The starting-point was to identify their objectives. Colin and Margaret explained that they wish to use the funds for their 10-year-old daughter Laura's private education.
Laura's current school fees are pounds 8,000 a year, which to date have been paid for out of earned income. Both Colin and Margaret are higher-rate taxpayers so this is not tax-efficient, but until now it has been the only method open to them. It was decided to stop funding from income and, instead, use the pounds 60,000 capital.
The next step was to consider the levels of acceptable investment risk, bearing in mind the time scale. In the case of Colin and Margaret, there is an ongoing liability of at least pounds 8,000 a year until Laura reaches age 16, at the earliest. They decided to split the funds available.
So pounds 16,000 was set aside to finance the anticipated cost of fees for the next two years. This sum was deposited in a postal account offering a competitive rate of interest. The interest earned will be liable to tax at 40 per cent, but the capital is protected from short-term fluctuations in its value.
The investment period for the balance of the funds ranged from the third academic year onwards. This is still a relatively short time scale, so it is important not to take unnecessary risks.
I therefore recommended that Colin and Margaret make full use of their general Pep allowances of pounds 6,000 each. Colin had previously invested in a share-based, unit trust Pep. I explained that because of the relatively short-term investment period envisaged, a further share-based Pep would not be appropriate.
Instead, I recommended they each invested in corporate-bond-based unit trust Peps. Corporate bonds are loans made by investors to companies, for a specified term. In general, the investor receives an annual fixed dividend, with capital being returned on the redemption date. They are generally seen as lower-risk than equity-based Peps, but the capital is not guaranteed in the same way as a cash deposit. I recommended that the relatively high income be reinvested, to increase the value of their capital.
With the rest of the funds, Colin and Margaret chose a portfolio of zero- dividend preference shares of split capital investment trusts ("zeros"), which offer a combination of low-risk and tax-efficient returns. A split capital investment trust invests in shares and securities of other companies. It has, however, two classes of shares, as well as a predetermined life span. When it reaches the end of its life, the zero shares have priority call on the underlying assets of the investment trust.
Zeros provide for investment purely in the form of capital growth. So any increase in value can be set against Colin and Margaret's annual capital gains tax allowances. Everyone has this useful allowance, but few understand and make use of it. The CGT allowance is set at pounds 6,800 for the 1998/99 tax year.
This combined portfolio will finance Laura's education in a tax-efficient manner. As for the pounds 8,000 a year Colin and Margaret will save, they have decided to use them to fund early retirement - but that's another story.
James Bruce is a senior financial planner at the fee-based independent advisers Corporate and Personal Planning. Highwoods Square, Highwoods, Colchester, Essex CO4 4BB (01206 853888)Reuse content