Ken recently enjoyed a share bonus of around £2m net from his employer. Apart from covering school fees and his mortgage, he wants his wife to be able to cease working but to have her own income from investments. He would also like to have enough to invest in a second property. Please could you advise him Ken's own earnings of around £120,000 plus £200,000 bon uses are sufficient to keep the family in its current lifestyle but not to achieve the objecti ves set out above, particularly as his wife has been earn ing a similar income to his.
His first step will be to pay off his mortgage and debts of around £1m but that will not leave enough to achieve all the above.
However, his objectives are achievable if we can take a medium-term view. We propose this sort of approach:
l Use his forthcoming bon uses to reclaim at least some of the tax paid on the share bonus by investing in an ent er prise zone property syndicate. An investment of £400,000 in this tax year should leave him in a neutral cashflow position once the tax has been reclaimed.
The use of non-recourse loans (covered by rental inc ome) will gross up this investment to nearly £1m. The effect is to replace a tax bill with a medium-term geared property investment with a net cost of only about £30,000.
l Set up a “sinking fund” of around £500,000 from which his wife can draw up to £7,500 a month.
l Establish a growth portfolio of around £500,000 to include the proposed property investments. Ken might need to top up this growth fund with his annual bonuses.
After seven years, the “sink ing fund” will have been ero ded entirely but the growth fund should by that time be worth over £1.7m. The enterprise zone property should then be sold.
If there is a profit, Ken will receive back his investment plus (hopefully) a profit share. Obviously, it follows that if the property is sold at a loss, he will get back less than the initial investment but that is still more than one will get back from the Inland Revenue.
Conservatively, the enterprise zone property syndicate will boost the fund to over £2m – a big enough sum to ach ieve all Ken's aims.
Looking more closely at how to construct the portfolio comprising the £500,000 “sink ing fund” and £500,000 growth fund, a conventional income portfolio might not be strictly appropriate. Flexibility and liquidity will be an issue.
Ken wants to invest in another property and the short-term cash req uirements might be a little heavy for a conventional portfolio to bear.
The “sinking fund” will be made up of cash or near cash investments whereas the growth fund can be a mixture of equities and perhaps the property investment. Ideally, over the next couple of years, Ken will add to the growth fund with his annual bonuses or part of them.
Ken's wife will make her monthly drawings of £7,500 from the sinking fund. Clearly, at that rate of drawing, the fund will be more or less depleted by the end of seven years.
Over the same term, however, the growth fund will hopefully grow sufficiently to replace this capital. Ideally, it will achieve additional capital growth to effectively inflation-proof the portfolio.
We can wrap most of the investment in the growth fund – the monetary investments, anyway – within an offshore bond to minimise the effects of capital gains tax. After the end of the seven-year term, Ken's wife can draw a tax-sheltered income.
The sort of investments one uses for the growth fund need not be particularly agg ressive or speculative.
Within the growth fund, it will be appropriate to earmark a certain element to pay school fees – using zeroco upon shares perhaps. That section of the portfolio should be ring-fenced from the rest for safety.
However, it is also possible to identify other elements to be included within the growth fund. For example, the enterprise zone property syndicate can be part of it, as can Ken's res idential property investment.
The general thrust of our strategy is that by using cash to buy time and to maximise medium-term tax-efficiency, Ken can build up a portfolio that will sustain him and his wife at the end of the seven-year term.