Questions on Cash With Nick Plumb

Where should Lady Luck put her lottery winnings?

Investing a largesum for income

A lady, who I will call ’Moneypenny’ to preserve her identity, contacted me this week to ask my advice on where to invest a lump sum. She recently had the good fortune to win a modest sum on the lottery, as well as inheriting a larger sum from an Uncle. All together, she has just over £450,000 to invest and has asked me for advice.

The first thing Moneypenny did right, is speaking to me. I don’t mean that in an arrogant way. What I mean is that she has spoken to an Independent Financial Adviser instead of a tied adviser who works for one bank or insurance company. That means that she will not end up with all her investment ‘eggs’ in the same company ‘basket’.

However, building a good investment portfolio is not just about having investments from lots of different companies. The key to a good portfolio is understanding the objectives of the client, their attitude to risk, and creating a spread of funds and assets.

Moneypenny is very much a medium risk investor. That means she is happy to take some degree of risk with some of her money and have that linked to potential stock market performance, but she also wants the stability of having some money invested in cash and lower risk areas. She has no outstanding mortgage and is a basic rate taxpayer. She would like to give up her work and concentrate on her hobby of landscape painting, providing she can replace her income of £17,000 a year with investment income.

I therefore suggested the following strategy to Moneypenny:

Keep £50,000 in pure cash investments. Around £10,000 should be held in an instant access account, with the remainder in internet banking or notice deposit accounts with a higher interest rate. Although interest rates on cash are low right now, they will eventually improve, and you should always have a good ‘emergency fund’ available that will reduce the likelihood of having to cash in longer-term investments for things like a new car purchase.

Ordinarily, I would probably also suggest an element of the funds be held in National Savings, such as Index Linked or Fixed Interest savings certificates, but there are currently no issues of these being offered. Premium bonds can be another option. Your capital is secure, but if you don’t have many wins, the returns can be lower than a bank or building society.

I would suggest an investment of £10,200 into an investment ISA now, and again in the new tax year after 6th April.

It is important to maximise on ISA savings allowances, as this money not only grows tax-free but can be used to produce additional tax-free income.

Next, I would suggest an investment of around £180,000into a wide-ranging Unit Trust or OEIC portfolio. This should actually be invested into low income yielding growth funds, not high income yielding funds. Although this may seem strange for someone wanting income, it will actually allow Moneypenny to take tax efficient capital withdrawals from the fund using her Capital Gains Tax allowance. This means she will pay only a small amount of income tax on the modest amount of dividend income received.

Funds can also be drip fed into ISAs from the Unit Trust portfolio in future years, to gradually move more money into the completely tax-free wrapper of an ISA.

The remaining £200,000 should split into two or possibly three investment bonds. I would suggest using a combination of asset classes within the bonds, such as Distribution funds which generate a good income yield, Corporate Bonds, Property, Fixed Interest funds, and Equities. The benefit of the bond wrappers is that she can take an income of up to 5% per annum of her original investment each year, without triggering income tax.

Although the above is a simplified breakdown of the suggested investment strategy, the investments recommended should produce a tax efficient income of around £18,000 a year, which would be equivalent to a taxable income of well over £22,000 a year. That more than meets Moneypenny’s objective of replacing her current income and leaving her free to enjoy painting the Suffolk countryside.

Nick Plumb is an Independent Financial Adviser and Practice Principal at Plumb Financial Services. Answers to any questions within articles within the Library section are provided only as a general guide and do not constitute personal financial advice. Any individuals who require advice should contact us to arrange a complimentary initial consultation to discuss their own position.