Monday, January 7, 2019






We want to give some of our wealth to our children now so they won't pay inheritance tax but we still need an income for 20 years - can we do both?

In our Money Pit Stop series, we ask an investing expert to give This is Money readers a free portfolio makeover.
Steve is 60, recently retired and lives with his wife in Redcar, North Yorkshire. 
The couple want to enjoy their retirement and plan to travel quite a bit. 
They'd also like to pass on some of their wealth to their three children before they go but still need to generate a good income to support them for the next 20 years or so. 
The couple live in Redcar, Yorkshire (left) and hope to visit their son in Australia (right)
The couple live in Redcar, Yorkshire (left) and hope to visit their son in Australia (right)
They have £350,000 invested in shares, £50,000 of which is held in an Isa, and £800,000 of savings. They own their home, which is worth £260,000.
Steve has a self-invested pension worth £692,000, a large proportion of which is currently in cash and which he is looking to invest. 
He will be able to claim his full state pension from 2024 on the basis he continues to pay national insurance contributions until then.
His wife will have a pension income of £5,000 a year from 2019 and becomes eligible for her full state pension in 2025.  
How much can they safely give to their children without compromising their standard of living? 
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Steve's savings and investments 

Risk appetite: Low to medium
Time horizon: 20 years or so
Shares: £350,000 invested in company shares: Dignity, Greggs, Shell, Aviva, BHP, Rio Tinto, SSE, Wimpy, Elementis, Empiric student property, Babcock, BT, HSBC, Johnson Mathey, Rentokil, Tesco, Morrisions, Standard Life & Senior Engineering
Investment trusts and ETFs: None
Cash: £800,000
Properties: Own main residence which is worth £260,000
Premium bonds: None

David Cabrera, consultant and financial planner at BBT Group - a retirement planning company, writes: The first goal Steve will have is to generate retirement income that provides a good standard of living. 
To achieve this Steve and his wife will need to establish what their regular monthly expenditure is. 
They shouldn’t just include monthly standing orders and direct debits, also remember to add groceries, petrol, socialising, charitable donations and other regular outgoings and add a small buffer for incidentals like coffees, window cleaners and miscellaneous items. 
This total then needs to be compared against the regular annual income which in this case seems to be £5,000 from 2019. This won’t be taxed because from 6 April 2019 we can each earn £12,500 before tax.
Assuming their regular monthly expenditure is somewhere in the region of £3,000 a month, then next year Steve and his wife could need just over £30,000 after tax to cover the income shortfall, less if they work part-time. 

What should they do with their existing shares? 

With shares valued at approximately £300,000 held outside Isas and a further £50,000 held within the Isa and the FTSE All-Share yield averaging 3.53 per cent a year over the past five years, if the shares they hold match the yield, they should be receiving in the region of £12,300 in dividends each year. 
The dividends held within the Isa aren’t subject to tax, whilst the balance will be.
Tax on the dividends will depend on who owns them. We can each earn £2,000 a year in dividend income before we pay tax. 
If Steve has no other source earnings he will not pay any tax on his dividends. However, if the shares outside the Isa are all owned by his wife, then because she will have £5,000 in pension income, she could pay about £80 in tax.
If nothing were done with the shares, the tax bill will go up when she receives her state pension because she will have more taxable income.
Directly held shares can be very high risk investments 
It often makes sense for a married couple or civil partners to transfer shares between them as this can allow you to reduce income tax and then capital gains tax liabilities when they are sold. But remember only transfers of shares between spouses and civil partners are exempt from capital gains taxes. Nobody else benefits from this.
Steve and his wife also need to consider if they should retain some or all of the shares. Directly held shares can be very high risk investments. 
In the 12 months to 14 December 2018 only two of the 19 shares held increased in value by more than 5 per cent. 
Meanwhile, 16 shares lost money and some of the losses were very significant. 
Dignity lost 60 per cent in value, Aberdeen Standard Life were down some 50 per cent and Taylor Wimpey and Elementis both lost about 33 per cent each. 
Even Aviva shares fell about 25 per cent. Therefore, you need to ask yourself if holding a large share portfolio is sensible when you want a below average level of risk and you are retired with guaranteed pension incomes that won’t meet regular monthly expenditure? 

How should they create an income? 

My advice to meet much of the monthly income shortfall would be to sell shares each year using their capital gains tax allowances which are £11,700 per person in the current tax year increasing to £12,000 from next April. 
In the 12 months to 14 December 2018 only two of the 19 shares held increased in value by more than 5 per cent
In the 12 months to 14 December 2018 only two of the 19 shares held increased in value by more than 5 per cent
If this is not enough, it could be topped up from the £800,000 cash deposits. If some of the shares held were bought recently, there could be losses which can be offset against other gains and used to increase the overall amount of shares sold in the current tax year.
A good stock broker will be able to construct a share disposal plan. They might also be able to reduce the degree of investment risk by giving you more exposure to FTSE 100 companies. 
As a rule they tend to be less volatile and also more global in nature. 
Nobody really knows how Brexit will unfold, but this more defensive approach will be less risky and could potentially reduce the effects of a no deal Brexit which will be felt most by UK-centric companies.
With an income shortfall of possibly £30,000 next year and the first state pension not due until 2024, Steve and his wife could need £160,000 to £170,000 in share disposals over the next five years when you allow for personal inflation of possibly 3 per cent a year. 
As a rule, older age groups tend to have higher rates of inflation than the under 35s so this should be considered as part of a financial plan.

What should Steve do with his pension? 

Steve has a pension fund valued at £692,000 and between them they have £800,000 in the bank. This balance is far too high for the vast majority of situations and will be earning interest rates below inflation, more on this follows later.
Steve would be wrongly advised to draw on his pension with all the associated tax benefits with so much cash in the bank. Whilst the pension fund remains invested it should normally increase in value over the medium to longer term (five to 10 years plus) and thus increase the size of the 25 per cent tax free cash, but this can never be guaranteed. 
Furthermore, whilst the money remains in the pension fund, it is exempt from inheritance tax which is why I would advise him to keep the pot untouched for as long as possible, instead using the more volatile share portfolio and cash to fund retirement income and capital until they have been nearly exhausted.
Steve should also complete an Expression of Wishes. This allows him to pass on any unused pension fund to his wife should she survive him. He can also specify that his sons can inherit the pension fund if his wife does not need it all. 
These transfers are exempt from inheritance tax and if the pension fund holder dies before age 75 they are often tax free. 
If Steve dies after his 75th birthday then it might well be that his sons inherit a pension fund which could be part of their own pension provision and potentially subject to income tax at their marginal rates.

What should they do with their cash savings? 

In the immediate term they will need advice on how to best invest surplus cash deposits to meet their aims, objectives and attitude to risk. 
Many firms of financial advisers have model investment portfolios available which allow clients to invest into a series of funds managed by a wide range of leading fund management groups. 
These are usually reviewed and rebalanced on a quarterly basis to maintain the appropriate risk level and take into account the prevailing investment climate. 
They tend to produce returns which comfortably outstrip inflation rates over the medium to long term. 
For example our BBT Portfolio 5 which has a low medium risk rate has over the past five years returned approximately 33 per cent. 
In the same period inflation as measured by the Retail Price Index was 12.5 per cent and the FTSE 100 with dividends reinvested produced 25 per cent. 
Therefore you can invest with some caution and still have returns which perform well when compared to just investing in shares.
Everybody needs an emergency fund which is usually about three month’s income in cash
Everybody needs an emergency fund which is usually about three month’s income in cash

How much cash should they keep? 

They have about £800,000 in bank and building society savings. Whilst term accounts from high street banks like the Post Office are currently paying 1.90 per cent for a one-year bond or 2.1 per cent for a five-year bond with the Coventry Building Society, inflation as measured by the RPI was 3.3 per cent in October 2018. 
Instant access accounts will earn less interest. So over the long term the real value of money on deposit will usually buy you less, which is why you never hold excess funds in the bank because it leads to less financial security in the longer term.
If you are reasonably cautious and in retirement, then keep on deposit the monies you are going to need in the first five years and then look at investments to generate growth above inflation from monies that you require for the medium and longer term. 
Everybody needs an emergency fund which is usually about three month’s income. In this case I would recommend they hold £10,000 in an instant access account directly linked to their current account for this purpose.
Steve and his wife plan to travel to Australia to visit their son in the next few years
Steve and his wife plan to travel to Australia to visit their son in the next few years
Beyond this Steve and his wife should gauge what they will be spending in the first five years of retirement which they can’t fund from pension income and share disposals. 
Based on outline travel plans - two to three holidays a year plus a visit to Australia - they may need £200,000 and they need to consider if any savings will be needed for home improvements and a new car before 2024. 
These balances should remain in bank or building society accounts, some of which could be held in fixed term bonds as they pay marginally more interest. 
However they should not hold more than £85,000 per person per authorised institution and thus exceed Financial Services Compensation Scheme limits. 
For example HSBC and First Direct are authorised under the same licence and therefore you are limited to £85,000 combined across both banks. 
They could hold up to £50,000 each in Premium Bonds where the winnings are tax free and the pay rate is 1.40 per cent. 
NS&I requires eight working days to cash them in so they are accessible.
Depending on their actual spending plans, they could have approximately £550,000 in cash earning less than inflation. 
In the current investment climate with high levels of uncertainty and markets falling, they might be best advised to stage their investments over a period of months as this reduces exposure to falling markets when investing a lump sum. 
By investing in staged intervals more shares are bought when share prices are low and fewer shares are purchased when prices are high and so they would be better off.
Stocks and shares Isas are a useful starting point for investments. In the current tax year and the next one too, we each have a £20,000 annual allowance which means that Steve and his wife could have £80,000 invested into Isas within a few months. 
If they were to invest more than £80,000 between them, in future tax years they could use their annual Isa allowances by switching non-Isa investments into Isas and benefit from the tax-free environment the monies would be held in. 

Can they give some money to their children now?  

If Steve and his wife want to leave their estate including their main residence to their direct descendants then they can leave jointly £900,000 before inheritance tax is paid. 
This will rise to £950,000 in April 2019 and £1,000,000 in April 2020. 
Those couples who do not have children or grand children or are using discretionary will trusts which include their main residence can only leave £650,000 before inheritance tax is paid.  
If your estate is above these figures you pay 40 per cent tax on the excess. 
Like everyone they should ensure that they have valid and up-to-date wills and if they are yet to do so, they should be granting each other and probably their sons too, lasting powers of attorney
Like everyone they should ensure that they have valid and up-to-date wills and if they are yet to do so, they should be granting each other and probably their sons too, lasting powers of attorney
Steve and his wife have £800,000 in the bank, £350,000 in shares and a house worth £260,000. By the time you add personal effects the total estate could be £1,425,000 meaning their sons have to pay £210,000 in death duties.
In a situation like this they might want to consider gifting monies to their sons. 
We each have a £3,000 annual gift exemption. So Steve and his wife could each gift £3,000 by 5 April 2019 and if they didn’t do so in tax year 2017/18 they can go back one year and also use last year’s allowance. 
So in total they can gift £12,000 in the coming weeks. 
On 6 April 2019 they can each make a further gift of £3,000 bringing the total up to £18,000. These gifts fall outside the estate immediately. 
In addition they can gift further sums to their three sons which will not be subject to inheritance tax providing they survive for seven years after the gift date.

LASTING POWERS OF ATTORNEY 

There are two separate LPAs, one deals with property and finances and the other health and well-being. Without a lasting power of attorney you can do very little for your spouse or parent. 
For example if Steve were unable to drive, his wife or sons could not cancel his car insurance or sell the car without asking the Office of the Public Guardian for prior approval. 
This can mean a lengthy delay and paying the court a fee. No estate agent will allow you to sell a parent’s property to pay for care fees for example, without seeing the court-stamped LPA. 
Just as the care home would need to see both court-stamped LPAs before they could accept the family member as a resident. All financial services providers have similar requirements. 
Apart from gifting they should also take advice on broader trust planning vehicles to reduce the current inheritance tax liability. 
Trusts serve to remove assets from the estate and can provide income or access to capital depending on the specific trust used. Independent financial advice is essential in these situations.
And like everyone they should ensure that they have valid and up-to-date wills and if they are yet to do so, they should be granting each other and probably their sons too, lasting powers of attorney.
If one of them loses capacity in the future, those who they nominate in advance can manage their affairs for them. 
If Steve and his wife do not have up-to-date wills or have not granted lasting powers of attorney, they should either see an appropriate solicitor or discuss this with a financial planner, as many have good working relationships with firms that specialise in this area of law.
In summary, Steve and his wife should sit down with an independent financial planner for two to three hours and go through all these points to establish what might be most suitable for them. 
Most advisers will not charge for these meetings and many do not charge for producing a suitability report that contains the financial planning recommendations they believe you should seriously consider. 
The information provided by our expert is for the purposes of this article and is not personal advice.
If you are at all unsure of the suitability of an investment for your circumstances please seek advice.
Nothing in this response constitutes regulated financial advice. Published questions are sometimes edited for brevity or other reasons.

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