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We want £40k income, a hassle-free portfolio and no IHT

Our experts help a reader to help his children and his spouse
September 26, 2019, Patrick Connolly and Hannah Owen

Ranbir is 80 and his wife is 73, and they both retired 20 years ago. They have three children, and three grandchildren aged six, 10 and 11 who are central to their financial planning. They own their home, which is worth about £270,000, and a buy-to-let property worth £380,000 on which there are no mortgages. Ranbir has been investing since 1967 when he put £103 into Unilever (ULVR).

Reader Portfolio
Ranbir and his wife 80 and 73
Description

Isas and trading accounts invested in funds and shares, residential property, cash

Objectives

Mitigate IHT, help children and grandchildren financially, £40,000 a year income, grow assets 3 per cent a year, replace buy-to-let income

Portfolio type
Inheritance planning

"Our pension income of £23,000 and rental income of £15,000 a year covers all our expenditure,” says Rabir. “We also receive dividend income of £21,000 a year from our investments, which we reinvest, and interest of £4,500. So our main objective is to mitigate our children and grandchildren’s eventual inheritance tax (IHT) bill by making gifts to family members, and giving 10 per cent of our assets to charity. I have avoided investing in enterprise investment schemes (EIS) for their IHT benefits because they are high-risk and illiquid. 

"We have already sold four buy-to-let properties and used the proceeds to help our children buy homes. We bought another buy-to-let property, which is held in the names of two of our children and the rental income goes into their managed personal pensions. 

"We opened child trust funds (CTFs) for our grandchildren when they were born. We also want to gift tax-efficient investments to one of our daughters who works from home as a child minder. We have bought her a larger home so that she can also foster children and hopefully come off tax credits as a result of getting a higher income. We also pay £240 a month into a pension for her.

"We want to generate an income for ourselves of £40,000 a year and grow our assets by 3 per cent a year.

"We plan to sell our buy-to-let property, which we let to students, because it is a hassle to manage, there are increasing expenses relating to this asset and the returns we make have fallen since the 1990s. So we need to replace the £15,000 a year income we get from this and thought of holding low-cost, stable equity funds instead.

"We have over £550,000 in individual savings accounts (Isas) and about £296,000 in a trading account. I and my wife hold about half of these each.

"We sold our home and moved to a smaller one, so have cash worth over £500,000 which we would like to invest. But we are reluctant to put money into the market because I think rising equity prices are not supported by economic fundamentals. I intend to wait until there is a major market correction, at which point I will invest this in exchange traded funds (ETFs). I avoid chasing the market and wait to buy a security until it seems to be at a sensible price.

"We are comfortable with losing up to 40 per cent of the value of our investments in any given year because we hold NS&I Premium Bonds and Index-linked Savings Certificates.

"I follow a buy-and-hold strategy, although sell investments on valuation grounds or if one does not perform well. I also sell unwrapped investments to make use of my capital gains tax (CGT) allowance. 

"I like investing in direct shareholdings because they do not have charges like collective funds and think this compensates for the greater risk. However, I am increasingly moving my assets into collective funds and keeping expenses down by using a low-cost investment platform and not trading frequently. 

"I aim to get exposure to a mixture of defensive and growth funds, and like income funds and stocks that grow their dividends. I have used both our full annual Isa allowances this year and am now considering investing in funds that would give us exposure to private equity, infrastructure and North American smaller companies. But, in view of our age, should I be considering fixed-income assets?

"I also wondered how to construct a simple, hassle-free portfolio of maybe 10 to 15 holdings that would be easy for my wife to start managing in about 10 years' time."

 

Ranbir and his wife's investment portfolio

HoldingValue (£)% of the portfolio
Fidelity Special Values (FSV)    280171.25
Finsbury Growth & Income Trust (FGT) 397451.78
JLEN Environmental Assets Group (JLEN)    281781.26
Mercantile Investment Trust (MRC)210060.94
Murray International Trust (MYI)   189000.85
RIT Capital Partners (RCP)381071.71
Troy Income & Growth Trust (TIGT)253591.14
Witan Investment Trust (WTAN)285601.28
Murray Income Trust (MUT)241701.08
Schroder AsiaPacific Fund (SDP)   280011.25
Standard Life Investments Property Income Trust (SLI)147950.66
Assura (AGR)151350.68
AstraZeneca (AZN)149650.67
Imperial Brands (IMB)210030.94
Lloyds Banking (LLOY)140190.63
Prudential (PRU)150080.67
JPMorgan Japan Smaller Companies Trust (JPS)120170.54
Unilever (ULVR)290021.3
Tritax Big Box REIT (BBOX)151200.68
National Grid (NG.)171130.77
Diageo (DGE)183090.82
Fundsmith Equity (GB00B41YBW71)361121.62
Liontrust Special Situations (GB00BG0J2688)181110.81
TB Evenlode Income (GB00BD0B7C49)220080.99
City of London Investment Trust (CTY)220030.99
Henderson Smaller Companies Investment Trust (HSL)116180.52
International Biotechnology Trust (IBT)153070.69
Polar Capital Technology Trust (PCT) 210090.94
Edinburgh Worldwide Investment Trust (EWI) 219170.98
Fidelity Asian Values (FAS) 127530.57
Jupiter European Opportunities Trust (JEO)219350.98
Ruffer Investment Company (RICA)103070.46
Scottish Mortgage Investment Trust (SMT)253081.13
RELX (REL)200090.9
Renishaw (RSW)111850.5
Vodafone (VOD)180290.81
GlaxoSmithKline (GSK)350861.57
HSBC (HSBA)280911.26
Royal Dutch Shell (RDSB)211180.95
NS&I Premium Bonds600002.69
NS&I Index-linked Savings Certificates30500013.66
Buy-to-let property38000017.01
Cash65015829.11
Total2233593 

 

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

 

THE BIG PICTURE

Chris Dillow, Investors Chronicle's economist, says:

You ask whether you should consider bonds at your age. I don’t think so. If you intend to leave a big bequest, age is irrelevant: your time horizons are in effect as long as your children’s. In fact, age might be irrelevant for portfolios even when this is not the case. Bonds can help to insure against the sorts of market fall caused by increased risk aversion or fear of recession. But this insurance is very expensive, and comes at the risk of losing money if we avoid recession and interest rates rise. Your holdings in cash and NS&I Index-linked Savings Certificates are probably just as good a way of diversifying equity risk.

You ask how to construct a hassle-free portfolio that your wife could manage easily in 10 years’ time. Such a portfolio would not include any direct shareholdings. Over the long term, even the best companies can be ruined by being on the wrong side of creative destruction or bad management – one ill-judged takeover can destroy a company. Simple long-term investment portfolios should be made up of ETFs that track major market indices, and perhaps one or two private equity investment trusts as it is likely that a lot of future growth will come from unquoted companies.

 

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

You seem to have plenty of scope to gift assets to your children and grandchildren, and reduce the IHT that your own and your wife’s estate may be subject to when you die. You are generating income that is considerably greater than your expenditure, allowing you to reinvest dividend income. And you also have investments and savings that you don't currently need to maintain your standard of living.

However, although you are keen to reduce a future IHT liability you need to ensure that your own requirements, now and in the future, are fully covered. For example, it could be that your expenditure will increase significantly if one or both of you has to go into care.

You have a number of options available to you, so if you are not sure what to do you should get independent financial advice.

[You can find independent financial advisers at unbiased.co.uk.]

You and your wife are able to pass assets to each other while you are both alive or when one of you dies without incurring IHT – no matter how much you pass to each other. You each benefit from a nil-rate band, currently £325,000, and can pass on assets up to that amount on which IHT won’t be charged. The survivor of a marriage or civil partnership can claim up to 100 per cent of their partner’s nil-rate band, assuming it wasn’t used on the first death, potentially giving them an allowance of up to £650,000.

The residence nil-rate band is a further allowance for those who pass on a residence to direct descendants such as children or grandchildren. This allowance currently stands at £150,000 per person and will rise to £175,000 per person from April 2020. If unused, the allowance can be transferred to a spouse or civil partner when you die. This means that you and your wife, between you, could potentially pass on assets of up to £1m from 2020 without incurring IHT.

However, if the net value of your estate is above £2m the additional main residence nil-rate band is tapered away by £1 for every £2 that the net value exceeds that amount. This might be an issue when the second of you dies.

Giving away assets while you are alive is a simple way for you both to reduce the size of your estates for IHT. You can gift up to £3,000 a year each and this is immediately exempt from IHT, or £6,000 each if you did not make a gift of this kind in the previous tax year. So a married couple making gifts for the first time could hand over £12,000 to their children in one year. After that, the maximum for a couple is £6,000 each year.

You can also give £250 to any number of people every year, but cannot combine it with their annual £3,000 exemption. Parents can give £5,000 to each of their children as a gift for a wedding or civil partnership, grandparents can give £2,500 and everyone else £1,000. But these are small amounts, relative to your assets.

However, you have more income than you need to maintain your standard of living, so could take advantage of the normal expenditure out of income exemption, under which qualifying gifts immediately fall outside the transferor’s estate for IHT purposes. To qualify, gifts must be made out of your normal expenditure and be out of income, and you and your wife must be left with sufficient income to maintain your usual standard of living. For you, pensions, rental income, dividends and interest would qualify as income. This exemption would allow you to, for example, increase regular contributions into your grandchildren’s CTFs or make additional pension payments for your children.

You and your wife could also make further gifts known as potentially exempt transfers (PETs). It seems as though you have already done this by helping your children to buy homes. For these gifts to be free of IHT you need to survive seven years after making them. If you die within seven years of making a PET, and the total PETs you make are less than £325,000, the value gifted will reduce your nil-rate band, but those receiving these gifts won’t be liable for tax.

If you make PETs in excess of £325,000 those receiving the gifts could have to pay IHT, although the amount payable reduces on a sliding scale if your death occurs between three and seven years after you made the gift.

You can give away most assets including cash and shares. However, it has to be an outright gift from which you can no longer benefit. So, for example, you can't give away your family home and continue to live there unless you are paying a market rent.

You and your wife need to ensure that you have valid wills so that your assets are passed on as you wish. You can also use wills to help pass on assets tax efficiently. It is important to review your wills regularly and update them if your circumstances change, for example if you have more grandchildren or change your mind about who you want to leave assets to.

You can also use wills to leave legacies to charities. Gifts to registered charities are exempt from IHT, and if you leave 10 per cent of the value of your estate, after the nil-rate band has been taken into account, to a qualifying charity any tax due may be at a reduced rate of 36 per cent rather than 40 per cent.  

You may also be able to mitigate IHT via trust arrangements, business property relief schemes such as the Enterprise Investment Scheme (EIS) or Aim shares, or a life assurance policy to pay any prospective tax bill. However, life assurance is expensive for older people. 

You and your wife want a total income of £40,000 a year. You have pension income of £23,000 a year so require a further £17,000 to replace rental income when you have sold your buy-to-let property. 

You have investment Isas worth about £550,000, trading accounts worth about about £300,000, cash and NS&I products worth about £400,000, and around £380,000 if you sell your buy-to-let property. This gives you ample scope to generate income of about £17,000, which is only 1 per cent of these assets, and potentially more, for example to give IHT-free gifts to your children and grandchildren.

It is very sensible to invest the maximum annual allowance into Isas and you should continue to do this every tax year. A big advantage of Isas is that they provide tax-free returns. So consider holding more income-generating assets inside Isas and more growth assets in accounts that may be subject to tax, such as trading accounts. You could then use your own and your wife’s annual CGT allowance to sell assets tax efficiently out of your trading accounts, and reinvest the proceeds in Isas.

Your Isas are worth around £550,000, so to generate £17,000 a year you would need a yield of 3.1 per cent, which may be just about achievable even without your other assets. You and your wife can also take advantage of the £2,000 annual dividend allowance and £1,000 annual personal savings allowance to generate more tax-efficient income.

With careful planning, and by holding assets in both your own and your wife’s names, you should be able to ensure that neither of you becomes a higher-rate income tax payer.

 

Hannah Owen, financial planner at Quilter Private Client Advisers, says:

In the next tax year, the main residence nil-rate band will increase, so together with your IHT allowances, you should be able to leave £1,000,000 to your direct descendants free of IHT, as long as your direct descendants inherit at least £350,000 of your main residence. If you want to take advantage of this, make sure it is set out in your wills.

If you leave 10 per cent of your estate value over and above your IHT allowances to charity, it will decrease the rate of IHT payable on your estate from 40 to 36 per cent. By doing this, less of your estate will go to your heirs, but if you are planning to leave money to charity anyway it will reduce their IHT bill. Anything left to charity in your will does not count towards the total taxable value of your estate.

You can give away £3,000 each year without it being potentially liable to IHT. You can also gift £250 per year per person, as long as you haven’t used up another exemption on them. And any gift made from normal income will not be counted for IHT purposes.

You can make gifts over and above this – potentially exempt transfers – which are not subject to IHT if you survive seven years after making the gift. If you die within seven years of making the gift it may still benefit from taper relief, meaning that the IHT payable on it might be reduced.

If you gift income, or an income-producing asset to your daughter who is receiving tax credits, this is likely to affect them. Also, tax credits are soon likely to be replaced by universal credit, and capital and savings are treated as though they will provide an income for universal credit purposes. So bear this in mind if you’re considering gifting capital. However, everyone’s individual circumstances are different, so it is hard to say exactly what effect this will have without knowing the full details.

While your daughter is not earning any relevant income you cannot contribute more to her pension. But if she starts to earn more and come off tax credits there are fewer limits on how you can help her financially. Also be aware that your children cannot access their pensions until at least age 55.

You can put assets into trust for your children and grandchildren, meaning you can have control over when they are able to access the capital or income. You should speak to a trust specialist to explore this further.

Although you can no longer open a CTF you can continue to contribute up to £4,368 a year to existing ones. This can be split over monthly payments, if the provider allows. However, you are likely to be able to find Junior Isas with more competitive charges and greater choice of funds than a CTF. CTFs can be converted into junior Isas, which allow regular or one-off contributions, up to a maximum of £4,368 per year. If you look into this, check to see if there are any exit penalties with your grandchildren's CTFs that might negate the benefit.

You are switching some of your direct shareholdings into funds. Consider funds run by a manager who will tailor the asset allocation of the fund for decumulation.

If you wish to continue to hold direct shareholdings but are concerned about whether you will be able to continue managing them, consider appointing a discretionary fund manager. They would discuss with you what shares to hold and create a portfolio that is suitable for your needs, so in your case that would provide an income. 

 

HOW TO IMPROVE THE PORTFOLIO

Chris Dillow says:

The asset allocation of your current portfolio seems reasonable for now. It has a clear theme – a preference for large defensives. These account for a large part of your direct shareholdings, and substantial parts of the holdings of funds such as Finsbury Growth & Income Trust (FGT) and Troy Income & Growth Trust (TIGT).

If history is any guide, this choice is right. But is it a guide? My fear is that investors might now or soon wise up to the fact that companies with sources of monopoly power such as strong brands or big capital requirements are underpriced. So they might eliminate that underpricing, implying lower returns in future.

But even if this is the case such stocks still have a role in your portfolio. They expose fund managers to the risk that they will underperform a strong bull market: if equities do really well, companies such as Royal Dutch Shell (RDSB) or Diageo (DGE) will probably lag behind. This risk means that many funds are underweight such shares. Other investors, meanwhile, are seduced by growth stocks so avoid dull ones. This means that defensives are underpriced so that those of you that are brave enough to hold them should make good returns. I’d stick with this strategy but not expect such great returns going forward as you’ve had in the past.

But don't wait for a correction to buy as we might not get one. The above-average yield of the FTSE All-Share index and substantial foreign purchases of US equities suggest that investors are discounting a lot of bad news. And US share prices are not high in light of the good performance of that country's economy, as indicated by low inflation and unemployment.

Also, the likeliest cause of a correction would be a recession, which would make you feel uncomfortable about buying. I would instead follow the 10-month or 200-day moving average rule: top up equities when their prices are above this average and reduce them when they are below it.

 

Patrick Connolly says:

You take a buy-and-hold strategy, and ignore short-term market noise, which is absolutely the right thing to do. However, you have 24 holdings in your Isas and 15 in your trading accounts. This is too many to hold in the longer term as you get older, and for a hassle-free portfolio that would be easy for your wife to manage.

You are comfortable with downside risk of 40 per cent, but there is no reason for you to take such high risk. You can generate a steady income, achieve tax efficiency and make gifts to your children and grandchildren with a balanced and diversified portfolio.

You are mindful of charges, so should consider getting broad exposure to global stock markets through passive investment funds such as open-ended trackers or ETFs. These would provide much better diversification than a portfolio of direct shareholdings. Alongside these you could continue to hold some of your good quality, broad-based funds such as Witan Investment Trust (WTAN) and Scottish Mortgage Investment Trust (SMT).

To generate income from your Isas, look to hold equity income, global equity income and fixed-interest funds. The addition of fixed interest can provide an extra level of diversification and a steady income stream. Funds to consider include Finsbury Growth & Income Trust, BMO Capital & Income Investment Trust (BCI), Murray Income Trust (MUT), Murray International Trust (MYI), Schroder Income Maximiser (GB00BDD2F083), Fidelity Global Dividend (GB00B7778087), Rathbone Ethical Bond (GB00B7FQJT36) and Jupiter Strategic Bond (GB00B544HM32).

Consider other asset classes for further diversification, such as commercial property and infrastructure. However, commercial property might face challenging times, depending on the UK economy and how Brexit plays out.

You could hold more growth-focused holdings in your trading accounts, including some higher-risk areas such as Asia and emerging markets. You could take profits on these each year using your own and your wife’s CGT exemption, and reinvest up to £40,000 of the proceeds into Isa, which could be used to generate extra income, if required.

Subject to CGT considerations, consider selling your direct shareholdings to make your portfolio more diversified, lower risk and easier and less time-consuming to manage.

You should also retain a significant allocation to cash. Although this is unlikely to give the best long-term returns, it will provide a safety net for your finances, and there may be buying opportunities if markets fall.