In this reader case study, three of us are trying our hands at giving a panel of answers to a reader's situation. It's our first time round the track doing this, so let's see if we're any good at it. The usual caveats apply - we're not qualified financial advisors and these opinions are only intended to feed in to people's own decision making processes.
Here's our reader's letter, along with their replies to my follow-up questions:
Hi Andy, I've just followed the link to your Ministry of FI blog via a reply on the Rebel Finance School forum.
My head is all over the place with where I'm at in life. I was widowed about ten years ago, I'm now 61. I am fortunate that he left some properties and we have equity in my house. My obsession is to make sure my kids are looked after with property. My situation is complex. I have ADHD and find it difficult to assimilate and understand information and things just go over my head and I get a mental block.
I would love to find someone to sit down with me, and help me navigate it and make a plan, but I don't think that person exists.
However this offer for 3 people to give an opinion on my situation could really help me out. How do I go about it please? I warn you it's not straightforward!!!
- Widow aged 61
- 3 children in 20s
- PAYE job £1500pm
- Residential - £340k mortgage (4.19%, £1.1k pm), £1.4m equity
- £350k savings, ISA etc
- Final salary pension to come @ £8kpa/£200k transfer value
- £30k in private pension
- £1.2m equity in other property (mortgaged currently bringing £4kpm gross)
- £300k equity in flat abroad
- Currently reluctant to sell family home as emotional attachment - maybe next 5 years
- No inheritances from anywhere
I know the easiest thing to do is sell the family home and flat abroad but right now not an option.
Objectives:
- try to give my children £400k+ each in next 5 years towards buying a house (would be a big deposit for them)
- have a gross income of £6kpm+ (after resi mortgage)
- not to worry so much
- not to constantly have my head scrambled with what to do all the time - I want a simple plan to take weight off shoulders
Semi commercial rental property, mortgage rate 4.85% until December (the one that brings in £4k).
Currently have an empty BTL, have been trying to sell since December, mortgage 1.76% till next year.
Empty short term let, mortgage rate 4.75% as my market has disappeared. Between these two empty BTL could be another £200k. Didn’t mention these as both empty and not generating any income.
Phew! Yes, you're right, that's quite complicated. I can see why you're struggling for headspace to deal with it all.
Here are the replies from the panel:
John
“Control what you can, ignore the rest”
Going in circles or being afraid of doing the wrong thing can stop you acting. It’s an easy trap to fall into, especially while things haven’t gone pear shaped, yet… It needs an action plan guided by general principles.
I will focus on the broad brush and leave the detail to others.
“You can have anything you want, just not everything you want.”
Initial observations:
Gifting a £400K house deposit for each of three adult children is very generous. It is also over £100K more than the average UK house price. Seems overly generous for a house, but perhaps more reasonable as part of estate planning.
£72K per year income for a single person in retirement is very high. I would work out how much you are really spending, and how much is adding to your cash mountain.
Are there enough assets to achieve these goals? How close are you to paying off the mortgages? Basic maths suggests you need at least £1.3M to support the extra income above state and DB pension and £1.2M for the gifts – after mortgages and excluding your main residence.
“When you are in a hole, stop digging.”
Liquidate non-working assets
The property voids need to be addressed. I would be trying to sell those properties as a priority at realistic prices. Just getting them sold and getting the capital working makes sense.
You need to come to a decision on downsizing your home and selling the foreign property. The older you get, the harder the decision to move is likely to become.
The income you need, paying off your mortgage, and the capital for gifting, requires liquid money apart from your main home.
“Never leave free money on the table.”
Take free money and get your money working
With £48K of rental income and £18K of employment income you are a higher rate taxpayer. Yet you are only contributing about £500-£600 to pension from earnings. I would strongly consider contributing the remainder of those earnings to a pension and claiming higher rate tax relief on your self-assessment. E.g. you could contribute say £12K a year to a SIPP, automatically get £3K added by HMRC as basic rate tax relief; and then claim another £3K as higher rate tax relief.
I would also strongly consider investing most of that cash for long term growth and income. You can reasonably expect to live 20+ years on average from here.
Planning for care
This is difficult to plan for, as the average amount of care funds required is only a few tens of thousands, which you could cover out of regular income. But for about one in twenty people it can run to perhaps a quarter of a million on average. All you can do is contingency plan and potentially have property (typically your home) that you could sell to cover the near worst case so you can have good quality care.
Be extremely wary of putting your home in trust. It’s generally considered a bad idea.
“Keeping it in the Family”
Inheritance Tax Planning and Gifting
I note you are likely to have less than the examples below unless you pay off all the mortgages. This is just to paint the picture and give examples.
If you pay off all the mortgages, then you have assets of around £3.5M. That’s likely over a million pounds of inheritance tax on death. Assuming you inherited your late spouse’s main inheritance allowance (Nil Rate Band) of £325K then the first £650K is inheritance tax exempt. (e.g. £3,500K minus £650K = £2,850K of taxable assets at 40% = £1,140K inheritance tax).
You would normally have your main home allowance (or Residence Nil Rate Band) as another inheritance tax exemption if leaving it to children. But you lose £1 of home allowance for every £2 you exceed £2M in your estate. Assuming you inherited your spouse’s home allowance you have £350K total. You therefore lose it completely at £2.7M.
Your current plan is to gift £400K to each of the 3 children (and live 7 years). That would reduce the estate by £1,200K and potentially regain some of the house allowance (Residence Nil Rate Band). If your estate is reduced to £2.3M then you keep £200K of the home allowance. (e.g. £2,300K - £650K – £200K = £1450K at 40% = £580K inheritance tax). I believe if you gift more than the main inheritance allowance in 7 years then the recipient is on the hook for the inheritance tax and not the estate.
You need to decide where the assets to gift this money will come from.
As almost all your assets are physical and not liquid there needs to be a plan to pay the IHT after you die. Whether that’s a life insurance policy in trust or some other method it needs thinking about and planning for.
I also wonder if there are other ways to shield your rental assets from inheritance tax. But that would need an inheritance specialist. Beware complex and expensive schemes.
Mike
I think it’s helpful here to start with the stated objectives, then with some observations dealing with separate areas and finally with some actions to address each in turn.
First, the objectives:
- The £400,000 gift to each child (totalling £1.2m) does not seem at all plausible in either the short or medium term as there are simply not enough assets available.
- Similarly, the desired £6,000 monthly income seems very unlikely as there are not enough assets to generate anywhere near this level of income.
- I can understand the level of concern as the wealth is tied up in various properties which do not appear to be performing well and these require a lot of involvement.
- The goal of simplicity is admirable, but there will need to be some major changes to get to a point where the finances are more manageable.
What is missing is any sense of a plan, including:
- How long do you intend to carry on working?
- Do you enjoy your job?
- Is there any potential to increase your salary?
- Are the children self-supporting or do they need your financial help?
The biggest initial concern is the imbalance between illiquid assets (property) and income: the current income of £18,000 p.a. will rise by £8,000 with access to the final salary pension at 68 and a further ~£12,000 from the state and private pensions, but this still only adds up to a gross figure of £38,000.
The high residential mortgage figure of £340,000 is another concern, especially when approaching retirement and it would seem relatively trivial to use some of the £340,000 of savings outside the ISA to reduce this to a more manageable amount with a view to discharging the mortgage completely in 5 or so years, in time for retirement?
The remaining cash invested in the ISA could be switched into a stocks and shares ISA where it would at least start to grow and eventually provide an income to supplement the pensions.
The £4,000 gross monthly income from the £1.2m invested in commercial property represents a poor 4% yield, even before tax and other costs are taken into account. Is this several properties? And could they be rationalised to remove the poorer yielding ones?
So far, I’ve only mentioned the financial issues and these shouldn’t decide what sort of life is wanted. What are the non-financial priorities? Since the family house is such a huge proportion of the net worth, there is no real hope of reaching anything like the income levels suggested without selling it.
But could this be an opportunity to start a new phase of life nearer the children and grandchildren maybe? And in a smaller modern house that requires less upkeep, with lower utility bills and one near accessible transport links for going away to travel?
Many people see property as their pension but overlook the level of involvement and the many things that can go wrong, especially later in life. If simplicity is a priority, then this does not sit well with owning property and relying on it for a stable income.
The general financial priority should be to move from unreliable (and poorly-performing) property income to pensions and investments that will look after themselves. There is already some small pension provision (see above) and this could be augmented with a self-invested pension funded from the current work. Obviously, any increase in salary would also help this to provide more money in the future.
As I see them, the actions required would be as follows:
1. Expedite sale of current empty buy to let property – i.e. lower the asking price – and get rid of the empty short-term let and foreign properties (not forgetting to pay any applicable capital gains and foreign taxes).
2. Pay off the residential mortgage within 5-10 years from savings, the equity released above or from income but be careful not to exceed any repayment limits.
3. Rationalise commercial properties with help from an estate agent and review rent and maintenance etc. – what is the return on equity and is it competitive?
4. Start self-invested personal pension (SIPP) and maximise contributions from job – if necessary, live off equity released above, allowing ~100% of salaried income to go into the SIPP until retirement.
5. Construct a five to ten year plan to downsize from current house, maybe aligned to the planned retirement date? At this point give the children a portion of the released equity, balanced with the additional income required, with the remainder invested in a general investment account and gradually transferred into the ISA.
6. Balance the income from the pensions, ISAs and set a sensible level of 3-6 months’ expenses into an emergency fund in readily available savings or Premium Bonds.
All of this will require discussion with the whole family and better with a family friend who knows about property (such as an estate agent) and someone who knows about investing.
At this stage I’d be very wary of talking to any finance professionals but make sure you complete the Rebel Finance School course before you do.
Andy
With a net worth of over £3 million, you could clearly retire today and live happily ever after, without running out of money - except you first have this legacy property portfolio to untangle, an attachment to expensive properties, and your head is in a spin.
There is clearly some excess in your plans, in various directions. You want £72k of annual spending, which is nearly double the RLS top tier spending level. You want to give £1.2m to your kids. And you want to keep a £1.75m home and a £300k flat abroad. Running these two homes probably goes a long way to explain the £72k desired spending figure.
You are most likely going to have to compromise on one of these fronts, but let's see what we can assemble before we simply take an axe to your plans.
Your assets look something like this, if liquidated:
- £350k savings / ISAs
- £30k DC pension
- £1.2m rental properties, less CGT, leaves an estimated £1,056,000
- £200k additional empty properties, less CGT, leaves an estimated £176k
- Total £1,612,000.
I'm making a guess on the CGT liability. I'm assuming the worst case of you paying 24% if it all falls into the higher rate tax band, and that the properties have all doubled in value during the time you've had them. If they're held in a limited company, that would change things.
I'll also round that total down to assume that you'll reduce some prices in order to get a sale. Let's work with £1.5m.
With this £1.5m how can we give you the desired annual retirement income? It takes some shoehorning to make it work:
- £30k "basic" retirement income
- £42k "stretch goal" retirement income
Let me explain my workings on that retirement income. I've done this using my "two pots" method.
If you were to buy a global index tracker fund, say Vanguard FTSE Global All-Cap, you could withdraw 3.5% per year and I think you would be utterly safe in depending upon doing that for the rest of your life. 30,000 / 0.035 = £857,000. Buy £860k of this fund and you can withdraw your backstop £30k from it on the 1st of January each year for life, and I think this would have withstood any bad event in the history of stock markets without running out. Oh, and you can safely adjust the £30k figure upward each year by inflation.
But that's only £30k out of your desired £72k spending. So what's next?
A second pot, for all of the optional spending, which doesn't have to be quite so safe. The idea here is you try to reduce withdrawals from this pot during a crash - so you cut down on things like holidays and new cars. You buy a different fund, to make it easy to keep track of which one is which. For instance, Vanguard FTSE Developed World Ex-UK. Use your remaining £640k for this, and we'll apply a more relaxed withdrawal rate, since this pot isn't for the critical "needs" money, it's in the "wants" category. To get a £42k spend from a £640k pot, 42/640=0.065 so that's a 6.5% withdrawal rate. Definitely not in crazy territory. If you get a bad sequence of returns in the early years of your retirement it may reduce the size of your pot, but it's not likely to hit zero before you slow down in your dotage. In any case, in about five or six years time you have a boost coming when both your State Pension and your Defined Benefit pension begin paying out, around £20k per year between them. There will be some tax on this level of income, but it should reduce the withdrawal rate from this pot down to around 4%. This de-risks this part of the plan - the pensions are the cavalry arriving later on in the battle.
Finally we come to the gifting, along with the elephant in the room - staying in a £1.74 million home and keeping a £300k flat abroad.
Why don't we roll these together? The kids each get £100k once the flat abroad is sold. This gives you a positive reason to let go of it, when you are ready to. And similarly, when you are ready to downsize your main home, you gift a third of the spare proceeds, after buying your next home, to each child. To reach your goal of gifting them £400k each in total, this would mean downsizing by £900k into a £840k property. These figures are broad-brush and don't include moving costs, but they give you an idea of what could be done.
I do have concerns that a gift of £400k goes way beyond what's necessary. There is helping them, and there's running their lives for them.
When you come to downsize both your home and the flat, this will reduce your spending.
Currently you have three excesses. Your home(s), your desired spending, and your level of gifting. We can accommodate any two of these right now, leaving the gifting for later. If you're willing to compromise on either the homes or the level of spending, then you can gift straight away.
Finally, this analysis brushed quickly over how you'd get from your current position to having all of your capital productively invested. You have empty properties, and properties up for sale which are not moving. I think this means that you need to lower prices to fit the reality of the market. The longer this takes, the more it is costing you in mortgage interest.
The priority is to dispose of the properties. I appreciate that there would be a small benefit from going slowly and selling one per year, in order to use a fresh batch of Capital Gains Tax allowance each year, but I fear that the overall effect of slowing down the project will be costly (more mortgage interest) as well as not being good for your mental health.
In short, I would stop being a landlord as soon as you possibly can, and become a passive investor. Simplify your life, and I hope that this will also remove stress. I fear the same goes for your home and flat - sometimes we are "owned" by our possessions, and I wonder if you would be happier if you simplified your living arrangements along with fulfilling all your gifting goals and setting up a passive income from the global funds.
Finally, I wonder if you will talk through your goals and the ideas from the three of us with your children? Discuss their goals too, and have a frank discussion about what will happen to your estate once you are gone. Perhaps they would prefer more modest help with property but some additional help with their investment goals? It may be more productive to help them use up their own annual tax allowances to build investment wealth over time with a view to becoming financially independent and being able to retire earlier. Setting them up with £400k-deposit houses risks encouraging a level of spending which they will struggle to maintain. Maybe some simplicity would be good for them too.
If you look at your wealth in terms of it being family money, gifting it down the generations sooner rather than later allows you all to pay less tax and helps retain that wealth.
Want to be a case study? Read more here.
Want to read more of my ideas? I have a new book out - Build Your Retirement, 5 ways to improve your wealth in retirement. Or other books here.
