Personal Finance: Money Makeover - Put your capital to work when you retire

Name: Joan Denton Age: 60 Occupation: Retired

The problem: Joan, from Norfolk, has recently retired and has purchased a house for cash.

She wants to maximise income to bring her as close as possible to her pre-retirement level of pounds 9,500 per annum net, while taking as little risk as possible. Joan would prefer guaranteed income that would rise over time. Her other concern is that she may require residential care at some point in the future.

Joan's occupational pension scheme income amounts to pounds 2,089 pa, which combined with State pension benefits will provide income of pounds 5,731 pa. She also has an additional voluntary contribution (AVC) fund of pounds 4,378, but is confused as to the options available to her.

Joan has around pounds 65,000 in a Halifax Gold Account, pounds 20,000 in Premium Bonds and around pounds 4,000 of "emergency" funds split between a Barclays' deposit account and The Saffron Walden building society. Joan wishes to invest around pounds 85,000 for future income in total.

The Adviser: Paul Smith, specialist consultant at Stirling Asset Management Ltd, 85a Great Portland Street, London, W1N 6JR, 0171 580 1555.

The Advice: The simplest part of Joan's restructuring is the purchase of an annuity with her pension AVC pot. Those funds are held with Equitable Life who have offered three annuities: a flat annuity at pounds 340 pa, an annuity of pounds 240 pa escalating at 3 per cent pa and an annuity of pounds 220 pa escalating at the retail price index (RPI).

Under occupational pension regulations Joan has no alternative other than to buy an annuity with her AVC fund. The principles behind an annuity are straightforward. Buying one is a bit like a bet with an insurance company, in return for your cash they will pay you an income for life. If you die early they keep your lump sum and in effect win the bet, if you live to a ripe old age, they lose!

But the amount of annuity offered will vary depending on the company, the age of the purchaser and the type purchased. Annuity rates can vary between companies and may differ by 20 per cent. Shopping around will pay off every time.

As Joan's other pension income is indexed and her AVC pot is quite small, the level annuity offered by Equitable Life would be the best choice.

It is not inconceivable that Joan may require income for another 30 years. A considerable proportion of her capital is in premium bonds, which generate no specific growth or income but can, and have, provided Joan with regular wins ranging from pounds 50 to pounds 150 per month. The marketing literature for premium bonds says anyone holding the maximum number of pounds 20,000 will, with average luck, win 13 times a year and enjoy returns of around 5 per cent pa tax free. Having said this, there is no guarantee Joan will have average luck and, as a lower-rate tax payer, the tax-free element has less effect.

The only way to absolutely guarantee future rising income would be to pool the available resources and purchase a life annuity linked to the RPI. Unfortunately, the maximum annuity indexation that most life companies offer as a matter of routine is 8.5 per cent pa and they only quote fully inflation-protected life annuities under special circumstances. An annuity based on pounds 85,000 could provide Joan about pounds 6,400 level, or a starting sum of pounds 2,200 indexed at 8.5 per cent pa. The advantage of life annuities over pension ones is that not all the income is taxed as income, a proportion is deemed to be return of capital.

I would also recommend some funds are held on deposit at a bank or building society. Bristol and West's postal account would offer 7.53 per cent.

A popular lower-risk investment is the with-profit insurance bond, which is in effect a single premium investment policy designed to provide a predictable investment return over a period of time. While these are insurance products and do usually provide increased death benefits to the underlying investment value, they are not designed to provide family protection in the event of death. Typically, the policy will pay 101 per cent of the value of the investment at death and technically, as an insurance policy, it enjoys special tax treatment.

Where this type of investment offers more security is that each year a bonus rate is announced in advance and will be payable on the amount of the investment. That bonus will be paid regardless of whether investment returns justify that level of return. This year's bonus rates look to be between 6 and 7 per cent. An investment may only attract annual bonuses of 7 per cent pa but may also benefit from 2 to 3 per cent pa in terminal bonuses.

There is no immediate personal tax liability on withdrawals of up to 5 per cent pa for the first 20 years of the bond, which can be rolled forward if not used in one particular year. As Joan is likely to remain a basic-rate tax payer there will be no personal liability on regular income taken from the bond.

Joan's concern is that as she becomes older she may need substantial care, maybe in a home. Residential care can cost anything between pounds 10,000 to pounds 20,000 pa and the average stay is around three years. These costs already exceed the level of income that Joan's pensions and investments could generate, which could lead to rapid erosion of savings, or the value of her house which she has spent her life working to purchase.

Since 1990, local authorities have been legally obliged to recover the cost of care. Most income is taken into account in that assessment, including pensions but, regardless of income, capital assets exceeding pounds 16,000 may make the individual responsible for paying for the standard fees of residential care.

While our main consideration must be income for Joan, it may be prudent to incorporate some provision for care. The life assurance company Lincoln has devised a more practical solution with their Independence Bond, due to come on the market shortly. This is in effect an investment vehicle, but can incorporate a level of benefits higher than the amount invested. These benefits will be paid out if the individual is unable to undertake certain activities of daily living, terminal illness and death. The cost of that insurance is taken from the investment fund on a monthly costed basis.

This may sound expensive, but, in reality, is not if the mechanics are understood. For an investment of pounds 25,000, and a protection level of pounds 50,000, the potential risk to the life company is only pounds 25,000 at outset. In the early years the investor has the security of knowing that a move to residential care may not erode other assets.

Where Lincoln score with this product is that it carries an investment management charge of 0.25 per cent pa as opposed to the more normal 1 per cent pa industry average. It allows penalty-free withdrawals at any time, should the necessity arise, but the capital growth would be better utilised at a later date.

In conclusion, I would suggest a portfolio consisting of retention of existing "emergency" deposit holdings; a pounds 50,000 with-profit bond with 5 per cent pa regular income deducted; pounds 25,000 invested with Lincoln's Independence Bond with pounds 50,000 worth of disability, terminal illness and death cover and pounds 10,000 deposited with the Bristol and West postal account.

Assuming current interest rates, inflation and tax allowances in the 1998/99 tax year, I estimate that Joan's net income could amount to pounds 8,768 pa, not too far away from her pre-retirement income. By only drawing 5 per cent income from the with-profit bond and none from Lincoln bond both should benefit from capital growth to insure that greater income will be available in the future.

While the two bonds suggested fall outside the local authority-assessed asset criteria (because they are technically life assurance policies) substantial provision has been made via one of them to ensure that Joan receives the level of care she would want while still leaving enough of her lifetime's accumulated wealth to pass on.

Independent Partners; Do you need financial advice on your investments, pension or insurance? Book a free consultation with an independent Financial Adviser at VouchedFor.co.uk

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