House Equity as Pension

jamesd

The sort of funds that might be used and their yields include:

9.6% Marlborough High Yield Fixed Interest
7.9% Newton Global High Yield Bond
7.2% Newton Higher Income
6.6% Invesco Perpetual Monthly Income Plus (pays monthly)
6.2% Invesco Perpetual Distribution (pays monthly)
3.9% Invesco Perpetual Income

Those yields are historic and not guaranteed. The capital value varies, by as much as 40% in some of them. He'd use many different funds, not just one. No income tax to pay on any of those inside the ISA. The capital is available at any time with no more than a week or two's delay to sell and get the money.

To be fairly prudent he might recon on taking about 6% income from those per year without expecting the capital value to fall by much long term. That's £2,340 a year or £195 a month.

To smooth out the income he might set up a savings account and put £2,300 in it and have the ISA pay the income into that savings account. Also set up a standing order from it to pay £195 a month into his normal bank account as the money he can spend. Once a year he can adjust the spending rate depending on whether the savings account balance is higher or lower than £2,300. Having a full year of planned spending in the savings account means that it would be many years before it actually ran out of money even if the investments had a long run of low payout years and he didn't change the spending rate at all.

An annuity might pay more but it'd lose the capital and since he wants to pass on an inheritance I doubt he'd go for it.

If he'd accept gradual loss of capital - perhaps guaranteed by you that you'd top it up if it dropped after five years if you're willing to do that - then he might take 8% instead of 6% and increase the monthly spending to £260. But the capital value would be likely to drop slowly at that rate so you should be willing to do the top up.

If you were collectively to buy the house there are lenders who wouldn't insist on a BTL mortgage with its higher cost but who'd accept use of a normal residential mortgage. The catch is that there wouldn't be a lot of difference between market rent and mortgage interest. And the mortgage repayments if it wasn't on interest only basis would be higher than the rent. Also he might well know that now is a bad time to be selling a house and he'd get less for it than waiting until a better time so he might be reluctant to agree now.

An alternative might be to buy the house over time, making regular monthly payments to do that and periodically updating the legal ownership record. That way the percentage of it bought per Pound can be adjusted as property values change. He'd end up getting the higher income from this without any need to use a mortgage and without you having to pay more than you can afford on an ongoing basis.

But maybe he won't want to sell? There's a comfort and certainty in owning your own home and it's his prerogative to want to stay that way.

Perhaps he'd go for an interest free loan to buy a new caravan?

Why the nervousness about markets currently? Worried about the bull market we've been in since early 2009 ending soon? The list of funds I gave earlier uses a mixture of bonds and stocks to produce income.

mrcharrington

Phew!!!

Seems I have a lot of reading to do ha ha

Many thanks James you have been a great help.

I wish id listened more in maths now.

Given some of the returns shown in your list could he increase his investment pot by remortgaging say 25% of his property (well we would get the mortgage) and investing that or are they to risky? (or am I being thick?).

jamesd

It's risky to do it with a remortgage and invest because the investment capital values do vary and dying dates are uncertain, so it's always possible that the last of them might die when the capital value of the investments is less than the value of the loan. That seems OK to you since you don't mind them reducing the inheritance and in any case the mortgage lender would come to some arrangement to deal with it if there was a desire to keep the house.

While those investments do vary in their yield/interest rate it wouldn't be sensible to pick just the high yield ones. Something like Invesco Perpetual Income doesn't pay out as much as some of the others but instead increases the capital value. That increased capital value is part of the inflation protection so the value is less likely to fall in after-inflation terms over the years.

Given current mortgage rates you might be able to get a fix for five years and invest and make say 2% on the difference between interest and investment returns that he could have as income. Maybe more, I've tried to deliberately understate the investment result a little.

Personally I am happy to invest with mortgage money - I have an interest only mortgage that I don't need and my money is invested instead of paying it off. But it is high risk.

mrcharrington

Thanks again James

I definately have plenty of food for thought and will have a chat with them when ive done some research.

Thanks

jamesd

One thing you might consider is that there's no need to charge them rent if you don't want to. The rent at fair market rate is needed for inheritance tax purposes but that only matters if the estate is big enough for inheritance tax to be due. Given the value of the property and money mentioned so far there's no real chance of any inheritance tax bill, unless there's half a million Pounds lying around somewhere that hasn't been mentioned.

You could just buy a portion of the place off them and not charge any rent at all. Then they would have the capital to invest without any costs and any remaining capital in the estate would presumably end up heading your way eventually anyway. The benefit of this is that it reduces risk for them, while you still get paid back eventually from the estate. So they get benefit while they can enjoy it while you don't lose out much overall.

They gain: use of capital, income from investing it.
You lose: interest cost of the mortgage, some borrowing power of your own for a mortgage in your own name.

As a partial sale this might be more palatable to them than simply a gift of money.

mrcharrington

I like the idea of them not paying rent it makes it all seem less sleazy. It was my original idea to do this although just to let them blow the lot on whatever.

My thinking now is that we buy say 50k worth of their property. This gives them 90k to play with. So 20k for a new caravan and 10k on bits n bobs leaving 60k. Mum retires April 2012 which saves her paying extra tax on 5 years of unclaimed state pension from 60 giving a total investment pot of 80k. Not a huge fortune I know.

With dads initial 60k would he be better putting it into a managed investment fund as they seem to be doing well and saves me having to decide what to put the cash into (which basically means closing my eyes and hitting the page). I have been reading that index trackers perform higher but not sure what they are. When mum retires she adds her 20k.

My interpretation of a managed fund is the cash is pooled with others and spread over varying degrees of risk factor from safe to risky and you live of the interest some of which is paid quarterly and others paid annually. Of course it can go pear shaped.

Am I in the ball park here or miles off.

Really appreaciate your advice James it is a great help.

jamesd

Mum should really be thinking longer term and going for the higher pension, not the lump sum. It's the long term income protection part of the package since it'll be there at a higher level as long as she lives.

"My interpretation of a managed fund is the cash is pooled with others and spread over varying degrees of risk factor from safe to risky and you live of the interest some of which is paid quarterly and others paid annually. Of course it can go pear shaped."

Not quite, managed funds are pooled where the investment manager decides, within some risk boundaries, where to invest. Then you choose different funds with different managers and risk levels to spread the risk even more and hit the target average risk level. There's a trade off between income/growth and risk so optimal is something like 20-205% drop in a bad year, without the income level changing much, knowing that it'll just recover later. The risk mostly comes from being a forced seller at the low point, which isn't going to hurt your parents, but might hurt you if they died at one of those times. But you could just invest the money and make it back in the recovery, so not really much of a big deal.

That's also why I didn't use just one fund. It's less likely that lots of different managers are all going to screw up in the same way at the same time, though each will be affected to some degree by big trends. and I chose managers who invest in a range of different ways for the same sort of reason: more diversification.

Managed funds like those I mentioned earlier are what I'd be using for this. Not only those but they are a good starting point. Index trackers don't perform better, they have lower charges. Big difference. Whether managed funds or dumb trackers are better is a hugely debated topic. The index tracker theories assume that stock markets are perfect and nobody can do better than anyone else while the managed funds assume that people have different abilities and can do better or worse as well as that different investments do better at different times. Those advocating trackers also make a lot of US studies that show that managed funds in the US beat tracker funds before tax but did less well after tax... without noticing or mentioning that in the US there are several taxes on short term profits that don't exist in the UK. that makes a nice lesson in the importance of taxation but doesn't do a lot for the arguments of tracker fans.

As a practical matter many people use some of each, using trackers at times and in some of the best studied parts of the market and managed funds elsewhere. You're mostly going to be interested in an area where human selection is likely to matter.

The £60,000 could generate around £300 a month of extra income (assuming 6% s taken, more if there's a willingness to let the capital value drop slowly). Five years of deferred full basic state pension taken as higher pension would increase your mum's pension by £220 a month (using 52% increase on £97.65 basic). That's ignoring any additional state pension she may be getting from the earnings-linked part. That's at least £520 a month increased income between the two things.

That's enough so that they could be comfortable spending knowing that what they spend of that money doesn't cost them later but it'll be around as long as either of them is, so they can spend it and enjoy it now without worrying about the future.

mrcharrington

Many Thanks James

I will be making an appointment with an advisor.

Someone has mentioned Closer Wealth Management to me as a good company to be dealing with.
Anyone any comment

Thanks