HYP #4 - How To Buy And Hold High Yield Stocks Tax Free

22nd Nov '13 by Stephen Bland

4 comments 12861 reads

This is part 4 in the Stockopedia High Yield Portfolio series by Stephen Bland (HYP). Last week I considered the desirability of certain types of investment for a UK based HYPer in addition to the usual home market equities. This week I’ll explore the various holding vehicles for an HYP and also whether the investor’s age has any bearing on the strategy.

There are three main ways to hold the shares of an HYP.

Directly by which I mean paper certificates, the nominee form used by many brokers or the CREST system.

In an ISA (individual savings account).

In a SIPP (self invested personal pension).

These are not mutually exclusive so that any combination of the three can be utilised.

SIPPS

I’ll start with the worst first - SIPPs. I don’t like these at all because of the very onerous restrictions involved. They are sold on supposedly advantageous tax grounds but I doubt that anyone would invest via a SIPP in the absence of the tax relief on the premiums. You’ve all heard the old cliché about not letting the tax tail wag the dog, well this is a prime example of just that.

SIPPs remove the very essence of the HYP strategy – investment freedom. It’s like taking a thoroughbred racehorse and hitching it up to pull a cart. Adding to the severely onerous restrictions, if you have some years to go until you draw the income from a SIPP you are making yourself a much endangered hostage to fortune.

That’s because your eventual income from the scheme will be tied in some way to the prevailing interest rates at that time which cannot possibly be known now. And also the government is forever changing the rules for personal pensions. Can you trust that these rules will remain unchanged for many years? I’ll tell you - no.

I make one exception for HYPs within a SIPP. This is where an investor has an old pension scheme to which no further contributions are being made. This could for example arise from a former employment. The funds are trapped but these paid up schemes might be convertible to SIPPs thereby enabling an HYP to be set up with the money trapped inside the scheme.

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jeavom

29th Nov '13

While I generally like Stephen's approach outlined in the 'HYP' articles, care needs to be taken when giving tax efficient advice as it is often specific to the individual. It is often much better to recommend seeking advice from a good financial advisor.

I agree that ISAs should be used first (making use of income here is tax efficient and can be used to diversify the portfolio as an income bedrock for your portfolio). There are a number of providers that offer fee free ISAs, e.g. TD Investing. However, using the trading account and investing in value / growth shares to make use of CGT allowances has been my next port of call. (Investing in income outside of an ISA is not tax efficient). This has eventually started to throw off enough capital gains to allow rebalancing, with money recycled into the ISA each year, tax free. Once you have used these allowances, and have £20k or more, then using SIPPs starts to make sense. I think the view should be: use all other tax allowances first and then when wealthy enough make use of SIPPs provided you have done some financial planning. I wouldn't avoid them completely.

Stephen's strategy means that you must be able to generate enough income to live comfortably (adjusted for inflation) plus a margin of safety (say 20%, in case of disaster and shares cutting dividends), without touching the capital. If you can do this, a 100% allocation to equity may be fine. However, if the portfolio isn't sufficient to generate enough income, then the capital value matters as you get closer to retirement. In this case diversifying into bonds is usually sensible as it allows you to match your cashflow requirements, while limiting downside risk (for a buy and hold investor). For the more sophisticated investor, switching into bonds when yields are comparatively high and equities look expensive based on valuation measures has proven to be a good way to take advantage of economic cycles.

Mark

Stephen Bland

30th Nov '13

I agree that tax situations are of course specific to individuals and that advice should be sought where necessary, though I am a little cynical about a lot of financial advisers.

You'll appreciate that a brief article like mine cannot cover all the bases for all investors. Nevertheless, I have found that there are certain areas that are common to the majority.

For example I'm certain that ISAs will suit nearly all HYPers and a lot of other equity investment approaches too. I am equally certain that SIPPs are not an attractive vehicle in which to hold an HYP for most investors, with the exception I mention in my article.

carla77

2nd Dec '13

Totally agree that ISAs are superior to SIPPs for a HYP, I have both although my SIPP (currently drawing down a small amount each month) is modest compared to the ISA.

I don't trust any government to leave pensions alone and hope that ISas will be left unscathed, but who can tell.

Peter Barrett

lightningtiger

6th Dec '13

Having been a financial advisor for 14 years & now drawing income from pension schemes, anything over your personal allowance is of course taxed. In addition to that your income is regular, usually each month. I learned a lot over the 14 years and we sold investment bonds where you could take 5% tax free for up to 20 years. That was a good way to get an extra tax free income.
I have to agree with Stephen that with a SIPP rules can change. You are not in control of what may happen in the future, and anything can happen.
Now with stocks & shares ISA's it is a much better investment vehicle to use. OK we have to pay a small charge to have the investments in them, around £40 - £50 a year but it is worth it. Compared with those bonds I now have a portfolio where I can take out extra money as needed and not limited to a specific month when it can be taken out should I need some extra money. The whole aspect is much more flexible. If I need a higher yield to draw from my portfolio I can easily top slice some shares if required to give a HYP a bit more zing to it.
The whole idea is to constantly be above inflation with the portfolio, and then we have the purchasing power to buy what we want without ever having to dip into extra capital from the portfolio.
I do have some shares invested directly but make sure it is not over the CGT threshold.
Cheers from Lightningtiger

HYP #4 - How to buy and hold High Yield Stocks tax free

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Stephen Bland

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