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Jane, aged 54, aims for £15k tax-free income

Our experts urge this investor to fine tune her holdings and concentrate on tax planning for a better outcome when she and her husband retire in 4 years' time

Jane is 54 and has been investing for 10 years, with the aim of generating a tax-free income in retirement.

She says: "I make all the investment decisions for me and my husband as he has no interest in investment at all. I feel fairly comfortable making decisions, but wonder whether I am on the right track, especially when there is lots to read around active vs passive investing which always makes me feel I am doing it wrong.

"I would not be happy paying for someone else to take decisions for me, but appreciate I am definitely no expert.

"My husband has a projected final-salary pension of £30,000 and I am trying to ensure that our individual savings accounts (Isas) and self-invested personal pensions (Sipps) will produce additional income of around £15,000-£18,000 a year.

"We are already taking the income from investments partly to see how this 'works' and using the additional income to pay down our £50,000 mortgage rather than simply using capital to clear this debt. I have worked out that paying off the mortgage would result in a net loss to our income.

"We would like to help our 22-year-old son on to the property ladder and have earmarked my husband's pension lump sum of about £55,000 for this.

"In the past we have focused on specific themes and sectors and concentrated on growth funds, but this has since changed as I hated the volatility associated with such investments.

"So for the past few years virtually everything in the portfolio has an income bias. I don't believe we will need to touch our capital for a number of years so feel relaxed about fluctuations in capital values so long as the income rolls in.

"We invest £2,245 each month into our Isas and will continue to do so until we retire in around four years."

Reader Portfolio
Jane 54

Individual savings account and self-invested personal pensions


Tax-free income of £15,000



Name of holdingValue%
Jane's Isa 
Artemis Global Income£11,9554.5
Artemis High Income£12,3765
Kames Property Income PAIF£14,4765.5
Rathbone Income Fund£20,0007.5
Schroder Asian Income Maximiser£10,0004
Stewart Investors Asia Pacific Leaders£5,7002
Troy Trojan Income £29,30011
Jane's Sipp 
M&G Optimal Income £13,0005
Majedie UK Income£20,5008
Neptune Japan Opps£9,9004
TwentyFour Dynamic Bond£6,5002.5
Husband's Isa 
Artemis Global Income£16,4006
Invesco Perpetual Distribution£30,00011.5
Kames Property Income PAIF£31,30012
Royal London Sterling Extra High Yield Bond£19,8007.5
Cash Isa£10,0004

Source: Investors Chronicle



Chris Dillow, the Investors Chronicle's economist, says:

There's big good news here: you are on course to meet your objective. To get an income of £15,000-£18,000 a year in retirement requires you to have a pot of around £330,000: I'm assuming an average total real return on equities of 5 per cent, implying that you could take such a proportion out of your portfolio while leaving capital intact. As you are saving almost £27,000 per year, you should achieve this target even with a zero real return on this portfolio.

In this context, the fact that you are taking income from the portfolio isn't as bad as it otherwise would be, especially as you're using that income to reduce your liabilities. Ordinarily, I'd urge investors to reinvest income not just because of tax considerations but simply because in a world of secular stagnation, most of the long-term returns to equities are likely to come from dividends, not growth.


Petronella West, chartered wealth manager at Investment Quorum, says:

You might want to consider paying off the mortgage now. However, with interest rates likely to remain low for the foreseeable future you might also want to fix the mortgage rate over the next four years. You would then need to ensure that the total return on overall capital is more on an annualised basis than the interest that you are paying on the fixed mortgage. This second option does carry the potential for downside risk.

It is very important that you continue to save £2,245 a month into the Isas, but keep reinvesting the income if you don't need it.

Paying off your mortgage now would result in a reduced amount of income and with interest rates at such historical lows there seems a strong case for retaining your capita, or at least until interest rates rise significantly.

If you retained your portfolio and invested the money wisely over the next four years, reinvesting the income, it could grow in excess of £300,000. To get to this figure, I used a total compound return rate of 5 per cent a year. If you then include the effect of your regular monthly subscriptions over the next four years, you could have accumulated a further £120,000-plus into your portfolio, bringing your overall wealth to £420,000. Then you could consider paying off your mortgage.

Taking an income of £15,000-£18,000 a year does seem a little ambitious because your portfolio would need to produce income of 6-7 per cent a year. With average inflation of 2 per cent a year over the next four years that income requirement would rise to £16,000-£19,000 a year. Looking ahead, with a larger capital sum of £400,000, the income requirement would drop to nearer 4.5-5.5 per cent a year, which would be more achievable.

I would not necessarily swap the final-salary pension for cash unless you know the 'commutation factor', which represents how much of a lump sum you get for every £1 you give up in income. It simply might not be worth it, so check carefully before you do so. If you are in good health and there is longevity in the family, the pension income, assuming a degree of inflation protection, will be far more valuable than the lump sum over the longer term.

I would also investigate the level of state pension you are likely to receive - this is easily done via the Department for Work and Pensions website and downloading a BR19 State Pension Forecast - that could boost the coffers when you both reach state pension age. There may also be an opportunity to top up if you haven't reached the maximum.

Before you start switching funds and paying off the mortgage, spend some time carefully matching cash flows to income, not only over the next four years but well into retirement to ensure that you have factored in unexpected capital expenditure, the effect of long-term inflation, longevity and the impact of long-term care. As a general rule, we tend to overestimate investment returns and underestimate our life expectancy - and that can lead to shortfalls later in life.


Lauren Peters of independent financial adviser Helm Godfrey, says:

Your husband will be pushing the limits of the basic-rate tax band once in receipt of both his final salary and state pension income so it's appropriate that he boosts his Isa to generate a tax-free income stream.

What about your income, however? You have not mentioned how much, if any, you will receive when you retire in four years' time, aged 58. You should remember that your personal allowance for income tax (currently £10,600) will still be available to you so it makes sense, where affordable, to build up your pension to make use of this tax-free band.

Even if you are not working, you can contribute £2,880 a year into a pension. This is grossed up by 20 per cent to £3,600, resulting in a £720 boost before you even invest.

At retirement, one option for achieving your £15,000-£18,000 annual net income target is to draw up to the personal allowance and take the 25 per cent tax-free lump sum in annual instalments. So, if the personal allowance is £12,000 in four years' time, £16,000 can be drawn tax-free (£4,000 constitutes the 25 per cent tax-free lump sum and £12,000 is equal to your personal allowance).This method could work for several years before needing to use Isas.

Maximising reliefs and allowances reduces the pressure to target high returns in your portfolio. But tax planning should be reviewed on a regular basis.



Chris Dillow says:

I'm in two minds about the bias towards income stocks in your portfolio. Part of me applauds it. History tells us that income outperforms growth over the long term, not least because a number of cognitive biases - such as overconfidence and the planning fallacy - cause people to overpay for growth. Yes, growth stocks have benefited from the fall in long-term interest rates in recent years, but as we cannot rely on this continuing, a bias to income stocks seems reasonable.

However, I hate the phrase 'income stocks' because it encompasses (at least) two different things.

On the one hand, there are defensive stockson a high yield because the market thinks they won't grow much: these include utilities, tobacco and big pharmaceuticals. Defensive high-yielders have tended to outperform over the long run, perhaps in part because the market underrates the virtues of having what Warren Buffett calls "moats" - sources of quasi-monopoly power such as high capital requirements or big brands.

On the other hand are stocks offering a high yield because they are regarded as especially risky - in many cases because they are especially exposed to the danger of recession. These include miners and banks now. Such stocks might also outperform over the long run, but for a very different reason to defensive high-yielders - as a reward for taking on the extra risk.

My concern is that some risks to these stocks might materialise. One problem is that when interest rates rise, investors could dump income stocks as the 'reach for yield' process goes into reverse.

Granted, UK rates probably won't rise for some time. But US ones might go up very soon. And a fall in US income stocks would hurt your global income funds, and might have knock-on effects for UK stocks: that's the downside of globalisation. This same process would also hurt lower-quality bonds.

Another problem is that it is possible that fears of a deep or long-lasting recession in China will intensify, to the detriment of high-yielding miners. I'm not sure this is likely - one leading indicator, monetary growth, is telling an encouraging story - but it is a risk.

What I'm urging you to do here is to check on what your income funds are holding. Exposure to defensives is a good thing - and Rathbone's and Trojan's funds have a lot of this. Exposure to more cyclical high-yielders, however, is more ambiguous. These might do fantastically well if fears about China recede, but this would only be a reward for taking especial risk.


Petronella West says:

I would sell the Neptune Japan Opportunities Fund (GB00B3Z0Y815), given its lack of yield, the M&G Optimal Income Fund (GB00B1H05718), and the PFS TwentyFour Dynamic Bond Fund (GB00B5VRV677) in favour of funds that might deliver better returns in a changing economic environment.

We would suggest investing into the Fidelity Enhanced Income Fund (GB00B7W94N47), CF Woodford Equity Income Fund (GB00BLRZQ737) and Invesco Perpetual Monthly Income Fund (GB00BJ04JZ25) which should help to enhance the strategy suggested. This assumes that the income is reinvested over the four-year period.


Lauren Peters says:

With a relatively short timeframe to retirement, consider lowering the risk and volatility profile; you are heavily invested in international equities - particularly Asian markets - and property, with only 27 per cent invested in fixed interest. You also have 17.5 per cent of your £261,000 in one fund, Kames Property Income PAIF (GB00BK6MJB36) so some further diversification may be appropriate.

Keep an eye on fees. Many of your funds are charging around 1.5 per cent per year, which is high in the current, low return environment and will affect how quickly you can repay the mortgage.

Choosing funds with an income bias is suitable as you approach retirement, although non-taxpayers should be aware that they cannot reclaim the 10 per cent 'tax credit' on dividends.

If you want to consider 'peer to peer' lending (investing in companies without a bank intermediary) note that these investments can be held within an Isa wrapper from April next year. While returns are currently taxed like savings and there's a chance of good returns, this is most certainly a high-risk investment. You could lose some or all of your money.