Wealth Check: 'My Navy cash isn't a drop in the ocean'

The problem

The problem

Alex Macrae, 40, has joined Civvy Street as an engineer after 22 years' service with the Royal Navy. But he must still deal with a legacy from his sea days: what to do with his £48,500 pay-off from the Navy.

"Should I use some of this to reduce my monthly debt outgoings or invest the whole lot in the hope that, if done wisely, it may produce a substantial sum by the time I retire?"

His wife, Rachel, has just qualified as a teacher and the couple have two children, Callum, nine, and Harriet, seven. The family expects money to be tight.

"We could resolve this by either extending the mortgage by five years or by using some of the grant to pay off a large slice of the mortgage," says Alex.

"On the other hand, I am also considering investing the bulk of the Navy payout in shares."

The couple have built up £2,500 worth of savings in Nationwide's e-savings account and £5,500 in Scottish Widows' UK equity income fund. There is also £5,000 in a Legal & General (L&G) income fund individual savings account (ISA), to which they add a further £250 a month.

Alex has just started receiving an annual pension of £8,500 from the Navy. He has also been investing in additional voluntary contributions (AVCs) for 14 years with Abbey Life, and plans to do so until he is 55. But his new employer is offering a stakeholder pension with L&G. "I wonder if I can pay into my Abbey Life AVC fund as well as the stakeholder?"

Rachel has yet to invest in a pension but has built up £1,500 in a Nationwide mini equity ISA.

The couple recently moved to Warwick, taking out a £125,000 mortgage on a £280,000 house. They have a tracker loan with Nationwide offering 0.4 per cent above the base rate for two years.

As for insurance, they have an Abbey Life plan giving £50,000 joint cover for a £27.50 monthly premium. Alex also has an AXA with-profits endowment policy providing £35,000 worth of cover to the age of 65, when a lump sum will be paid out.

Interview by Sam Dunn

The patients

Alex and Rachel Macrae from Wellesbourne, Warwick.

Jobs: Alex is a Serco defence engineer, Rachel a newly qualified teacher seeking full-time work.

Income: £28,500.

Savings: £2,500 in an online savings account with Nationwide.

Investments: £5,500 in a Scottish Widows unit trust, £6,500 in stocks and shares individual savings accounts.

Goal: to find the best use for Alex's £48,500 Navy payoff.

The cure

The Navy grant should be split and used for different financial goals rather than targeting just one priority, says Philippa Gee of independent financial adviser (IFA) Torquil Clark. At least half the sum should be used to repay a chunk of the mortgage.

Kevin Anderson of IFA Budge & Co suggests Alex should also leave some of the money in an instant access account for emergencies.

Ben Yearsley of IFA Hargreaves Lansdown says it might be worth waiting until Rachel has found a job before they act, leaving the cash in the Nationwide account instead.

Savings

Alex won't be allowed to put money into a mini cash ISA this tax year since he is already investing in a maxi equity ISA with L&G, says Mr Yearsley. However, up to £3,000 of the Navy cash could be invested in a mini cash ISA in Rachel's name.

Both he and Ms Gee recommend Abbey's postal ISA deal. This offers 5.35 per cent and guarantees to be at least 0.5 per cent above the base rate until 1 April 2005.

It's also worth considering Yorkshire building society's cash ISA, which pays 5.2 per cent, adds Ms Gee.

The Nationwide account should be topped up to between £5,000 and £10,000 for "rainy day" savings, advises Mr Anderson.

Investment

Using much of the grant for direct investment in shares would probably be too high risk, says Ms Gee. In any case, Mr Anderson believes that the L&G and Scottish Widows funds are both "excellent performers".

However, Mr Yearsley disagrees: "Alex is in the right kind of investment [income funds] but not in the right funds themselves; neither [of the above companies] would be my first choice for equity investments." The Invesco Perpetual, Jupiter or Artemis Income funds are worth considering instead, he says.

Alex should stick with the AXA endowment policy, adds Mr Anderson.

Property

With signs that interest rates are near their peak, a tracker loan is a sensible choice, says Mr Yearsley.

Subject to penalties, Alex should consider using up to half of his Navy payout to reduce the mortgage, says Ms Gee. "The one proviso is that any money saved be invested elsewhere to build up his [savings] again."

Mr Anderson says they could then consider overpaying on their loan when Rachel secures a full-time job.

Retirement

Since Alex is no longer part of an occupational pension scheme, he won't be able to invest in the Abbey Life AVC fund, says Ms Gee. He should consider switching the AVC premiums into the stakeholder, particularly as his employer will match his contributions.

Mr Yearsley agrees, saying Abbey Life's track record has been "moderately awful". If the penalty isn't too high, Alex might also want to transfer his money from this fund into the stakeholder plan.

With any pension transfer, it's worth visiting a specialist IFA for advice.

Rachel should join the pension scheme for teachers when she gets a job, adds Ms Gee. "However, if it takes longer to find the right post, it may be worth considering a stakeholder [in the meantime]."

Protection

The couple's mortgage is not adequately covered by their current insurance, warn our IFAs. Since the cost of simple life cover has been falling, they can, in effect, get twice as much insurance for the same price. L&G offers £125,000 joint cover up to the age of 65, for £30.88 a month, says Mr Yearsley.

If you would like a financial makeover, write to Melanie Bien at The Independent on Sunday, Independent House, 191 Marsh Wall, London E14 9RS, or email m.bien@independent.co.uk