Ways to Maximise Income
Regular investment in ISAs could save pensioners a hefty tax bill on their retirement income.
Building up an ISA pot over thirty years to around £700,000, could produce an income per year, just under the 40 per cent bracket, assuming a typical yield on an income fund of 4 per cent.
If this were outside an ISA, and assuming this amount was £36,000 and you also received the state pension of £5,078 plus an occupational pension of £10,000, you would have total income of approximately £51,000, which is about £7,200 above the higher-rate threshold.
This example shows that income bearing funds should normally be sheltered in ISAs before other funds. Generally, income tax rates are higher than capital gains tax rates and capital gains tax can be deferred, whereas income tax from funds or shares cannot, even when the income is reinvested.
Dividends on shares are taxed at 10 per cent, even when held in an ISA, although the benefit for higher rate taxpayers is that there is no additional tax to pay as there would be on dividends from holdings not held in ISAs.
It is recommended that investors use a portfolio of funds covering fixed interest securities, equities and property, which are all providing reasonable income yields compared with the historically low rate of interest available from cash.
Equity income funds
These funds aim to deliver an above average and growing income without sacrificing the potential for long term capital growth through an investment in the shares of UK companies. Such funds can yield above average returns with retail investors paying a 5 per cent initial charge and 1.5 per cent annual management charge.
For diversification, it is not unusual to see such funds yielding around 3.5 per cent and 5.3 per cent. Diversifying is important due to the concentration that you get in the UK market, with the top five stocks representing a large portion of the overall dividend on the UK market.
Due to the likelihood of rising interest rates, experts are not keen on bond funds at the moment, preferring, instead, strategic bond funds. One advantage of these is the ability of the manager to invest in higher yield as well as investment grade bonds, which should reduce the risks when interest rates rise.
Investing in UK real commercial property, as opposed to the shares in property companies has a historic yield of 3.30 per cent and has delivered a high performance over the past year and fallen less than its sector over five years.