Personal Finance: Financial Makeover - Keep it in the family

NAME: JILLIAN RAYNER AGE: 63 OCCUPATION: RETIRED

In 1997, Jillian, who is widowed, moved in to a cottage in Suffolk, and invested the balance of the proceeds from the sale of her previous home in a deposit account. She is currently renovating and decorating the property, and when it is finished she would like to sell it and build an environmentally friendly home, perhaps in Wales. The cottage will take another 18 months to finish, finances permitting.

Jillian's assets consist of her cottage, worth around pounds 65,000, and pounds 25,000 in a deposit account with Cheltenham & Gloucester. She receives a pension of pounds 73.46 per week (pounds 3,819.92 pa). The recent falls in interest rates are putting pressure on her tightly controlled income and expenditure arrangements, and she is looking for ways to increase her disposable income, including any possible government support. She is also concerned to ensure that as much of her estate as possible eventually passes to her three children.

The adviser: Thomas McPhail is pensions development manager for Wolverhampton- based independent financial advisers Torquil Clark (01902 576778).

The advice: Jillian will not be entitled to any income support unless her capital savings fall below pounds 8,000. There is no easy way around this situation, since the DSS will look closely to see if she has deliberately impoverished herself - by giving money to her children, for example.

The DSS assumes that capital of pounds 7,750.01 will generate income of pounds 20 per week. This is equivalent to an annual return of 13.42 per cent, which seems improbably high, particularly for cautious investors. Similarly, she is not entitled to any help with her council tax unless her savings fall below pounds 16,000.

Jillian's immediate priority is to make her money work harder for her. The Cheltenham & Gloucester account is paying just pounds 81.95 per month at the moment, and rates are unlikely to rise in the short term. Jillian has a cautious-to-moderate attitude to risk, and this must be taken into account. She cannot afford any significant loss of capital, so the alterations to her investment arrangements must err on the side of caution.

As a first step, she should take advantage of the modest tax breaks offered by the Government. A cash Mini-ISA can be used to invest pounds 3,000 of her savings in a tax-free deposit account. There are very few ISA providers paying monthly interest, of which Direct Line is among the best at 5.5 per cent.

For the pounds 3,000 equity element of Jillian's ISA entitlement the Fidelity Extra Income fund has been selected. This fund is yielding around 7.34 per cent. It invests in a mixture of corporate and high-yield bonds which should generate competitive levels of income with only low levels of risk. The combined income from these two tax-free investments will be around pounds 385 per annum.

A with-profit bond would be a suitable investment for a portion of Jillian's savings. An investment of pounds 10,000 into the Prudential Bond would generate pounds 500 a year. This can be paid monthly.

By limiting her withdrawals to 5 per cent Jillian will avoid a "chargeable event" occurring. This means that the income is ignored for income tax purposes, though it should be noted that the underlying investments in the fund are subject to tax. She can also look forward to the possibility of modest capital growth. A with-profits bond invests in the insurance company's with-profits fund, usually made up of a mixture of equities, gilts, cash and property.

The insurance company will add bonuses every year, which can be drawn as income, and they will normally guarantee that the value of the investment will not fall. This type of fund can pay a higher level of income than a deposit account because of the mixture of underlying investments. It would not be suitable for all of Jillian's money however, as it should normally be used as a medium-term investment, and it is important for her to retain access to some of her capital at short notice.

For her remaining capital, Jillian should consider placing it on deposit with Standard Life bank, which pays interest of 5.27 per cent gross, with no restrictions on access to capital.

Jillian's personal allowance is pounds 4,335, so she is currently liable for some tax on her savings income, which is being paid net of 20 per cent. As a result of the various investments she is making, the bulk of her income will be moved outside the income tax regime. In fact the only income which would be taxable is the interest on her deposit account, and because this income falls within her personal allowance she can register to have it paid gross. This is done by completing form R85. The result of these changes is that Jillian's investment income will increase from pounds 983 pa to pounds 1,357.

As far as passing on her estate is concerned, Jillian will not have any kind of inheritance tax (IHT) problem. Her total estate will be less than the nil rate band, which is set at pounds 231,000 for this tax year. If she wants to exercise control over her estate then she should think about drawing up a will.

For anyone who might facing an inheritance tax problem, the most obvious steps are to use up the annual gifts exemptions, redistribute assets to a spouse to use up the nil rate band for both partners and, if necessary, make lifetime gifts using suitable insurance to cover any Potentially Exempt Transfer liability.