My wife and I have been retired for five years. We have modest pensions and additional income comes from the amount of money I have on deposit. Recently, I have seen the income generated reduce significantly as interest rates fall.
I understand that I need to accept a degree of risk to generate a higher income. We have used both our Isa allowances for the year in corporate bonds. I am prepared to move £50,000 out of the money I have on deposit but would like our capital to be protected if possible. I am a basic-rate taxpayer and my wife does not currently pay tax. What do you recommend?
There are a number of issues to consider. Most important, you need to understand fully the move from completely safe deposit accounts to investments that, while able to provide a greater income, cannot guarantee a return of all your capital investment. You should also take into account any tax implications that the new investments may create.
It is sensible that you are not prepared to commit all the capital you have on deposit to riskier investments as the watchword for all your investments so far has been safety.
Tax planning will be key to your new strategy as you want to minimise the amount of tax you pay on investment income. You have sensibly used your Isa allowances for this year in investments that match your risk profile. Unfortunately, this means there will be tax issues to address for the new addition to your portfolio.
Considering your tax position, I would strongly suggest you look at investing in an offshore income bond. It would be advantageous to establish this in your wife's name to take advantage of her currently unused tax allowances. These bonds run for a set period of time, typically between one and five years. In some cases, the income level is fixed throughout while the capital return is linked to an investment fund.
As you want a degree of capital protection, you should check the small print of some of the products on the market. Recently, the general format has been that capital will be returned in full but only if the index does not at any time fall by more than a set percentage. In such an instance, the capital return will be reduced according to a pre-set formula.
In many instances, this potential for a negative return is the flip side from the high income offered by the bonds. Bonds that use a formula to calculate the capital return are by no means all low-risk investments and the variety comes from the back-testing that the bond provider has performed before selling the bond.
Back-testing helps structured fund providers calculate their own and, therefore, investors' exposure to risk. If done correctly, all possible permutations using real data from the relevant stocks are tried to ensure predictions are based on realistic and reliable evidence. The more rigorous the back-testing, the more secure you can feel. If a company has done its sums correctly, it and the investor should feel confident about the capital return.
In general, when selecting an income bond, there are four main factors to consider:
Degree of capital protection.
There are a number of products that combine the degree of capital protection you require with a reasonable level of income. There are two factors you need to be careful of – the volatility of the index that makes up the underlying fund and the number of shares that are monitored to determine the amount of capital return.
The table shows a selection of typical protected income bonds in the marketplace. Considering your tax position, I would suggest you look at an offshore income bond. It would be advantageous to establish this in your wife's name to take advantage of her unused tax allowances as this would allow all the income to be tax-free.