IHT & Investment issues

Aussie_Bird_2

Following the death of my father-in-law (un-expected), I have been assisting my Mother-in-law with sorting the finances.

Due to ignorance both of the impact and the complete financial situation we didn't take the IHT trust out of the estate before everything passed to her ownership (oops). But no use crying over spilt milk...

Her estate is now substantial, but having struggled to make ends meet as a child, and not being aware of the financial security until her husbands death she is reluctant to disperse assets.

We have spoken to a financial adviser that her husband previously used, and although the products he presents are decent, they earn him substantial commission on an ongoing basis, which frustrates me.

We have used up current ISA benefits and will take advantage of each tax year’s allowances.

She has now started to "gift" money to her children. In the anticipation that she survives longer than 7 years.

Some of the money is generating an income which she is obviously reluctant loose. A sum of money has been moved into Trusts to be distributed between her children after her death etc.

After a long background I have a couple of specific questions:-

1. Are there any tricks we are missing to reduce IHT liability
2. Following the maturity of some bonds we now have £200k to invest and would like to obtain a 5% income from (current option estimates 6% so 1% capital growth) - 5+ years investment duration with option for early withdrawal

I haven't put a lot of specifics re £ on purpose, if you have any suggestions but these are dependant on more detailed understanding please PM me and I will discuss as appropriate.

Thanks in advance to all who help....

dunstonh

We have spoken to a financial adviser that her husband previously used, and although the products he presents are decent, they earn him substantial commission on an ongoing basis, which frustrates me.

Well don't pay him the substantial amount but pay Gordon Brown even more when the time comes.

Don't look at what the advisor gets paid. In many cases, the illustrations are not accurate and it is all gross. This really can distort the figures. If you honestly think that all the money shown by the IFA goes in his pocket, then you are very mistaken. For example, my costs came to over £80,000 last year.

If you look at a retailer, and just assumed that his turnover was the income, you would think they are raking it in. In reality, the profit margin will be far far lower. Often around the 10-20% of the turnover. Your IFA could be only seeing 20% of that figure shown on that illustration.

You sought advice, it's an area that really does need advice on larger estates yet you are not willing to pay for the advice, even though it would save far more money in the long term.

If after all that, you still think that the advice is expensive, go down the fee route instead or find another IFA who can do it cheaper, if you think you can. You could compare the charges to the market averages which you would have been supplied with.

Aussie_Bird_2

dunstonh

Thank you for your comments, I dont have an issue with paying someone for their services. I agree its better than paying Gordon Browne.

My main purpose of the post was to see if we are missing any tricks, that people are aware of.

With regards to the re-investment we have been given one product to look at but I'm sure there must be alternatives. At an estimated 6% return (4.9% after fees deducted) it doesn't seem any better than a standard savings account. So I was interested if any other money savers knew of anything else...

EdInvestor

You might like to look at a High Yield Portfolio for part of the money. This takes advantage of the fact that dividend income is tax free to people on basic rate.This is a DIY idea which is quite similar to the Equity Income fund concept, but you pay effectively no charges if you set it up with a no annual charge online broker, because virtually no trading is involved.

It's a portfolio of 15 diversified blue chip shares with high yields but also built in risk adjustment factors.The overall yield obtainable now is 5%, without accessing the capital. Capital growth in the last few years has been excellent (in the 15-20% range), and long term it seems an annualised overall double digit return is quite feasible.The portfolio proved very resilient in the last downturn (as did Equity Income funds)and the income is very stable. It's a buy and forget investment suitable for oldies who are willing to take equity risk ( as found in investment bonds).

Commercial property funds and trusts are lower risk and generate a yield of between 5 and 7% plus capital growth, which has lately been very high but will probably settle at around 3% one of these days :)They can now be put in an ISA.

The two make a good match IMHO.

dunstonh

With regards to the re-investment we have been given one product to look at but I'm sure there must be alternatives. At an estimated 6% return (4.9% after fees deducted) it doesn't seem any better than a standard savings account. So I was interested if any other money savers knew of anything else...

You are mis-reading the example. 6% is a required figure to be given on all non-tax free investments. It doesnt mean it will grow at 6%. It could be higher, it could be lower. I am just about to visit a client who has a number of investment bonds over the last 7 years and all are performing in excess of 10%p.a. (after charges).

Also, be wary not to mix up implicit and explicit charges. You have charges on savings accounts. You dont see them as they dont need to disclose them. You just see the savings rate after all the charges/profit margin is built in. The example on the bond you have is 1.1% reduction. A savings account could be closer to 3% but as you dont see it, people believe it is charges free. If savings accounts had to show explicit charges the same way as most investments, then the reduction would be more than 1.1%.

Please be wary of Eds suggestions. That would not be at all useful for IHT purposes. Plus it is a limited area portfolio that has done well over the last 5-7 years but would have performed below Growth portfolios the 5-7 years before that. Past performance is no guide to future returns.

EdInvestor

Past performance is no guide to future returns.

This is the official FSA warning of course.

Suffice it to say that it's a proven fact that the vast majority of the real returns from equity investment long term are made up of the dividend income, not the growth in the capital value.

Another useful adage is "Don't let the tax tail wag the investment dog". You may of course pay higher tax if the estate is bigger, but you'll still end up with more money

dunstonh

Another useful adage is "Don't let the tax tail wag the investment dog". You may of course pay higher tax if the estate is bigger, but you'll still end up with more money

So are you saying that an Equity Income fund in a unit trust/isa (picking funds for funds sake but could equally apply to shares), lets say Invesco Perpetual High Income fund would outperform the same fund in an investment bond by enough to cover an inheritance tax bill?

Another useful adage is "Don't let the tax tail wag the investment dog". You may of course pay higher tax if the estate is bigger, but you'll still end up with more money

It's best you understand what means if you are going to quote it.

It is often a good idea to work out how you are going to invest first and then look at the tax wrapper second. Its not a 100% rule but it's a good guidence.

Where you have the same investment funds available across the various tax wrappers then the tax wrapper comes into play.

So, lets take an income fund such as Invesco Perpetual High Income. You can get that fund in Pensions, OEICs (Unit trusts), ISAs and life funds. So, if the same fund is available across the various tax wrappers, then it is best to then select the most appropriate tax wrapper.

A unit trust/Oiec/Shares suggestion that Ed is making would leave all the funds in the estate and liable for any IHT calculation. In the life funds, they can be used with an appropriate trust to help reduce the IHT liability. The OEIC would have a liability to CGT, the bond wouldnt. However, the reason it doesn't as it pays a little more tax within the fund. With the OEIC you would have to buy/sell periodically to utilise CGT allowances. The bond wouldnt. If IHT was not an issue, then the OEIC would be the better option due to the slightly better tax rate. This issubject to charges differences in which case the bond can often be lower but in others can be a lot higher.

Nowadays, you can pick the funds you want and use the appropriate tax wrapper.

al_yrpal

You might like to look at a High Yield Portfolio for part of the money. This takes advantage of the fact that dividend income is tax free to people on basic rate.This is a DIY idea which is quite similar to the Equity Income fund concept, but you pay effectively no charges if you set it up with a no annual charge online broker, because virtually no trading is involved.


Yep,
The Motley Fool has great epistles on it, with examples of various high yield portfolios over the last few years showing the lousy performances achieved, especially when compared with almost any index trackers and the best managed funds, even after taking into account the terrible charges levied by the wicked fund mangers!

Its a great way to watch your returns achieve barely that of a decent savings account, whilst the capital may slump unexpectedly like Shell's did when they discovered they didn't have as much oil as they thought they had etc. Be careful which shares you choose... Railtrack, Marconi etc etc.

In fact its just the thing for the complete novice investor with a pile of money to lose .............................(or is it?)

EdInvestor

Aussie_Bird wrote:

2. Following the maturity of some bonds we now have £200k to invest and would like to obtain a 5% income from (current option estimates 6% so 1% capital growth) - 5+ years investment duration with option for early withdrawal

Hi AB

You may like to look at a High Yield Portfolio for say half of this money.

Here's a link to a demo portfolio which was bought at the top of the market in late 2000, and thus endured the brunt of the crash. Note the comparison with the index. The resilience is I think quite reassuring

HYP 5 year performance Dec,2000-05

The portfolio paid out approx 4.6% in tax free dividends p.a ( listed separately on the link) and increased in value at an annualised rate of just over 6% over the 5 years.

An HYP portfolio bought now would pay tax free dividend income of 5%.
Let's be conservative ansd say the capital would grow at 7% on an annual basis (almost certainly it will be higher.)

At the end of the 5 years if you invest 100k, you should have 140,255 in capital and the HYP will have paid out tax free income of 5% p.a.

Of course you can access it any time and sell shares if needed. Ideally such a portfolio should be held at a low cost online broker which charges no annual fee and has no inactivity costs - such as Squaregain.

In addition it would be sensible to pop it into an ISA as time goes buy, and possible to utilise a CGT allowance to sell and rebuy any shares which have gone up a lot.There is however no need to trade at all.

Of course you should compare this return with other products.I understand that in the case of insurance bonds, the 5% "income" is actually a withdrawal from capital, which may have an unfortunate long term effect on returns, though it may reduce exposure to IHT due to the smaller size of the estate.

dunstonh

Of course you should compare this return with other products.I understand that in the case of insurance bonds, the 5% "income" is actually a withdrawal from capital, which may have an unfortunate long term effect on returns, though it may reduce exposure to IHT due to the smaller size of the estate.

If you draw 5% of a HYP it will have an equal impact. Indeed, draw 5% of any investment or savings account and you get a drop of 5% funnily enough.

I thought the whole point of the investment was to look at IHT issues. Can you please tell me what trust could be used to reduce IHT liability with a HYP?

EdInvestor

You don't draw the 5% income out of the HYP, it is paid separately in the form of dividends.As I said:

At the end of the 5 years if you invest 100k, you should have 140,255 in capital and the HYP will have paid out tax free income of 5% p.a.

The OP asked about both IHT and investment issues.

Seems to me it's hard to advise about IHT on the investments without knowing a lot more detail about the other assets. (Not that I am a tax expert in any way.)