gain right now. Ideally, you would have considered transferring any shares in her name to your father before he died so that she would have got them back via the will free from capital gains tax. If your father died on or after 3 December 2014, then from 6 April 2015 it may be possible to transfer some of his Isa assets to your mother while retaining their Isa status (this scenario is subject to further HMRC clarification). If he died before that date, then they lose their Isa wrapper.

Volatility in dividends could be reduced by increasing exposure to a greater variety of blue-chip stocks - mature businesses that turn out dividends time and time again. A hands-off alternative could be the use of an immediate needs annuity which can guarantee income payments.

Accordingly to Office for National Statistics mortality tables, a 92-year-old female is expected to live for at least another four years. Assuming no other health complications, an immediate needs annuity provider may ask for capital of 5 times the income needed to cover the shortfall in meeting your mother's care home expenses. This equates to needing £115,000 to provide a rising income of £23,000 for the rest of your mother’s life, no matter how long she lives.

The danger here is an unexpected early death although for a bigger premium, capital protection can be built in. The advantage is that meeting the shortfall becomes hands-off, it also takes away the worry over whether dividends will be enough and it ring-fences the cost of care from the rest of the estate, assuming no significantly greater health needs in the future. Should your mother live 10 years, the immediate needs annuity would indeed be very good value.

With your duties of an attorney in meeting your mother's income needs met, you can consider investing some of her remaining portfolio in Alternative Investment Market (Aim) shares that attract Business Property Relief (BPR). If such shares are held for two years or more and are still in her possession at death, they become free from inheritance tax. Note, however, that Aim shares are high risk and not suitable for everyone.

Inheritance tax planning by way of gifting is limited under a 'Lasting Power of Attorney' unless approval is given by the Court of Protection. However, investing in BPR assets and making on-going pre-existing gifts from expenditure, for example at birthdays and Christmas, are allowable.

There is no mention of your mother having a property but should there be one, inheritance tax is an even bigger problem but there are also possibilities to generate rental income to meet care costs.

Finally, it's worth making a check that both day and night time Attendance Allowance is being claimed as this can be overlooked.

With no details of risk attitude and both the intricate and high risk nature of some of your options, it is important that you take financial advice, ideally from an adviser accredited by the Society of Later Life Advisers, to fulfil your duties as an attorney.