In the light of the forthcoming new pension freedoms, many advisers will be looking for alternatives to annuities - not necessarily to totally replace annuities, but perhaps to bridge the gap between retirement and a later annuity purchase or to work alongside an annuity.
Solutions that fit the bill would provide income, tax relief and possibly inheritance tax relief without sacrificing flexibility. A well-constructed portfolio of EIS investments could be one option.
We looked at something similar to this in our annual EIS Industry Report. In our theoretical example, the client, who is approaching retirement, has ÂŁ10,000 of surplus investment assets each year.
The surplus ÂŁ10,000 is invested in an exit focused EIS fund with an expected duration of three years and the intention is to re-invest that money in another EIS fund on the same basis.
Assuming each investment does what it is supposed to do and returns 1.3x capital in three years, after eight years the first investment pot will have grown to just shy of ÂŁ22k. This could then be crystallized. Each subsequent pot could be treated exactly the same, providing a significant tax free annual income.
Click here to see the chart showing this.
So our hypothetical client, at the end of his career and at the height of his earning power, can offset his final few tax bills and build a portfolio of asset-backed, capital gains tax and IHT proof investments with the intention of progressively exiting them and drawing them down to provide an income in the early years of retirement when spending is typically higher.
This strategy could also be used when crystallising a pension pot. Building an EIS portfolio like this could be a smarter plan than immediately purchasing an annuity and sacrificing flexibility, leaving the money in volatile stock markets or placing it in poor value, low yield bonds.
Of course in reality, not every fund is going to exit within their stated timeframe or achieve 1.3x capital. Some will do better, some will do worse.
Careful manager selection and ensuring diversification across a range of companies and sectors help to mitigate the risks and careful scenario planning is required - what happens if the exit slips by a year or two, or the returns are lower than anticipated?
There is an example of this kind of stress testing on page 23 of our report and EIS providers are increasingly aware of the need to help advisers undertake this sort of work if they are to secure their business.
For advisers with wealthier clients, the expectation will be that they can offer something creative to take advantage of the new at-retirement flexibility. EIS investments are an option, and we view this as an area where advisers can demonstrate real value to their clients.
A longer version of this article first appeared in Intelligent Partnership’s annual EIS Industry Report. Download a complimentary copy here
Dan Kiernan is an associate director of Intelligent Partnership
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