Mrs W is in her late 60s, a widow with no dependent children. She has been retired for some years and her only income comes from her state pension and her investments. She has money in a building society account, on which she has suffered a severe drop in interest, and a share portfolio which is not yielding a high amount.
Like many people in her situation, she is asset-rich but income-poor. She is determined to live life to the full while she can, so is looking for a higher, more stable level of income, with a mix of medium- and low-risk investments.
Although there is a potential inheritance tax liability on Mrs W's estate, she is not concerned to offset the liability as her prime focus is on increasing her income.
As regards her share portfolio, I suggest that she could cash in a portion of this each year, within her capital gains tax allowance, to reinvest for a greater yield. Meanwhile, having set aside an emergency fund of £17,000, which I advise her to leave in the building society account, she has some £215,000 to invest.
As her income has fallen, she has already had to dip into capital to cover her expenditure. Since she has no opportunity to acquire further capital in the future, she wants to preserve what she has left as far as possible to underpin her future income. Although current income is a priority, it is important to keep an eye on the capital value as well.
My first step is to recommend a temporary annuity. This will provide the higher, stable income that she is looking for and also tax-efficiency since only the interest part of the annuity payment attracts income tax. I suggest that around £100,000 is invested into a six-year annuity with Standard Life, which has been chosen on a rate basis.
Of course, at the end of the term, the annuity income will cease and the original capital will have gone, so the next step is to look to replace the capital through a growth investment. For this, I recommend a number of second-hand endowment policies to the value of some £90,000.
The annuity will produce more income than Mrs W requires, so she has money to spare to fund the ongoing premiums on the policies. Although the growth rate cannot be guaranteed, at a conservative estimate they will produce enough to cover their own purchase cost and the capital spent on the annuity. This means that, in six years' time, Mrs W will have roughly the same capital as at present, having enjoyed a bigger – and guaranteed – income in the meantime.
The secondhand endowments have the benefit of being low risk, with much of the value locked in already, and there are also tax advantages. I have chosen a selection of plans that mature in consecutive tax years. They are also mixed between qualifying and non-qualifying policies.
Qualifying policies attract no income tax, being subject to capital gains tax on the gain at maturity. Non-qualifying policies, on the other hand, are subject to income tax on any gain but only for higher-rate taxpayers, subject to top-slicing relief. So, by choosing a mix of policies with different maturity dates, we can use Mrs W's tax allowances to minimise any liability and therefore maximise her capital growth.
For the remainder of Mrs W's capital, I recommend an Isa and an offshore bond, both of which offer tax-efficient growth. For the Isa, I suggest Threadneedle's European select growth fund, which is a medium-risk investment aiming for above-average, long-term growth. The bond I recommend is Clerical Medical's flexible with-profits bond, which can be tailored to provide growth or income, giving Mrs Wthe option to switch between the two in future years.
A final move is to use some money encashed from the share portfolio for an immediately-vesting stakeholder plan. A contribution of £3,600 provides £900 tax-free cash plus an annuity based on the remaining £2,700. The net cost, after tax relief and the tax-free cash, is just £1,908, meaning the annuity return is worth around 9 per cent of the investment – an excellent boost to income.
In summary, then, the recommendations will provide Mrs W with:
A significant increase in her current income.
A six-year plan to return her capital back to its existing level.
The opportunity to use her income and capital gains tax allowances to the full.