Improve your income through tax planning

"I will reinvest my tax-free lump sum worth 25 per cent of the Sipp in my stocks-and-shares individual savings account (Isa) for emergency funds, and use some for property improvements," says Jon. "I'm not overly optimistic about returns from my Sipp and realistically would only expect 3 per cent. But we live a modest lifestyle and don't have any debt or mortgages, so think we could live quite comfortably on £30,000 a year - or even £27,000.

"I receive basic state pension, plus another small personal pension, which together pay out around £800 a month net. My wife, who is 63, has a small occupational pension that pays £150 month, but she can't claim state pension until she is 65.

"Our home is worth £575,000, but we intend to move to Cumbria and let this - a local letting agent estimates that it could generate a monthly income of £1,600. So after charges and tax the net income from this should be in the region of £1,200 a month.

"Our house in Cumbria is worth £150,000 and we also own a house in France worth £125,000, which we do not intend to use for rental, but has running costs of about €1,500 (£1,264.15) a year.

"My parents lived into their early 1980s, so I expect to live another 15 to 20 years if I'm lucky. Nevertheless, and thanks partly to the post-referendum surge in share prices, I've sold most of my Isa holdings to buy the house in Cumbria.

"I have been investing for 25 years and, while I was working I was a bit gung-ho in terms of my approach, so like many others over the past decade I have carried my fair share of lame duck stocks - at one point my Isa investments were down at least 40 per cent. I now tend to dabble and take profits occasionally, so some of this will hopefully be capital gains as well as dividends.

"I'm now more careful, and in the past two years have mainly bought funds and investment trusts. As I now invest in collective funds I do not expect my losses in a bad year to be more than 20 per cent. I particularly like investment trusts as they can be traded like shares.

"I have recently taken profits on some investments as I expect the market to fall after the Brexit vote/Trump rally is over. After the next major market correction I am going to invest a larger percentage of my assets in exchange traded funds (ETFs) and trackers such as L&G US Index Trust (GB00B0CNGS66).

"I have tried to diversify my holdings as much as possible, but I'm not sure the bond focused funds are paying their way, so I might re-invest these.

Jon's portfolio

THE BIG PICTURE

Chris Dillow, Investors Chronicle's economist, says:

One of the basic rules of investing is to minimise charges and taxes legally, so you should try to keep as much as possible in tax shelters for as long as possible. If you need cash for property improvements, you should first run down any funds held outside Sipps and Isas. And you shouldn't rush to take that 25 per cent lump sum from your Sipp, to ensure that you take advantage of future growth.

Financial advisers can help you navigate the tax system and pension rules, so check with one before you take out the tax-free lump sum from your Sipp.

Danny Cox, chartered financial planner at Hargreaves Lansdown, says:

You can improve net income with some tax planning. Your wife is not a taxpayer so when you move north, if you transfer your current home into her sole name there will be around £1,900 less tax to pay on the rental income than if it was in your joint names. This tax position will change when your wife starts to receive her state pension, but even then the position will be no worse than at present.

The key to a successful income drawdown plan is to use a balanced portfolio that draws no more income than comes naturally from the Sipp investments, known as the natural yield. Spending only the income allows the capital to grow - and with it the income - offsetting the effect of rising price inflation. This also means the Sipp is better protected during market weakness.

Drawing no more than 4 per cent is a good rule of thumb. On this basis, the Sipp should be able to produce a sustainable and increasing income of around £5,000 a year after tax.

Your individual shareholdings, worth around £33,000, are capable of producing further income of around £1,000. But unless you have a particular investment reason in mind, consider switching these into funds to diversify risk.

The 25 per cent tax-free cash withdrawn from the Sipp should be sheltered in cash Isas. Emergency funds should always be in cash and they need to be available at short notice. The Isa allowance is £20,000 this year - or £40,000 for you and your wife.

Jeremie Vuillard, group head of advisory at Kleinwort Hambros, says:

I like that you have set some money aside for emergencies and planned for your retirement - it is surprising how many people don't think about this until it is too late. Your living expenses of around £2,500 a month are almost entirely covered by your income, and this has been enhanced by the use of tax-efficient vehicles such as your Isa and Sipp. Your careful planning means you can enjoy your retirement and maintain your current standard of living.

As you approach retirement you may wish to consider managing risk in a way that matches your lifestyle moving forward, preserving your portfolio's value in real terms and earning some return above the inflation rate. Your return objective of 3 per cent a year should realistically be met in the medium to long term, through a combination of income and with an element of capital growth. Your expectations in terms of return are achievable, but more important they are achievable even if you take less risk, providing greater certainty of the value of your investments for when you need them most.

HOW TO IMPROVE THE PORTFOLIO

Chris Dillow says:

Your portfolio looks rather equity-heavy. Bonds might not be paying their way, but neither has my car insurance for years. That doesn't mean I'll not continue to buy it: the point of insurance isn't to make money, but to protect you in the event of disaster. If or when equities fall, bonds might well mitigate your losses. I say might well because it's not guaranteed - and why there's a case for cash.

Your portfolio is well diversified among equities. But is it sufficiently well diversified across asset classes to protect you from a general market downturn? I'm not sure it is.

Your portfolio also incurs a common problem seen among diversified portfolios of actively managed funds - that it ends up being something along the lines of a global tracker fund, but with higher fees than necessary. And fees, remember, compound horribly over time. For example, over 10 years an additional 0.5 percentage points of charges will add up to around £15,000 on a £200,000 portfolio.

You should therefore ask of each of your funds: could I get something similar at lower cost? In many cases, the answer is yes.

Take, for example, absolute-return funds. These offer consistent but low returns, and sometimes with high fees and opaque charges. You can often do as well by holding a basket of equities, cash, bonds and gold - which you can do cheaply.

However, if you put a gun to my head and forced me to buy an actively managed fund, I'd pick ones such as Fidelity Enhanced Income (GB00B87HPZ94), CF Woodford Equity Income (GB00BLRZQ737) and Troy Income & Growth Trust (TIGT). This is because these invest in bigger UK defensive stocks - and, on average, defensives tend to outperform over the long run.

Danny Cox says:

You have a good range of funds in your Sipp, although any more than 20 might prove to be a handful. Few of the global or overseas funds offer much in the way of yield, so a shift to income-bearing funds would improve your pension income.

Just over one-third of your holdings are overseas, which include global, Asian and European funds, as well as some single-country funds focused on areas such as India. But you might be better holding general emerging market funds as their investments are spread across different countries, so they are a lower-risk approach to areas that are more volatile and higher risk.

Your watchlist includes a US tracker, which is a sound choice for low-cost exposure to US markets, although you already have some US holdings in your global funds.

It is true that there is little income or value from bonds. So strategic bond funds are perhaps the best way to access this area, as their managers can invest in all kinds of fixed income to reduce risk and improve returns.

Jeremie Vuillard says:

Your portfolio has a high equity content with a large amount of overseas exposure. Although we highly regard some of the funds in your portfolio, we are concerned about the level of risk in relation to your investment objectives. It is possible that your allocation could lose more than 20 per cent in an adverse market environment.

Even though you hold some high-yield bonds, infrastructure and alternatives, you are not sufficiently diversified across all available asset classes to limit market volatility.

You would be happy if you generated 3 per cent a year, and this is more than achievable if you hold lower-risk, uncorrelated asset classes alongside your equities, smoothing the return from your portfolio.

Active trading - taking profits when asset prices are increasing - may not necessarily be a winning strategy all the time: empirical evidence shows that it is hardly possible - even for professional investors - to catch all the peaks and troughs, and there is a large risk of missing out on positive market performance.

That said, we do support the notion of dynamic portfolio management, and suggest underweighting or avoiding asset classes where the risk is not adequately rewarded. Government bonds are the most obvious example of this at the moment.

Consider reducing your exposure to equities, as preserving your capital while aiming to conservatively grow your wealth should be most important to you at this stage.

I agree that bond investments are not paying their way, so be very selective in the fixed-income space while carefully managing duration. For example, you could consider floating-rate notes or alternative sources of income, such as investment companies that invest in the financing of infrastructure projects or student accommodation. With these you can gain access to investments that have a return profile similar to bonds, but within the alternatives space, and that would provide an element of protection against inflation.

I would propose an asset allocation along these lines: