- Our reader faces a dilemma over how to take his deferred state pension
- He and his wife wonder whether their portfolio is too racy for their age
- They want to move away from single stocks
Isas, pension
De-risking and simplifying the portfolio, funding care fees, leaving an inheritance
Not all investors dial down on risky stocks and shares as they retire. For the fortunate who stop working without drawing from their investments, such de-risking might come later in life, once care costs and leaving an inheritance become more pressing.
Steve and Grace, both 80 and retired, are a case in point. Grace receives the full state pension while Steve has a £90,000 inflation-linked defined-benefit pension. This is enough to cover their spending, so Steve has deferred taking his state pension.
He is now considering his options. “I decided to defer drawing my state pension as I had no desperate need for it and considered it a saving scheme accruing interest. I now have a dilemma. Do I start drawing a substantially increased state pension or take a lump sum? I am probably inclined towards taking the lump sum, but I wonder if there is any way of alleviating the tax bill.”
The couple has a £900,000 portfolio split between two individual savings accounts (Isas) and a personal pension and comprises a mix of individual stocks, exchange traded funds (ETFs) and investment trusts. The portfolio is invested aggressively, with stocks accounting for most of the assets, albeit with some exposure to gold, infrastructure and property. The couple has always run a buy-and-hold strategy and reinvested dividends. They also hold £50,000 in Premium Bonds and £15,000 in cash.
“Our portfolio is by accepted standards overweight in stocks for our age. The buffer of the defined-benefit pension has allowed for it and I suspect that historically it has just about proved the correct choice,” says Steve. “Maybe this should now change. We have been thinking of selling some individual stocks and moving the proceeds into investment trusts, ETFs and short-dated gilt or bond funds.”
Steve and Grace have two financially independent children and no immediate necessity to draw from their savings. Their goals are having enough for care costs if the need arises and to leave a healthy inheritance to their children and grandchildren.
NONE OF THE COMMENTARY BELOW SHOULD BE REGARDED AS ADVICE. IT IS GENERAL INFORMATION BASED ON A SNAPSHOT OF THESE INVESTORS' CIRCUMSTANCES
Natalie Kempster, chartered financial planner at Argentis Wealth Management, says:
You deferred your state pension before the rules changed in 2016. There are no limits on how long you can defer it for, but it sounds as though you have decided that now is the time to start taking it. For every five weeks you have deferred, your weekly entitlement increases by 1 per cent, which is 10.4 per cent for each full year of deferral. Alternatively, instead of a higher rate of state pension, you can get a taxable lump-sum payment plus the state pension paid at the normal weekly rate. The lump sum is calculated based on the amount of unpaid state pension and a compounded interest rate of 2 per cent above Bank of England base rate. Since your pension income is £90,000 a year, whichever option you choose will be subject to higher-rate income tax. But, helpfully, the lump sum is not added to your income to calculate the tax, so it will not impact your personal allowance, which normally starts reducing once your adjusted net income reaches £100,000.
To reduce your tax liability, you could make a charitable donation or invest in a venture capital trust (VCT). As a higher-rate taxpayer, you can claim the difference between your tax rate (40 per cent) and the basic rate of tax (20 per cent) on any charitable donations. For example, if you make a charitable gift of £1,000 with Gift Aid, the charity will receive £250 from HMRC and you can claim a further £250 back via your self-assessment. Or you could invest in a qualifying VCT or enterprise investment scheme (EIS) and receive 30 per cent income tax relief on the amount you invest. But keep in mind the higher-risk nature of these investments, which can make them unsuitable for some.
You might also want to consider your inheritance tax (IHT) position. Since you intend to pass an inheritance to your children and grandchildren, you will have a combined nil-rate band and residence nil-rate band of £1,000,000. Excluding your pension, your current assets total £1,356,972, so even without the lump sum from the state pension, today you would have a IHT bill on the second death of £142,788. In the worst case scenario, you could end up paying 40 per cent income tax on the lump sum plus 40 per cent IHT. A better option might be to tackle the inheritance tax position now.
The pension has a fairly large equity exposure, but this isn’t necessarily an issue. You say you are unlikely to need capital or income. Given that withdrawals would be subject to income tax and the favourable death benefits of pensions, this should be the last pot of money you should access. The Isas instead sit within your estate and exacerbate the IHT situation. I would consider transferring some of the money (the excess over the nil-rate bands discussed earlier) into an Aim Isa while switching the remaining Isa assets into a more conservative portfolio. Broadly speaking, you would be taking roughly the same level of risk but with one pot available to fund any care costs if required and the other invested in stocks that after two years will qualify for business relief, and as such free of IHT. Compared with placing assets into trust, with an Aim Isa you retain access to the funds and don’t have to wait for seven years to pass before they are outside of your estate.
You have many holdings in the portfolio, with quite a high degree of overlap within US stocks. For example, on top of the exposure to the 'Magnificent Seven' you get from your ETFs, Nvidia (US:NVDA) is a key bet for both Allianz Technology Trust and Scottish Mortgage, and Microsoft (US:MSFT) for both Allianz Technology Trust and Fundsmith Equity. While the region has recently performed exceptionally well and you can invest this aggressively, arguably you do not need to. Directly held gilts, which provide a predictable return and capital uplift, might be an interesting alternative.
Jason Hollands, managing director at Bestinvest, says:
Your investment portfolio is quite high risk. On an underlying basis, around 85 per cent of the portfolio is in stocks and only 4 per cent in bonds, with the remainder split between commodities and infrastructure. Even our adventurous managed portfolios typically have no more than 80 per cent in stocks.
Such a high allocation is more typical of an investor with a very long-term horizon who has the time to recover from periodic bear markets, rather than someone many years into retirement, even though you do not currently need to draw on these assets. While high equity exposure has no doubt served you well given the strength of markets over many years, you should consider dialling down the risk profile.
Ultimately, it seems likely you will either look to pass on these assets or need to draw on them to support care costs, so preserving the value of the capital you have so carefully built up might be a priority rather than taking risks to try to maximise the value (and the corresponding tax liability).
Given asset values are currently quite ‘rich’, especially with US equities, which represent 44 per cent of your stocks exposure, this might well be an opportune time to bank some of the gains and either gift some of the assets or increase the exposure to bonds, where yields are currently positive in real terms. Attractive yields can currently be locked in for both US treasuries and gilts.
As an indication of how the asset mix of the portfolio might be reshaped, in our lower-risk models, weightings to bonds range between 45 per cent and 65 per cent; even in more adventurous portfolios, we would have a bond allocation of circa 15 per cent and stocks around 75 per cent. A balanced portfolio would be no more than 60 per cent stocks and 25 per cent bonds, with allocations to gold and infrastructure on top.
Your stocks are well-diversified geographically, with a 44 per cent weighting to the US, 28 per cent in the UK, 13 per cent in Europe, 9 per cent in emerging markets and 6 per cent in the Pacific region, but a quite low 2 per cent position in Japan. If you wanted to increase this, you could look at Jupiter Japan Income (GB00B5TGB445) for an actively managed fund or iShares Japan Equity Index (UK) (GB00B6QQ9X96) for a very low-cost index fund option.
Diversification is a good thing, but the portfolio does have quite a lot of holdings, with more than 40 funds, investment companies and ETFs, as well as 10 individual company shares. Consolidate so the portfolio is simple and easier to monitor. Consider swapping out the direct holdings in UK-listed stocks for a well-managed UK equity fund, such as Artemis UK Select (GB00B2PLJG05) or IFSL Evenlode Income (GB00BD0B7C49). Among the trusts, funds and ETFs, you have some solid investments. None leap out as a concern, which is good news.
