- These investors have sufficient income from their pensions so they would like to pass on their assets to their children tax efficiently
- Shifting their investments' focus to income rather than growth is not necessarily a good way to mitigate a potential IHT liability
- Their investments do not match their risk profile
Pensions, with-profits funds, Isas and trading accounts invested in funds and shares, cash, residential property.
Cover costs of holidays and large expenses, help family financially if necessary, pass on assets and home to children to help fund their retirements and grandchildren to buy homes, minimise IHT liability.
John is age 72 and his wife is 71. They both receive state pensions and he receives two final salary pensions. These provide them with an income of £44,500 or, after tax, £38,400 a year. Dividend payments and interest from cash takes their total annual income to about £48,000 a year.
Their children are ages 46 and 45, and they have four grandchildren.
John and his wife’s home is worth about £350,000 and has been mortgage free for 35 years.
“Since retiring, we have not needed to draw from our investments as our pensions provide sufficient income,” says John. “We also have healthy cash balances for any unseen bills or holidays. But we will draw from our investments, if necessary, to cover the cost of holidays and larger expenses, and to help our family when necessary.
"We plan to pass on any remaining assets and our home to our kids. This will help to fund their retirements and maybe help our grandchildren get onto the housing ladder.
"Over the 25 years that I have been investing my main aim has been a good level of growth – around a minimum of 5 per cent a year. And our investments have increased in value well over a fairly long period of time. But I now want to diversify our holdings, and set them up to generate income rather than growth to try not lose too much to inheritance tax (IHT).
“We have gone from having a fairly high, to a medium to low risk appetite over the past few years due to being retired. I have not made any changes to our investments since I retired, and during the past 10 years the only addition has been Fidelity Global Dividend (GB00B7778087) in December 2020. This was because I was happy with what we had and how these investments were performing.
"I used to buy direct shareholdings at their initial public offerings and had companies including British Airways, British Gas, Centrica (CNA), O2 and Marks and Spencer (MKS). When their share prices increased to a certain level I sold them, and reinvested the proceeds in funds and direct share holdings, in some cases within individual savings accounts (Isas).
“I am now thinking of investing another £10,000 within an Isa this year but I will wait to see how the current financial situation develops.”
|John and his wife's total portfolio|
|Holding||Value (£)||% of the portfolio|
|NS&I Premium Bonds||86,000||18.89|
|FTF Franklin UK Mid Cap (GB00BYW0QZ27)||46,034||10.11|
|Janus Henderson European Selected Opportunities (GB00B412VB02)||40,209||8.83|
|FTF Franklin UK Smaller Companies (GB00BYVDZV14)||35,138||7.72|
|Janus Henderson UK Smaller Companies (GB0007447625)||27,010||5.93|
|Lloyds Banking (LLOY)||7,050||1.55|
|Legal & General (LGEN)||5,989||1.32|
|Fidelity Global Dividend (GB00B7778087)||5,829||1.28|
|J Sainsbury (SBRY)||1,903||0.42|
|Banco Santander (BNC)||646||0.14|
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:
One feature of this portfolio is its unusually high weighting to UK rather than overseas stocks. But I don't think that is a big problem.
Years of underperformance means that the UK market is relatively cheap. Of course, we could have said that for many years only to discover that UK shares became even cheaper. But with valuations of US big tech companies now wobbling, a UK weighting might not be as expensive as it has been in the past.
It is also not so bad to avoid emerging markets equities right now. Momentum is against these, and rising US interest rates and a stronger dollar are often bad for them, too. Also, UK equities are more defensive than emerging markets equities so are more likely to hold up relatively well in bad times. That matters for low-risk investors.
It’s a good idea to hold lots of cash rather than bonds. Recent events have reminded us that you cannot greatly reduce risk by diversifying among equities alone. You also need non-equity assets. And dull as it is, there’s much to be said for cash. Bond prices tend to rise when investors fear recession or lose their appetite for risk, protecting investment portfolios nicely from losses on equities. But bonds will fall if investors fear more inflation or higher interest rates than are currently priced in. Cash, by contrast, protects investment portfolios from rising interest rates. And the worst-case real-term loss on cash is inflation minus the interest rate which is less than the worst-case loss on bonds and certainly less than the worst-case loss on equities.
One issue is your desire to shift into income stocks, which generally fall into one of two categories. Some are big dividend payers which have gone ex-growth and investors require them to have high yields to compensate for their share prices' perceived lack of future growth. But others, such as house builders and miners, are cyclical so investors require these to have high yields to compensate for the risk that they will do badly in recessions.
These two types of share are quite different to each other. Ex-growth stocks are well worth considering because they can be cheap due to investors being over confident about their ability to predict future growth and selling them too much. Mature stocks also tend to be defensive and, on average, over the long run defensives outperform.
But cyclicals are trickier. They do nicely in upturns, but at the price of horrible falls in recessions. Unless you’re willing to try to time the market, perhaps by using the yield curve, there’s no strong case for shifting into these.
Instead, what matters is total returns. You can create your own dividends by selling shares and units of investments. And if your total returns are good enough, you could try to reduce your IHT liability by making gifts to your children and grandchildren.
This doesn’t mean that you should sell risers – run your winners. But don't chase income stocks just for the sake of income.
Tom O’Brien, financial planner at Brewin Dolphin, says:
It's good that you are in a comfortable position, the vast majority of your expenditure is covered by fixed pensions and you are clear of liabilities. This means that your investments can provide you with some flexibility and potentially fund larger ticket items. But there are a number of ways in which you could improve and maximise your financial efficiency, including tax planning, drawdown strategies and investment planning.
Ensure that you have up to date wills and Powers of Attorney in place which are current with your wishes. And consider having a health MOT. You can get a private health check for about £500-£1,000 which can be useful for identifying issues early.
Your risk profile and approach is a little disjointed. Going a from a fairly high to a medium risk profile, as you have done over the past few years, is not uncommon. However, having £69,456 in direct equity holdings with £48,152 in one company alone is a high-risk strategy. Your holdings also include UK smaller companies funds that invest in a smaller portion of the home market than broader UK funds. So I don't think that your portfolios are medium to low risk.
Diversification of assets and a good geographical spread help to mitigate risk. It would also be sensible to consider diversifying the direct equity holdings and transferring some of your holdings into Isas. You are both probably paying dividend tax so, as you appear not have not used your annual Isa allowances, you could each put assets worth £20,000 into Isas this tax year and very soon again in the next tax year. This could be a good way to reduce the amount of tax you have to pay in future, though be mindful of any capital gains and possible tax liabilities when selling investments held outside Isas.
You have about £179,000 in cash-related assets which are losing pace with inflation. Your allocation to this asset is unusually high and over the longer term this could have a significant impact on the overall value of your assets. You may need to pay for care later in life and the costs of this have risen to around 4 per cent higher than in recent years. So you should not have as much money in an asset which is losing pace with inflation.
I question your plan to reallocate the portfolios so that they generate income more than growth. Income which you do not reinvest is likely sit in cash although you could distribute this to your family on a regular basis. Also set aside some cash to pay for possible care costs. But trying to time the market to sell at the highest price can painful, so taking some profits at times, rather than waiting for a high price, can be a better strategy.
There are many types of accounts into which you could save and invest for your children and grandchildren including Isas, Junior Isas, Lifetime Isas and pensions.
Assess your lifestyle to estimate how much money you will require in the coming years and then consider your options. You have assets worth about £455,000, some of which are in trust, and a property worth £350,000. You appear to qualify for the residence nil rate band so have an allowance of £1mn. This means that at present your estates do not have an IHT liability, assuming that you have no other substantial assets.
If you can build up further benefits in pensions, and each invest £2,880 a year into one, you will each receive tax relief of £720, making these gross investments of £3,600. Pensions are outside your estates for IHT purposes and, if you do not draw from them, they could be passed onto your family.