Use tax breaks to bolster your strong position

"We want to generate an income of about £20,000 a year over the next six years until we both reach state pension age and around half that amount thereafter," says Patrick. "The main issue is what to do with all this cash. We would like some ideas about how to rebalance the portfolio for the long term – in the past we would have invested it in fixed-interest, but the environment has changed. Our portfolio has been built up over 20 years, and as my attempts at investing in individual shares have mostly not been successful I prefer collective investments.

>A reason why returns on sale assets are so low is that investors fear either falls in share prices or sustained periods of low growth

"I am a higher-rate taxpayer, but my wife has almost no income of her own and has not paid tax for a couple of years. We are in good health, but will need to make provision for the probability that one of us will eventually need long-term care. We own our own house, which is worth about £1.5m, and don't have children so inheritance planning is not an issue."

Patrick and his wife's portfolio

NONE OF THE COMMENTARY BELOW SHOULD BE REGARDED AS ADVICE. IT IS GENERAL INFORMATION BASED ON A SNAPSHOT OF THESE READERS' CIRCUMSTANCES.

THE BIG PICTURE

Chris Dillow, Investors Chronicle's economist, says:

This is a conservative portfolio, almost two-thirds of which is in safe assets such as investment-grade bonds and cash – Fidelity MoneyBuilder Income (GB00B3Z9PT62) and Personal Assets Trust (PNL) hold bond investments. So should you rebalance towards equities? 

Your age is largely irrelevant. The idea that older people should own fewer stocks was shown to be an old wives tale by Narayana Kocherlakota and Ravi Jagannathan in the mid 1990s. It's tempting to make such a shift simply because returns on cash and bonds are paltry. There are, though, good reasons to resist this temptation.

A reason why returns on safe assets are so low is that investors fear either falls in share prices or sustained periods of low growth. We can't tell if such fears are correct, but they are reasonable. Think of cash and bonds as insurance – and insurance is expensive when everybody wants to buy it. 

Your income requirements are very low. If equity returns are around average, you can get an income of £20,000 a year even with a conservative asset allocation.

And the prospect of a big long-term care bill perhaps argues for a safer asset allocation, simply to avoid the small but nasty risk you'll be hit with such costs after share prices have fallen. It's almost impossible to quantify this danger, but Andrew Dilnot estimated that one in 10 people will need to spend over £100,000 in 2009-10 prices – around £125,000 in today's money.

On the other hand, you can think of your defined-benefit pension as a safe asset. If we take this into account your asset allocation is very cautious so you might want to hold more equities.

Wayne Berry divisional director at Brewin Dolphin, says:

Given the asset base the two of you have and the requirements from your investments, your target income should be achievable. And because you hold a good deal of this in tax-efficient wrappers the income could be taken in a very tax-efficient manner.

You are a higher-rate taxpayer so any withdrawals taken from your Sipp will attract higher-rate tax which is unnecessary given the other assets you hold. As your wife is a non-tax payer and inheritance tax (IHT) is not a consideration, I would suggest taking withdrawals from her pension arrangements to use up some or all of her annual personal allowance of £11,500. But if IHT tax were to become a consideration for you both this would probably not be a good option, based on current legislation.

You are right to continue to subscribe to Isas each year and shelter more investments from tax. Based on the current value of the investments you do not have in Isas, it will take another three tax years to move the remaining investments into the Isas.

I agree with your preference for collectives as you will be reliant on the income produced from the investments to maintain your standard of living. The use of collectives such as open-ended investment companies and investment trusts not only spreads the risk of the capital falling but the income too.

Your cash balance is relatively high, especially if we add it to the NS&I holdings. You are right, however, to be nervous about adding fixed income investments at the moment as rising interest rates will have a negative impact on the capital value of your bond holdings. I would suggest holding your cash at current levels for the immediate future and reassess periodically – especially if gilt yields rise in the next few years. While this can be frustrating at current interest rates, the cash element will help balance the overall exposure to equities with the rest of the investments.

Stewart Sanderson, head of relationship management at Seven Investment Management, says: 

Your affairs are well organised, you are making use of the available tax wrappers – pensions and Isas – and you have accumulated excess cash. Your pension income is guaranteed by the UK government, which is as good as it gets, and you have enough funds to generate the additional income you require, so you are in good shape.

Make sure both your wills are up to date, and your expressions of wishes are complete for passing on the pensions. If you pass pensions on before you are 75 they are tax-free – even on drawdown. You could also give part of them to a charity free of tax.

I would consult a financial planner to ensure you have made use of the available pension and Isa allowances, including any carry forward available from previous years. Although annuity rates are currently poor, they may be sufficient to provide your requirements with limited risk. A planner could explain this as the death benefits of the various pensions may impact the income requirements for the survivor.

Your income requirements are relatively straightforward and do not require you to take much risk. Because of this, and because you do not need to plan for IHT, you are in the fortunate position of being able to spend some of your excess cash. You could even draw on your Isa to enjoy your retirement – I would be thinking of a holiday home in the sun if I were in your position!

HOW TO IMPROVE THE PORTFOLIO

Chris Dillow says:

The most obvious way to increase your equity exposure is to invest the £170,000 lump sum in a global equity tracker fund. You should think of it as a cheap fund of equity funds, and the default option for investing in equities.

The case for doing this might be especially strong for you, because your existing equity investments probably carry less general market risk than most people's. Some of them are focused on defensive stocks – Personal Assets Trust and Finsbury Growth & Income (FGT) have large holdings in defensives. And Scottish Mortgage Investment Trust (SMT) and Fundsmith Equity (GB00B41YBW71) come closer to being proper stockpickers than most funds, so are bets on their managers' ability to do this. Given such holdings, a global tracker might help spread equity risk.

Even if you want to keep a high cash weighting, I'm not sure you should do this in Sipps. Cash returns on these are generally awful. A better option might be to hold savings bonds of which the interest rates are a little better. As your wife has little other income she should do this to take advantage of her income tax allowance. 

As for how you should take income, remember that you have a capital gains tax (CGT) allowance and that you can create your own dividends simply by selling some of your investments each year. You do not need to invest in income stocks or to take taxed dividends.

Wayne Berry says:

The Isas, taxable account and your wife's pensions have a capital value of nearly £877,000. An income of £20,000 would equate to a yield of about 2.3 per cent on these, which is more than achievable.

This can be achieved via a few tweaks to the portfolio to increase the natural yield from the holdings to cover the income withdrawals. As most of the investments are in some form of tax wrapper – Isa or pension – whether the return comes from income or capital growth doesn't matter.

As you both have at least 25 years to plan for, exposure to emerging markets is advisable as this is where tomorrow's growth will largely come from. Your holdings in Scottish Mortgage Investment Trust and RIT Capital Partners (RCP) should also provide attractive compounding growth over that time. It is worth taking profits on these occasionally to 'lock in' some of the capital gains you have accumulated. I tell clients who have seen attractive capital growth that taking gains is a good discipline to have. Capital growth is meaningless until the investments are actually sold.

I suggest investing the cash in all the pension funds to generate some returns – even if Patrick's is not touched for now. Higher-yielding funds such as Man GLG UK Income (GB00B0117D35) and CF Miton UK Multi Cap Income (GB00B4M24M14) have impressive yields of over 4 per cent and good performance records over the longer term. Regarding overseas allocation, Artemis Global Income (GB00B5N99561) would complement the holdings in Scottish Mortgage Investment Trust and RIT Capital Partners.

Another area to consider adding to is infrastructure as this can offer attractive income and, in most cases, inflation-linked returns. We will always need infrastructure – even when robots and technology companies take over the world. Ways to add exposure to this area include HICL Infrastructure (HICL) and Legg Mason IF RARE Global Infrastructure Income (GB00BZ01WT03).

Stewart Sanderson says: 

Your Isa appears to be well diversified geographically. However, I would question the equity content given that you do not need to take much risk to achieve your objectives. Having said that, you have some stellar performers – Scottish Mortgage Investment Trust in particular. This trust offers exposure to unlisted investments otherwise unavailable to most investors, for example, Airbnb, Spotify and Grail where you are invested alongside Bill Gates, Jeff Bezos and Google, as well as top-performing listed companies such as Amazon (US:AMZN), Tesla (US:TSLA) and Ferrari (Ita:RACE).

Make sure you use your income, CGT and dividend allowances with your taxable investments, or by taking income from your wife's pension. To rebalance the portfolio I would reduce the risk of the Isas and invest cautiously in the Sipps. There is little value in fixed income, so choose managers with large allocations to fixed income alternatives such as market neutral funds.

If you do want a pot to 'play with' I would use your Sipp because you may not need to access this for some time, if at all.