Money Makeover
Name: Jeffrey Davies

Age: 68

Occupation: Retired

The Problem: Mr Davies' income from both his state and private pensions is about pounds 12,500, on which he is able to set money aside. He does not own a home but lives with his partner in her house, in Kent.

Mr Davies, who has a fairly cautious attitude to investment risk, has two small endowment policies, one of which will pay out next year, the other in 2008. He also has more than pounds 100,000 in a postal account.

He would consider himself speculative with a small proportion of his capital and has recently purchased 635 Halifax shares. However, he feels the stock market is "so high that it is likely to fall before long".

Mr Davies's main aim is to enhance his income and he is considering the purchase of two, perhaps three, flats for letting purposes. He would like to pass on as much as possible of his assets to his beneficiaries, without jeopardising his own situation and lifestyle.

The Adviser: Andy Harris, independent financial adviser at Maddison Monetary Management, 44 High Street, Bagshot, Surrey, 0800 0742233.

The Advice: Property can be a good source of additional income and capital appreciation. However, as Mr Davies quite rightly points out, it can also be a headache. The potential issues include the lack of, or problems, with tenants; liability to income tax on profits; maintenance costs; initial and ongoing expenses as well as liability to capital gains tax on any future sale proceeds. Given Mr Davies' circumstances, I would not recommend that he invest in property.

His partner owns the property in which they live and he is not a named beneficiary of her will or the property, so Mr Davies will need to allow for the potential purchase of a property in the future and is comfortable allowing pounds 50,000 to this end.

Although he feels that his net income exceeds his expenditure by approximately pounds 2,000 per annum, this money is not saved at present. Therefore, it would be prudent to assume that his actual expenditure is closer to pounds 11,000.

He would like an additional gross annual income of about pounds 6,000. Careful consideration has to be given to this in order not to cause a reduction in his age allowance, currently pounds 5,220 per annum, allowable from 65. This can fall by pounds 1 for every pounds 2 of income in excess of pounds 15,600, down to a minimum of pounds 4,045 (the current personal allowance).

First and foremost, Mr Davies should consider setting aside pounds 5,000 as a cash reserve which is instantly accessible and available for any emergencies.

Safeway Bank is offering 7.3 per cent gross interest on balances in excess of pounds l,000. It also has a link with Abbey National, with whom Mr Davies currently holds his savings.

Long-term care is a growing concern for the older generations, given that the Government will only support those with savings and investments of less than pounds 16,000. Serious consideration should therefore be given to methods of funding this.

Mr Davies could consider using a plan which incorporates long-term care benefits, such as Royal Skandia's Care Account, however, these plans tend to be more expensive than other similar forms of investment due to the fact that the long-term cover benefits are costed in.

As the capital may need to be used for something other than long-term care, such as the purchase of a property, Mr Davies could be incurring unnecessary costs.

National Savings Certificates can provide security of capital with tax- free income if held for five years. Mr Davies should therefore invest pounds 10,000 (the maximum allowable) into 11th issue index-linked certificates, currently offering 2.75 per cent above inflation. As he invested pounds 3,000 into a tax-exempt special savings account (Tessa) in March 1997, Mr Davies should therefore invest a further pounds 6,000 over the next four years, as existing Tessas will be allowed to run their full five-year term before having to be rolled over into the new Individual Savings Accounts (ISAs).

Although Mr Davies would not normally consider personal equity plans (PEPs), advantage should be taken of the limited opportunity available prior to the advent of the proposed ISA. The Halifax shares should also be "Pepped" into a single company PEP, thus avoiding tax currently payable on dividends and any future capital gains.

A maximum of pounds 6,000 per annum can be invested into a general PEP and, given Mr Davies' risk tolerance, I would recommend he opt for a relatively cautious fund such as Guinness Flight's Cautious Managed Fund. This aims to invest at least 30 per cent of its assets into more secure bonds and Government securities.

Mr Davies should invest pounds 6,000 now in the above PEP and a further pounds 6,000 at the start of the 1998/99 tax year into an alternative PEP for diversification, such as a corporate bond PEP. This could be funded from his endowment plan maturing in April 1999. Investment at the start of the tax year will provide the maximum tax-free growth over the next 12 months.

After allowing for the above investments and cash reserve, Mr Davies will be left with pounds 80,000. This capital could be "allocated" to provide for the above-mentioned long-term care and/or property purchase, while providing potential capital growth and supplementary income as required. Putting pounds 70,000 in an investment bond would enable him to withdraw pounds 3,500 per annum without affecting his age allowance. This is because withdrawals of up to 5 per cent of the original investment are deemed a return of capital, as opposed to income.

Should he require more income, as a basic-rate taxpayer he can make further withdrawals with no tax-liability, as it has been paid in the funds.

I would recommend the investment is left to grow for two years - in other words, the first withdrawal should be from "interest" rather than original capital.

Canada Life's Mercury Balanced Investment Fund, in its investment bond range, balances actively managed holdings of UK blue-chip shares with lower-risk investments such as gilt-edged index linked, other fixed-interest securities, cash deposits and property.

In addition to an excellent track record of fund performance over one, three and five years in comparison with other funds within the same sector, the charges are very reasonable given that for investment in excess of pounds 50,000, an additional allocation of 3 per cent is granted.

The remaining capital of pounds 10,000 can be used to supplement Mr Davies' income in the first two years and should remain in his postal account. He should also continue funding his existing endowment plans to maturity in order to benefit from its terminal bonus.

Currently, inheritance tax is not an issue as his estate is valued at less than the nil-rate band of pounds 215,000, although the current limit could reduced in the March Budget.

A gift of pounds 30,000 was made by Mr Davies to his son in August 1997. Under current legislation this is a potentially exempt transfer (PET) for inheritance tax purposes as long as he lives for a further six and a half years. Given his current income needs, further PETs may not be a option.

One final point worth noting is that the above recommendations would change considerably should Mr Davies marry.

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