VCTs don't offer IHT benefits

Paul has a buy-to let property worth around £375,000, which generates an income of £9,000 a year. He has an interest-only mortgage on it of £140,000, which he expects to eventually pay off using an inheritance.

Paul and his wife will be eligible for a full state pension at retirement age and their main home is worth about £725,000.

"I gave up full-time work to have more leisure time and I have had less incentive to work since I hit my pensions lifetime allowance two years ago," says Paul. "I have crystallised 25 per cent of my self-invested personal pension (Sipp) as a tax-free lump sum, which I have invested into my individual savings account (Isa).

"I want to grow the Isa, although may need to start drawing 3 per cent a year from it from mid 2019. I would like my income to be around £45,000 a year – just below the 40 per cent tax threshold.

"I would like my Sipp and venture capital trusts (VCTs) to grow indefinitely, given the inheritance tax (IHT) benefits of passing these on to my children.

"We need to do more to mitigate IHT, but also want to time when we help our children so that they strive hard to fulfil their own potential, and settle down with long-term committed partners. They have finished university and have varying degrees of student debt, although three of them are nearly financially independent. We want to help them to buy first homes, so I have earmarked £80,000 of my Isa to help my two repay their student loans, or at least cover the impact that debt is having on their incomes.

"My wife wants to crystallise a tax-free lump sum from her workplace additional voluntary contribution (AVC) pension, which is worth £120,000, and invest it in her Isa. She is considering moving a £90,000 with-profits fund and £30,000 discretionary fund into a Sipp with a wider choice of investments and lower costs.

"Although my wife lives comfortably on her income of £30,000 a year we are both considering taking up part-time jobs – paid or voluntary."

"I have been investing for 25 years and have a more adventurous attitude to risk than my wife. But I would be concerned if the value of our investments lost more than 25 per cent in any one year. 

"We are keen to protect against inflation so think that an appropriate asset allocation of our Sipps and Isas would be around 70 per cent equities, with the remaining 30 per cent in assets including bonds, property, private equity, commodities and infrastructure.

"I am cynical about the performance of many active funds. I think the long-term performance of many exchange traded funds (ETFs) are superior and I look to keep fund costs to a minimum. But I am happy to pay for top-notch performance and I want a low-maintenance portfolio that I can forget about 99 per cent of the time. I like the simplicity of mixed asset life strategy funds which have low charges. I have thought about re-balancing our portfolios more towards Vanguard LifeStrategy 80% Equity (GB00B4PQW151) or Vanguard LifeStrategy 60% Equity (GB00B3TYHH97).

"However I am not convinced that the long-term performance I could get from these would be as good as what I would get if a discretionary fund manager ran my portfolio. But I would have to pay a discretionary fund manager's yearly charges. 

Paul and Sue'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

Patrick Connolly, certified financial planner at Chase de Vere, says:

You are in a good financial position. But there are some inconsistencies in your approach, so you should speak with an independent financial adviser on your overall finances and tax planning.

You want to mitigate IHT but you have taken money from your pension, which isn't subject to IHT, and reinvested in Isas, which are subject to IHT.

You want to grow your VCT portfolio for the IHT benefits, but they don't provide any. Enterprise Investment Schemes (EIS) aren't liable to IHT if you hold them for at least two years, while VCTs offer other tax benefits, for example they could be used if you have hit the pension lifetime allowance. But they are high-risk.

Reconsider how you and your wife help your children. If they are trying to get onto the housing ladder maybe help to finance this. You have ring-fenced £80,000 to help your two children repay their student loans. But many people will never pay off these debts and have them written off in the future.

You and your wife should also make sure you have up-to-date wills.

Although some discretionary investment services are expensive there are competitively priced ones which could be ideal if you want a low-maintenance portfolio. Alternatively, consider an advisory investment service.

Jason Hollands, managing director at Tilney Investment Management Services, says:

When you start drawing your defined-benefit pension you will enjoy a decent household income from your final-salary pensions and property rental income. 

In a few years your incomes will be boosted by state pensions, but in the meantime you could work part-time to keep yourselves occupied and top up your incomes. Or you could draw the natural yield from your sizeable investment portfolios in tax-efficient structures.

Pensions are very tax-efficient from an IHT perspective, as residual pension assets can be passed onto your beneficiaries without giving rise to an IHT liability. However, VCTs will form part of your estate for IHT purposes, as will your investment properties and Isas. So you might want to exhaust these before you touch your Sipp. 

EIS companies qualify for business property relief after you have held them for two years, which exempts them from your estate for IHT purposes. However, EISs are considerably riskier than VCTs and do not generate tax-free dividends – a key attraction of VCTs. As you only invested in the VCTs two years ago you need to hold on to them, because if you dispose of VCT shares less than five years after you got them you have to pay back the 30 per cent income tax credits you received. But your VCTs are run by high-quality managers and the tax-free dividends should provide a boost to your income.

Although EISs can be useful you don't need to invest in esoteric tax schemes to reduce an IHT liability. The easiest way to do this is to make lifetime financial gifts as these are potentially exempt from IHT purposes if you live for at least seven years after making them. So helping your children clear their student debt or build up deposits for a property purchase is a sound move.

In terms of how to fund this, disposing of your investment property should be the priority. The net yield on the property is not particularly compelling and it is not very tax-efficient. As you may need to replace the income stream this provides with something else, perhaps a good time to do it would be when you start receiving the state pension. 

Ben Yearsley, director at Shore Financial Planning, says:

I'm a big fan of VCTs because they offer income tax relief, tax-free growth and tax-free dividends. However VCTs have raised a lot of money in the past few years that needs to be invested so, at present, I would exercise a degree of caution when making new VCT investments .

There are many Sipp providers to which your wife could transfer her AVC pension, including AJ Bell, Charles Stanley Direct and Hargreaves Lansdown. The costs of these providers and their investment choices aren't dissimilar to each other, so which one she opts for will largely come down to usability. Your wife will have to transfer her assets as cash and then choose investments.

You are in good position in terms of income, but IHT is a key concern for you. The new residential nil-rate band will protect some of your estate, but it may be tapered due to the value of your assets. Paul could switch his £373,000 Isa into an Alternative Investment Market (Aim) IHT scheme and after two years it should become IHT-free. However I wouldn't do this just now as a lot of money has been chasing IHT-eligible Aim shares and stretched their valuations.

And many other investments mitigate IHT and offer a reasonable return, which often have capital preservation as a key priority. These schemes are IHT-free after you have held them for two years, as long as you own them at the time of your death. Notable providers of these schemes include TIME Investments, Downing and Foresight. And you remain in control of these investments – they don't involve gifting money to your kids.

HOW TO IMPROVE THE PORTFOLIO

Patrick Connolly says:

Your suggested allocation of 70 per cent to equities and 30 per cent in a range of other assets within your investment portfolios seems reasonable considering your risk profile, especially as you have the security of final-salary pension schemes and investment properties.

Many active funds have mediocre performance so there is a strong argument for holding low-cost passive funds as part of an investment portfolio.

Your portfolio includes passive funds, broad-based equity and specialist funds, and a couple of direct shareholdings, which means it isn't low-maintenance.

You have over £220,000 in various Vanguard LifeStrategy funds. These low-cost passive portfolios, which invest in equities and fixed interest, can play an important role in long-term buy-and-hold portfolios. By holding other passive funds alongside these you are effectively making your own geographical asset allocation calls. 

But if you want to continue managing your own investments you should reduce the number of holdings. You could sell your specialist funds and individual shares, and focus on passive funds alongside some diversified funds run by good quality active managers for which the extra costs are more likely to be worth paying. If or when you need income, you could tailor your portfolio accordingly.

Jason Hollands says:

You want to draw 3 per cent income from your Isa from next year, a level that is perfectly achievable and would generate in excess of £11,000 a year tax-free income based on its current value. However, this will require a radical overhaul of your Isa, which is largely invested in low-yielding equity funds focused on growth stocks.

Your Isa is heavily exposed to equities compared with the typical multi-asset income and growth portfolio that a discretionary investment manager would probably construct for you. And it is aggressively overweight in US, Asian and emerging market equities. The high US exposure is partly due to the Vanguard index funds you hold and the actively managed global funds.

To achieve greater diversification, build an allocation to more defensive, absolute-return funds.

Your Isa has a strong bias to growth rather than value managers because you hold funds managed by Baillie Gifford and Lindsell Train. Although growth investing has worked well in recent years this has not been the case over the long term and, in time, I would expect value managers to do well. So you could take a more balanced approach by adding exposure to funds run by managers with a greater valuation discipline such as Jupiter Income (GB00BQXWPW10).

The bias to growth also means you have quite high exposure to tech, new media and biotech companies, of which the valuations look rich on most measures and could be vulnerable when this long bull market runs out of steam. 

If you rework your portfolio to generate a sensible income, it is likely that it will be more diversified across asset classes, have a less extreme style bias and a relatively higher allocation to UK equities. The UK remains the premier developed market for dividends.

Most of the funds you hold are decent, with the exception of Aberdeen Japan Equity (GB0004521737), which has not performed well. I would exit Templeton Emerging Markets Investment Trust (TEM) as its manager has recently left, and you both need to reduce your emerging market and Asia weightings. Also consider taking profits on Worldwide Healthcare Trust (WWH). Its longstanding manager has stepped down following sexual harassment allegations and it adds to your exposure to US growth stocks.

Ben Yearsley says:

You have a messy portfolio, and why have holdings that account for 1 per cent or less? If they are historic and you no longer have conviction in them, sell them. Or if you like them buy more. Your investments are held in tax-efficient wrappers so selling them won't incur capital gains tax.

Your allocation to cash and premium bonds is fine – you need a buffer.

A 70/30 split between equities and bonds in your Sipp and Isas seems sensible for a total return of about 5 per cent a year, and also if you are concerned about inflation and will have to rely on your investments for 30 years or more.

I will disagree that passive funds largely beat active funds, as over the long term a portfolio of quality active funds will outperform market indices. There are some exceptions, for example active managers find it hard to consistently outperform the US market. But we are moving into a phase when it is likely that the index will broadly stand still and some big sector rotations will give active managers an opportunity to make money.

I wouldn't passively invest in fixed interest. You have quite a bit invested in life strategy funds, but their passive bond element puts me off them. And why do you have three of these? You're just tripling up on your exposure.

You could hold one of these as a core holding across your accounts alongside smaller allocations to your more specialist funds.

Your investments, excluding your properties, VCTs and cash, come to about £1m, so if you want a 70/30 equity/bond split you could put around £750,000 into Vanguard LifeStrategy 60% Equity which would give you an exposure of about £300,000 to bonds. Your specialist equity holdings would bring your overall equity weighting up. I would ditch the other Vanguard Lifestrategy and broad passive funds.

Some of your active funds are good, including Baillie Gifford Japan Trust (BGFD), Legg Mason IF Japan Equity (GB00B8JYLC77), Fidelity Asia (GB00B6Y7NF43), Lindsell Train Global Equity (IE00B3NS4D25) and - one of my favourites - First State Global Listed Infrastructure (GB00B24HJL45).

But I would ditch Templeton Emerging Markets Investment Trust for Lazard Emerging Markets Fund (GB00B24F1G74). And I would ditch iShares Core MSCI EM IMI UCITS ETF (EMIM) as active funds are better in emerging markets.