‘I need £40,000 a year – how should I invest my £560,000 cash pile?’

Investing a lump sum is always difficult. There is timing to consider, knowing where to keep the cash, and finding the most tax-efficient way to buy shares and funds. Add in an approaching retirement and buying a new home and you’ve got yourself quite a conundrum.

That’s everything facing Edward. Add to this an investment portfolio made up of single stocks and a couple of investment trusts, and there’s a lot of planning to be done.

Edward is 62 and earns £35,000 a year working part-time but wants to retire in two years. At this point, he says he and his wife will need £40,000 a year to get by, which will be fully taken from his investments until he’s 67 in 2028 when his state pension will kick in. At this point, his savings will need to kick off £30,000 a year. His wife Jackie will receive her state pension in 2038 when the call on the investment pot will reduce to £20,000 a year.

From a house sale, he has £561,000 in bonds and he intends to use up to £250,000 to move to Brighton, selling his current mortgage-free £650,000 home and buying a Brighton home for around £900,000. The rest he can invest, although he wants to keep some cash back to help his two children, 18 and 23, who currently live at home. Ideally, Edward would help both onto the housing ladder, although there is no timeframe for this.

“A lot is going on, but I would like to sell my home and buy in Brighton, safely invest my pension savings, retire in two years, help the children and keep my money away from inheritance tax when I die,” Edward adds.

He hasn’t yet withdrawn any money from his pension pot and hasn’t saved into it this year, so has the full £60,000 pension annual allowance available this tax year. His wife, Jackie, who is 53, does not earn so does not have a full pension allowance.

Their assets, shown below, are mainly in cash. Edward needs help figuring out how to invest the cash in his pension, the cash in his individual savings account (Isa), and the remaining cash from his bonds account, to make sure he has enough income in retirement.

When it comes to investing, Edward says he’s been investing for 30 years and considers himself a high risk investor, but perhaps needs to tone that down a little. The high levels of cash in his Isa and pension are partly because he sold £100,000 of Nvidia (US:NVDA) shares at $450, thinking it was overvalued – it currently trades around the $467 mark – and partly because he’s worried about a market crash. Otherwise, there is around £57,000 spread across eight small-cap stocks and esoteric investment trusts.

NONE OF THE COMMENTARY BELOW SHOULD BE REGARDED AS ADVICE. IT IS GENERAL INFORMATION BASED ON A SNAPSHOT OF THESE INVESTORS’ CIRCUMSTANCES

Rachel Winter, partner at Killik, says:

After moving house and accounting for stamp duty, you should be left with approximately £670,000 across your various investment accounts. A withdrawal of £40,000 a year would equate to 6 per cent of the value of your portfolio, and this would be likely to run down the capital value over time. You both could easily have 30 years ahead of you and therefore it is important you keep trying to grow your investments so that your income withdrawals keep pace with inflation and you can maintain their standard of living.

Bond prices have fallen since 2021 as interest rates have risen, and the result is that even short-dated bonds are trading at attractive prices with good yields. The bond market is therefore a suitable home for money intended for future property purchases. The safest option would be to invest in UK government bonds that mature before the property purchase date. Buying individual bonds would be much more tax-efficient than buying bond funds, as individual bonds are not subject to capital gains tax, but funds [held outside of an Isa and pension] are. This is particularly important because so many bonds are trading below maturity prices.

For the remainder of the portfolio, you should have a shares allocation of at least 50 per cent. An overly cautious portfolio would be unlikely to generate the return you need. You clearly have experience buying individual stocks, so can continue with this approach, but ensure the portfolio has a good level of diversification by sector and geography.

Nvidia is a leader in the semiconductors that are used for artificial intelligence. Although the share price has increased significantly in recent years, the earnings have also increased. One way to judge whether a share is ‘expensive’ is to look at the price/earnings (PE) ratio. Despite an impressive share price rise, the PE ratio is currently not far from its 2019 level. Although I think there is a great opportunity ahead for Nvidia, the £100,000 holding was too large as a share of your portfolio, so you were right to sell most of it. Ideally, a portfolio of individual shares should contain at least 30 holdings.

You could also consider a fund-based approach. An exchange traded fund (ETF) such as SPDR US Dividend Aristocrats (USDV) would be a good option, as it focuses on income and growth. It invests in companies that have consistently increased their dividends every year, for at least 20 years.

 

Laith Khalaf, head of investment analysis at AJ Bell, says:

The remainder of your portfolio will be around £700,000, depending on how much you give to your children. £40,000 requires a yield of 5.7 per cent, which is a little punchy although still possible. The good news is once your state pension kicks in, this drops to 4.2 per cent. 

It’s a fortuitous time to consider drawing an income, because higher interest rates mean you can get a reasonable income stream from cash and bonds. Five years ago, you wouldn’t have any choice but to invest almost exclusively in the stock market.

There’s some work to do to optimise your tax situation. It also looks like your assets are mainly in Edward’s name, and it may be possible to pay less tax if it’s shared between the two of you a bit more. Some thought should be given to the 25 per cent pensions tax-free lump sum. This could be useful to supplement income in those early years of retirement before the state pension kicks in, and can also gradually be recycled into Isas to ensure the money is protected from tax.

In terms of which kind of funds they should consider: equity income, bond funds and money market funds can all help to generate an income.

You may also want a more growth-orientated approach, but whether you can will be dictated by whether your income needs permit it. If you need to generate a high yield from your investments, that doesn’t leave much scope for investing in growth. You can create an artificial income from funds that pay no dividends by selling units, but this is a highly active approach that requires decisions to be made about which funds to sell, and when and how much.

Rather than managing a portfolio, you should consider a multi-asset fund. These will invest across a range of stocks, bonds, cash and sometimes property and alternatives, and come in a variety of risk buckets, so you can choose what’s right for you.

James Marston, financial planning consultant at Quilter, says:

Of the £561,000 in bonds, some £250,000 is earmarked for the house move, let’s say a further £60,000 for your two children, at £30,000 each. This leaves £251,000 that could be invested.

The best way would be to roll this into yours and your wife’s Isas and pensions. If you put it into pensions you can benefit from tax relief of 20 per cent: so if you contribute £60,000 the government will top this up to £75,000. The pension is also excluded from your estate for inheritance tax purposes. However, the pension is taxable when you draw an income in retirement (after your 25 per cent tax-free portion). The Isa offers tax-free growth and no tax when you take the money, but will remain part of your estate. 

Given the size of your estate and spending intentions, you and your wife are unlikely to have a large inheritance tax bill. So I would max out your Isa contributions each tax year and as much pension as you can, and arrange a whole of life insurance policy to cover the expected bill.

As you have a specific plan for the £310,000 in a short time frame, I do not advocate taking investment risk. Keep it as cash, interest rates are currently good at circa 4.5 per cent.

Based on a 4 per cent withdrawal rate and having a couple of years for this to grow, it is reasonable to go higher than this at the beginning and front load the withdrawals (taking £40,000 for the first five years) accepting that the funds will be depleted more quickly in the short term. Your spending is likely to decrease in the longer term as you age.