Investment trust tips for all ages using Isas and pensions

There are two main ports of call for those looking to invest for the longer term and shelter their assets from the taxman: an Isa or a Sipp. Both are tax-efficient, with one important distinction: a pension attracts tax relief on contributions, whereas an Isa allows tax-free withdrawals.

‘The different tax treatment can be a considerable hurdle when thinking about how to construct an intelligent and long-term strategy for investing tax-efficiently, but overcome that hurdle you must, if you’re to avoid paying more tax than necessary on your investment returns,’ says Simon Bullock, a partner and chartered financial planner at central London wealth planner Mulberry Bow.

He points to advisers and their clients ‘taking another look’ at investment trusts in a fee-based world where closed-ended investment trusts are on an even footing with open-ended funds and the range of investment trusts has expanded to offer greater choice to long-term investors.

‘If used properly, the long-term advantages of gearing [borrowing to invest] are huge, and for those seeking a stable and growing income, the revenue reserve means that dividend payments can continue uninterrupted even at stress points in the market cycle,’ adds Tony Yousefian, investment trust research specialist at FundCalibre, the fund ratings provider.

But how should investors at different life stages slot investment trusts into a coherent and tax-efficient investment strategy?

Younger years

Because assets in both an Isa and a Sipp grow free of income and capital gains tax, the tax wrapper matters less for younger investors, provided you are not likely to be making withdrawals.

If access is an issue – maybe you will need the savings in the medium term to pay for some of life’s big-ticket items – use an Isa, as this money is accessible at any time.

If you are saving for retirement, however, Diane Weitz, a director of Ashlea Financial Planning in Cheltenham, Gloucestershire, says a Sipp ‘always trumps an Isa’ (unless the lifetime pension allowance has been hit), thanks to the immediate uplift from tax relief that contributions attract.

How you should populate either investment portfolio depends upon your risk tolerance and investment timeframe.

Weitz rates RIT Capital Partners, a global investment trust run by the Rothschild family, as a solid core holding for Sipp savers or Isa investors with an investment timeframe of at least five years. Francis Klonowski, founder of Leeds-based Klonowski & Co, likes 150-year-old Foreign & Colonial, the world’s oldest investment fund, for a ‘tried and tested’ global equity holding.

The longer the time horizon, the more risk you can take – making a case for those with at least 10 years to retirement putting riskier propositions into a Sipp.

‘As most investors tend to have a longer time horizon for their pension – an Isa might be used for something other than retirement savings – you can afford to hold higher-risk assets in the Sipp as you won’t be able to access them until age 55, rising to 57 in 2028,’ says Ben Yearsley, a director of Plymouth-based Shore Financial Planning.

‘On that basis you may put punchier growth-oriented investments – emerging markets, Asian or smaller companies, for example – in your Sipp.’

He highlights BlackRock Frontiers, which has half of its assets in Argentina, Kuwait, Vietnam and Egypt, as ‘higher-risk and longer-term’ and therefore an investment that would sit well in a Sipp for a long-term investor. Pantheon International, a private equity trust, Downing Strategic Micro Cap or Baillie Gifford Shin Nippon, which invest in small companies in the UK and Japan respectively, are others to lock away.

‘Obviously, don’t put everything in very high risk,’ adds Yearsley. ‘You need a balanced portfolio with a mix of UK and overseas investments, so include stalwarts such as Personal Assets and Murray International to give some ballast.’

Middle age

Many younger investors struggle to save significantly into a pension due to the expense of repaying a large mortgage or funding their children’s education, for example, so middle age could be the time to play catch up.

This is particularly true if you are a higher- or additional-rate taxpayer and expect to move down to a lower rate tax band in retirement, or if passing an inheritance to your heirs is a priority.

You could net tax relief of 40 or 45 per cent when making pension contributions, but pay 20 per cent when drawing an income from your pension pot. Pensions are typically held outside your estate so are free of inheritance tax (IHT) in most cases, whereas Isas are liable to IHT if left to anyone other than a spouse or civil partner.

During the accumulation phase, Klonowski advocates building up pension funds due to the tax relief on contributions and with pensions remaining the main source of regular income for most retirees.

‘Equally, a pension fund is not so good for ad hoc withdrawals,’ he notes. ‘That’s where the Isa and indeed any other investment capital comes in, because you can draw ad hoc sums without incurring fees.’

Klonowski gives the example of a client Tom, who is single, in his early 50s and has a one-man limited company providing IT services. He is paid a mixture of salary and dividends and is a higher-rate taxpayer.

Each year Tom’s company makes a single contribution out of surplus profits to his Sipp, while Tom himself makes a contribution to his Isa from surplus income. Klonowski maintains mirror asset allocations for each wrapper in line with Tom’s risk profile (70 per cent equities, 25 per cent bonds and 5 per cent property), with the equity allocation comprising a mixture of growth- and income-oriented trusts: Monks, which is focused on growth, and Bankers, which aims to grow capital and income. The latter has increased its dividend for 51 consecutive years and yields 2.2 per cent.

‘In this way, Tom builds up both his pension as an income source for regular outgoings and his Isa as a capital sum from which tax-free withdrawals can be made for one-off spending and holidays,’ says Klonowski.

If, however, you are a higher-rate taxpayer and expect to remain so in retirement, funding an Isa to produce a tax-free income stream is the better option, says Mark Stone, head of advice at Bristol-based Whitechurch Financial Consultants: ‘The option of taking income from an Isa first and then a pension could allow more to be passed to beneficiaries free of IHT.’


Once you are drawing income from your savings – either your Isa or your Sipp – it makes sense to hold some investments that are generating good yields.

Yousefian at FundCalibre likes City of London – a ‘real dividend hero’, topping the table alongside Bankers with 51 years of dividend increases. The former yields 4.3 per cent. Yearsley likes Standard Life Equity Income Trust, which yields 3.9 per cent and is among the next generation of dividend heroes, having consistently raised its dividend for 17 years.

While Isas provide tax-free income, most people use both an Isa and a Sipp to provide the most tax-efficient income in retirement. Klonowski highlights the potential of tax planning with pension income to ensure it remains within the basic-rate tax band.

Another client, Paul, recently retired early, three years before his state pension age. He used tax-free cash from his Sipp to buy a holiday home, leaving enough in cash to meet up to two years’ income. He draws a monthly income from this, which will reduce once he and his wife’s state pensions become payable. The remaining pension pot is invested 60 per cent in equities, 30 per cent bonds and 10 per cent property. Income generated by the investments is retained as cash to replace the monthly withdrawals.

One thing that can often get overlooked is that even though they might be taking benefits from their pension, most investors still need an element of capital growth.

‘While income-generating trusts are important, we have also included a good proportion of growth-oriented trusts,’ says Klonowski. ‘With assumed life expectancy of 30 years at retirement, it’s important that the underlying capital has a chance to grow.’

Tax breaks: how to make the most of your allowances

Income drawn from a pension is counted as income regardless of whether it comes from capital or dividends, and will be taxed at your marginal tax rate.

However, if generating a tax-free income stream is your priority and you have used your Isa allowance, you could think about making use of the annual tax-free dividend allowance in the future. This fell to £2,000 from £5,000 on 6 April 2018, but still enables you to take tax-free dividends up to this level from investments held outside a tax wrapper.

Think, too, about using your capital gains tax (CGT) allowance. Simon Bullock at Mulberry Bow gives the example of client Eileen, 52, who has a £300,000 Sipp, £100,000 Isa and has a further £100,000, which she is considering putting into an ‘unwrapped’ general investment account.

She is single and uses both her personal income tax allowance and basic rate tax band by undertaking part-time consultancy work, but has seldom used her CGT allowance. She wants to buy both a high-income debt investment trust and a growth-orientated emerging market equities one.

‘Holding the high income trust in the unwrapped pot, rather than her Sipp or Isa, is unlikely to be a smart idea; the investment income could push her into a higher tax band,’ says Bullock. ‘However, putting a growth-focused investment in this pot and crystallising annual gains could work well. This is unlikely to exceed her full £11,700 CGT allowance and frankly, if the investments do make more than 11.3 per cent per year and she pays some tax, she isn’t going to be crying into her soup!’

Keep up to date with all the latest financial news and investment tips by signing up to our newsletter. Email subscribers will also receive a free print copy of Money Observer magazine.  

Subscribe to Money Observer Magazine

Be the first to receive expert investment news and analysis of shares, funds, regions and strategies we expect to deliver top returns, plus free access to the digital issues on your desktop or via the Money Observer App.

Subscribe now

Add new comment