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Multi-manager view

Around 3.4 million people are caught by the 40 per cent income tax rate and a large number of these are retired.

In this year’s Budget, the starting point for paying higher-rate tax was again not increased in line with earnings. The means that a further 100,000 or more people will now be paying income tax at 40 per cent. On the other hand, only about 170,000 people pay capital gains tax in any tax year.

Why are these facts important to those who use multi-manager products? Because large numbers of higher-rate taxpayers seeking income from their investments totally ignore their annual CGT exemption. Many such investors will use index-linked savings certificates and Isas and possibly VCTs if they are more adventurous. Some will take tax-deferred withdrawals from life insurance bonds but unless they are going to stop being higher-rate taxpayers at some stage, this is not a good solution.

Over a reasonable timescale, equities will typically outperform other forms of investment. Regular withdrawals out of the growth from an equity portfolio will effectively provide additional tax-free “income”. The problem, of course, is that equities can perform badly for sustained periods and they can lose substantial proportions of their value very quickly. Making regular withdrawals to provide “income” in a falling market does not make sense as a greater number of units have to be sold to provide the required withdrawals.

An effective solution to this problem has been provided by WAY Fund Managers, a multi-manager provider which has grown out of an investment IFA practice. The WAY Income Plan is uses the longer-term growth potential of a multi-manager international equity portfolio, combined with the short-term security of cash deposits from which the “income” withdrawals are made. Although withdrawals of units are made from the equity portfolio, these are taken only after a period of capital growth as they do not have to coincide with the need for income of the investor. The withdrawals from the equity portfolio are used to top up the cash fund.

Under the plan, the investor chooses a level of “income” of, say, 3 to 5 per cent and in this range there is the possibility of an increasing income in the future. Higher levels of “income” are possible but in present conditions investors would be well advised to exercise restraint. A sum equal to five years’ worth of drawings (for example, 20 per cent in the case of 4 per cent income) is taken from the amount to be invested and placed in the Elite income plan cash trust. This means that the investor has security of income for the next five years.

The balance of the money (say, 80 per cent in this case) is invested in a multi-manager fund. A number of the WAY portfolios use Citywire-rated IMS investment managers Paul Kim and Richard Timberlake. Subject to the outcome of each quarterly “rebasing” review, a portion of any capital growth achieved within the portfolio is automatically transferred to top up the cash fund and leads to pro rata increases in the level of income. Investors are freed from day-to-day concerns about short-term stockmarket volatility. The plan aims to withstand prolonged bear markets, without any need to reduce drawing levels or to dilute the growth portfolio.

The process is very tax-efficient. There is a liability for CGT on transfers from the multi-manager portfolio to the cash fund but these should be within the investor’s annual CGT exemption.

The plan is available on a joint life basis, so up to 17,000 during the 2005/06 tax year would be able to be removed from a married couple’s multi-manager portfolio in a rising market, without attracting CGT. Tax has to be paid on the interest generated by the cash account. However, investment tax will be deducted at source and as, say, only 20 per cent of the investment is held in cash, the actual amount of tax paid by the investor as a percentage of his total investment will be minimal.

WAY Fund Managers has taken its income plan a step further by linking it to its series of inheritor trusts. Investors can make a potentially exempt transfer for inheritance tax purposes, while generating a longterm and potentially rising income for themselves.

Arthur Childs is managing director of Arch Financial Planning

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