Contractors’ Questions: How to invest £25,000?

Contractor’s Question: The winding up of a trust has left me, after tax, with £25,000 and I’d like to invest it in a way that eventually gives me access to a regular drip feed of income, separate to my existing limited company which I work through unrelated to the monies.

I have been looking at garages and lock-ups to purchase with the £25,000, but I am unlikely to secure any such property at an affordable price in my locality.

Already, I have £20,000 invested in a stocks and shares pension which is showing a healthy rate of annual growth. So I could ‘top up’ the pension with some of the monies -- say £15k. But I know it’s important with investments to diversify. So I was thinking to put some of the cash into premium bonds -- say £10k.

Or, although it looks like Individual Savings Accounts would put money I invest into them out of reach for too long, should I open an ISA instead? The worst option would be to put all £25k into a savings account due to the negligible rate!

Just a word on garages and lock-ups to end my query. It might seem an odd investment route to mull, but the trust due to distribute the £25,000 was set up by a late relative who had investment properties. And I wanted to 'tip my hat' to him, potentially following in his footsteps by purchasing some form of property with the £25k. But he’d be equally happy, I’m sure, if I just made a decent return on the £25,000 in the years to come. Please advise!

Expert’s Answer: The first thing to say is that you really should speak to a qualified financial adviser about your circumstances, because your situation is both specific and multi-faceted.

However because yours is an interesting situation, I will endeavour to at least offer some guidance around the investments you mention, to potentially inform that conversation I recommend you have with an IFA.

As you’ve already indicated in your question, I believe you have several options – most of which you’ve already identified. Choosing the right solution (or mix of solutions) will be a personal choice, influenced by your own circumstances, experiences and preferences. But to help inform those decisions, here’s a few pointers based on the information you’ve provided.

Pensions

You mention investing into your pension -- and this would be a sensible choice if you’re a UK taxpayer because you’ll likely be able to ‘top-up’ your contribution with tax-relief. Thereafter, the sums invested grow free of tax. And when you come to withdraw from your pension, up to 25% of your withdrawals could be tax-free too.

However, you are exposing your pension funds to investment risk -- and while you mention that you’re currently enjoying good returns, these are not guaranteed and your investments may lose value in the future. You’ll also be locking funds away until you reach the minimum pension age, currently age 55, but soon to increase slightly.

Variety

It’s good that you understand the importance of diversification. By which, in this context, I believe you mean diversification across different solutions – such as pensions, ISAs, cash savings, premium bonds etc. This is important – but so is investment diversification.

For instance, I’d recommend making sure that the investments within your pension contain a wide spread – perhaps of different equities, government and corporate bonds (not to be confused with Premium Bonds!), commodities, commercial property, alternative investments and so forth. Ideally across different currencies, geographical areas, and industry sectors.

Individual Savings Accounts

Regarding ISAs, you have a choice of cash ISAs or ‘stocks & shares’ ISAs. The latter could give you access to similar investments available within your pension, and with the diversification described above.

Lock-in periods are rare for an ISA though – and usually only apply to cash ISAs with fixed interest rate guarantees. Generally speaking, ISAs are seen as more immediately accessible than pensions. They’re also tax-efficient – all growth is tax-free, and so are any withdrawals or income. There isn’t the same tax relief on initial ISA deposits as there is for pensions however.

Cash, bonds and funds

On the subject of holding cash, you raise a valid point. Often inflation outweighs the cash interest rate, which effectively means that cash savings actually lose value in real terms. That said, it is always a good idea to hold an ‘emergency fund’ in cash. Three months’ of your usual expenditure is a decent rule of thumb.

Premium Bonds are a curiosity in many regards. They subject your capital to relatively low risk – in fact the biggest risk is probably capital erosion by inflation again. Returns are entirely unpredictable of course. You may win nothing, or you might scoop the big prize! Some people see premium bonds as a safe haven for their capital. But many others regard them simply as a game of chance!

You talked about wanting to receive a regular income from your investments. There are many investment fund choices available which will fulfil this need for you (they’re usually called ‘distribution funds’). The tax treatment of these can be complicated, but if you held such a fund within an ISA, then this shouldn’t be a concern.

Property: go commercial and own it via a SIPP

And finally, here’s some thoughts for you on the subject of property, which seems closest to your heart. The subject of property investment is obviously worthy of an essay in its own right, and so I’m not going to try covering the entire topic here. But your question does hint at one specific possibility which might suit your needs – so I’ll cover that.

You might have noticed that above I mentioned commercial property as an investment possibility. Commercial property can be owned by a Self-Invested Personal Pension (SIPP). Let’s assume that the lock-ups you mention are indeed classified as commercial property (residential property doesn’t qualify). You may be able to set up a SIPP and deposit, for example, £20,000 into it. You can claim tax relief on these funds deposited, as described previously, where eligible. The SIPP could then use these funds to purchase the commercial property. And it can then arrange to let these properties out. The rental income goes back into the SIPP, and not directly back to you – so you won’t be able to receive the income until you get to minimum pension age. The SIPP will be subject to the risks which face all property investors and letters. The set-up costs will be rather high too – and so you should pay close attention to estimating these costs before committing.

Invest, before you invest

Finally, my answer is by no means an exhaustive list of every choice available to you – but hopefully it helps your thought-process! To get serious about making your late relative’s trust money work for you, first invest a little time in a one-to-one with an expert. Good luck!

The expert was Paul Mayhew, associate partner practice of St. James’s Place Wealth Management.