- These investors should estimate their future expenses to get an idea of what they can afford
- They do not necessarily need high-yielding stocks for income as they could sell investments which have grown strongly
Pensions, Isas and general investment accounts invested in shares and funds, residential property, cash.
Sell buy-to-let properties, cover future care costs, continue to live in current home and cover its running costs, hold assets tax efficiently, mitigate IHT, make gifts to family if possible.
Michael and his wife are ages 74 and 72, and have two children and several grandchildren. They receive an annual income of around £80,000 a year from occupational, private and state pensions, about three-quarters of which have inflation increases built in. About 80 per cent of that income goes to Michael. He also works part time and earns about £18,000 a year, but expects to stop doing this in the next year or two. They are both higher-rate taxpayers.
Their home is worth about £1.4m, and they have eight buy-to-let properties with a total value of about £2m. All the properties are mortgage free.
“Until four years ago, our only assets were our primary home, pensions and buy-to-let properties,” says Michael. “But properties can take a long time to sell, and income from residential letting can be volatile and uncertain. I have also found self-managing the properties increasingly difficult and stressful over the past four years, and if we pass them on after we die it will result in major inheritance tax (IHT) bills for our heirs.
“So as tenants leave the properties we sell them and have paid substantial amounts of capital gains tax (CGT) on the proceeds. When they are all sold we may end up having paid CGT of £1.5m or more in total.
“I would like to reduce our estate’s IHT liability by making significant gifts to our family, but expect that we will have substantial care costs in the future. My wife has a long-term illness which does not reduce her life expectancy, but means that she will probably need a lot of medical attention and professional care as she gets older. So we need to retain significant capital. We have also already given our children deposits to buy homes and other significant gifts.
"Our home is large, old and expensive to run. But we have lived here for the past 40 years and are determined to spend the rest of their lives in this house. So the expense of running it will substantially increase due to costs such as maintenance, heating, stair lifts, cleaners and renovations.
"We each hold about 50 per cent of our assets with the exception of the family home which is in my wife’s name. When I ran my own business I put it in her name to reduce risk, as this was our principal asset. But should we now hold it jointly?
"Over the past few years we have reinvested proceeds from the sale of properties in equities or given them away. We have put the maximum possible into individual savings accounts (Isas) each year in which we hold about 17 per cent of our investments. We plan to continue to fully using our annual Isa allowances.
"The rest of the investments are in a general investment account. I cannot make further pensions contributions as the value of my pensions is above the lifetime allowance [currently £1,073,100].
“I don’t take income from the Isas but my wife does.
"Our fund and share investments are heavily weighted to real estate investment trusts (Reits). But these pay reliable dividends which are likely to increase. And they are balanced by the certainty of our pension income – also the reason why I am prepared to take investment risk.
That said, I am upset because the values of our holdings in National Express (NEX) and Amedeo Air Four Plus (AA4) have fallen by more than 50 per cent and 70 per cent, respectively. These investments are in Isas so their losses cannot not be offset against capital gains.
"We have cash worth £250,000 but are not sure what to invest this in.
"We get income from our investments of about £28,000. Several of the larger holdings, such as Berkshire Hathaway (US:BRK.A), do not pay dividends but we could switch these into income producing shares in the future.
"I also wondered if I have too many holdings. Should I sell the smaller ones and reinvest the proceeds in a large investment trust?"
|Michael and his wife's total portfolio|
|Holding||Value (£)||% of the portfolio|
|Tritax Big Box Reit (BBOX)||265,000||6.39|
|Tritax EuroBox (EBOX)||131,000||3.16|
|Edinburgh Investment Trust (EDIN)||124000||2.99|
|F&C Investment Trust (FCIT)||120000||2.89|
|Herald Investment Trust (HRI)||113,000||2.73|
|Urban Logistics Reit (SHED)||105,000||2.53|
|Liontrust Asset Management (LIO)||99,000||2.39|
|North Atlantic Smaller Companies Investment Trust (NAS)||82,000||1.98|
|Merchants Trust (MRCH)||75,000||1.81|
|National Express (NEX)||69,000||1.66|
|NS&I Premium Bonds||50,000||1.21|
|Bankers Investment Trust (BNKR)||46,000||1.11|
|Alliance Trust (ATST)||43,000||1.04|
|Fundsmith Equity (GB00B41YBW71)||40,000||0.96|
|Supermarket Income REIT (SUPR)||40,000||0.96|
|Berkshire Hathaway (US:BRK.A)||38,000||0.92|
|Caledonia Investments (CLDN)||33,000||0.8|
|Mountview Estates (MTVW)||32,000||0.77|
|Primary Health Properties (PHP)||30,000||0.72|
|DS Smith (SMDS)||22,000||0.53|
|BlackRock Sustainable American Income Trust (BRSA)||21,000||0.51|
|Finsbury Growth & Income Trust (FGT)||20,000||0.48|
|MP Evans (MPE)||18,000||0.43|
|Michelmersh Brick (MBH)||13,000||0.31|
|Brunner Investment Trust (BUT)||11,000||0.27|
|Marks and Spencer (MKS)||10,000||0.24|
|Dechra Pharmaceuticals (DPH)||5,000||0.12|
|Anglo American (AAL)||4,000||0.1|
|Amedeo Air Four Plus (AA4)||1,000||0.02|
NONE OF THE COMMENTARY BELOW SHOULD BE REGARDED AS ADVICE. IT IS GENERAL INFORMATION BASED ON A SNAPSHOT OF THESE INVESTORS' CIRCUMSTANCES.
Chris Dillow, Investors' Chronicle's economist, says:
Your situation is a reminder of an awkward problem for all of us – that we don’t know what our future liabilities will be.
The only thing we can do is to give ourselves margins of adjustment to respond to unexpected developments. These margins could be working or saving more, or downsizing your home. For you, the margin is simply that your portfolio is big enough to cover enormous extra amounts of spending. You could respond to unexpected outgoings by simply running down your wealth.
The barrier to doing this is psychological. Having spent a lifetime saving and accumulating, we feel uncomfortable seeing our assets dwindle. Our wealth – however great it is – acts as a reference point, and shortfalls from it disquiet us. It’s tremendously difficult to make the adjustment from being a net saver to a net spender, which is why many of us work longer than we need to and deprive ourselves of enjoyment. One counterweight to this is to remember orthodox economics. This assumes that our spending has a pattern over our lifecycle: in our peak years we save and in retirement we run down our money. Therefore, seeing our wealth fall should be normal. You’ve earned the right to spend.
Two other things you are doing are entirely reasonable.
Even with negative real interest rates, holding a good amount of cash is reasonable. It's quite possible that rates in the UK and US will rise next year, causing bonds and equities to fall. But cash protects us from this risk.
It’s also reasonable to cut your property holdings. Not only are these illiquid, but their prices could fall if interest rates rise. And house prices are more sensitive to interest rates than share prices. This combination of illiquidity and rising interest rates is also a threat to Reits, and the illiquidity will manifest itself via a fall in their share prices relative to net asset values, if their property holdings become hard to sell. This is why you should consider trimming these, especially in view of their disproportionate weight in your portfolio. And you don’t need appropriate alternative investments to reinvest in. Rather, your default equity investment should be a global equities index tracker fund.
It worries me that you’re considering dumping holdings such as Berkshire Hathaway in favour of income-producing shares. A high yield is often just compensation for some defect such as extra risk. For example, miners and housebuilders pay good yields to compensate for their vulnerability to recession. And sometimes it is a perceived lack of future growth, as is the case with tobacco and utility stocks. By all means buy high-yield stocks if you think that the market is exaggerating these defects and underpricing the stocks. But don’t buy them for their income.
Remember that you can always create your own dividends simply by selling some shares, so what matters is total return.
I’m also worried that you’re upset by losses on National Express and Amedeo Air Four Plus. Don’t be. Every stock picker sees losses on holdings sometimes. They are inevitable given that nobody has a crystal ball. Remember that what matters is total returns of your portfolio as a whole.
Shelley McCarthy, chartered financial planner and managing director at Informed Choice, says
I suggest doing doing a cash-flow forecast and making a financial plan to help you understand your income requirements now and in the future, taking into account potential care costs. This would also help to determine the amounts that you could gift away now without impacting your financial future. When doing this, you should include likely one-off capital expenditures, such as installing stair lifts, and ongoing maintenance costs.
When considering a gifting strategy, you need to work out if you can afford to make the gift outright, the tax payable on it and the income you are giving up. When putting a plan in place also consider the order in which the gifts, loans or trusts are made and set up, and gifts you have made previously.
Be careful when selling your properties as you could end up incurring both CGT and IHT, and remember that capital gains ‘die’ with you. Whether you should hold your main residence in one or both names depends on what you have written in your wills.
Make sure that you are fully using all of your various tax allowances, such as the £3,000 gifting allowance, each year. You could also use the ‘normal expenditure out of income’ allowance. This allows you to gift excess income over expenditure on a regular basis and it immediately falls outside your estate, rather than after seven years as with other gifts not covered by allowances. For example, if your cost of living is £50,000 and your net income is £100,000, you could gift £50,000 without any IHT liability.
You are unlikely to be able make further contributions to your Sipp if you have protection against the Lifetime Allowance. And when you are age 75 or older, you no longer receive tax relief on pensions contributions. If you are drawing income from your Sipp, consider stopping doing this and instead drawing income from an alternative source as your Sipp is outside your estate for IHT purposes. The death benefits also change at age 75 so, if you have not already, consider withdrawing the available tax-free cash.
Trusts can also play a part in estate planning and are not necessarily as complicated as people often think. They are particularly useful if you would like to retain control of a gift, generate an income for yourself or retain access to the capital, which you can do via a loan trust. An investment within a trust structure could be suitable as it could potentially generate an income via a discounted gift trust. A loan trust could also ensure that you retain access to the initial loan amount but any growth on the investment is outside your estate for IHT purposes.
If you have a high enough risk appetite there are investments which can mitigate IHT. For example, some Aim shares qualify for Business Property Relief after being held for two years, and can be held within Isas. However, these are often small start-ups with a higher risk of failure, so you could be getting a 40 per cent reduction in IHT in exchange for a loss of a greater value.