Personal Finance: Budget for future investments

THE MAKEOVER

Name: Ryan Williams

Age: 49

Occupation: Engineer

The problem: What to do with cash "slopping around" in a PEP, which he does not know what to do with. He is concerned that the UK stock market may be over-valued at present.

The advice: Look to corporate bond PEPs as an alternative way of using your tax-free allowances with the possibility of some capital gains but without the same risk as with equities.

Ryan Williams is 49 and married with two children, both of whom have flown the nest. He and his wife are members of their employers' pension schemes. Their home in paid for and valued at around pounds 150,000. He has some cash on deposit with a building society. Their major investments are in self-select PEPs worth around pounds 65,000, of which around pounds 40,000 is currently held in cash. In addition, they hold around pounds 10,000 of equities and Mrs Williams contributes the maximum to an employee share option plan (Esop). Both have Tessa's.

Ryan is concerned about the impact of the Budget on his financial planning, and is looking for suggestions regarding future investment strategy, with the main priority being capital growth. He earns pounds 25,000 a year and has a company car. Mrs Williams earns pounds 10,000.

The adviser: Bruce Clark, of the independent financial advice firm Fraser Smith, Maple House, High Street, Potters Bar, Herts, EN6 5BS, 01707 672900 (the firm also has a London office).

The advice: Ryan and his wife are in a reasonably strong financial position, having paid off their mortgage. He has been a member of his final salary company pension scheme since he started work over 30 years ago and has regularly topped up his contribution each year to the maximum 15 per cent of salary allowed, via a free-standing additional voluntary contribution (FSAVC). He pays pension contributions net of 23 per cent basic rate income tax, which is claimed at source.

He should continue to fund at the maximum level to the FSAVC to take advantage of the tax reliefs while they last.

There is a word of caution, however. Ryan may be close to earning the maximum two-thirds pension and should check each year that his additional contributions won't result in an over-funding problem. Since it is possible to include all taxable emoluments, this rarely causes a problem. Pension schemes tend to provide benefits linked to basic salary only and so exclude bonuses and other benefits in kind, such as the company car.

To get a full picture of income in retirement, a forecast of the potential benefits available to both Ryan and his wife should be obtained, as well as a forecast of state benefits, which can be obtained by completing DSS form BR19. A cashflow management exercise can then be undertaken which will identify the income set to be generated from all sources during retirement.

The couple both have Tessas. The announcement that existing Tessas will be able to continue their five-year life span is to be welcomed. It makes sense to maximise Tessa contributions to enjoy the tax-free benefits of this investment. Contributions to Tessas can continue for their normal five-year life, and the capital value can then be rolled over to an Individual Savings Account (ISA) without impacting upon the normal annual allowance.

The future of PEPs was also clarified, with the pounds 50,000 limit for transfer to the new ISA scrapped after sustained industry lobbying. This is good news for Ryan with PEP holdings of pounds 64,000 and 1998/9 PEP allowances still to use. Mrs Williams has still to use her 1997/8 PEP allowance and has been considering a corporate bond PEP.

A corporate bond is similar to a gilt issued by the government, except that it is a loan stock issued by a private company paying a fixed interest rate. The capital value fluctuates in line with market expectations, although they are more stable than equities. Ryan is concerned with the prospect of a single currency, but this development should see UK interest rates fall into line with the generally lower rates in Europe, and this is expected to boost the capital value of UK corporate bonds.

Ryan is holding so much cash in his PEP because of concerns about the height of the UK stock market, hence the interest in the corporate bond PEP. Mrs Williams should structure this by making use of her general PEP allowance. The fund selection can always be varied in the future. The relatively high yield available of, say, 7.8 per cent could be reinvested to boost capital growth, as income is not needed now.

Corporate bonds could also prove to be a more attractive investment than cash in Ryan's PEPs for the reasons highlighted above.

Although the traditional bed-and-breakfast arrangements have been outlawed, selling part of their direct equity portfolio for reinvestment into the more tax advantageous PEP environment is still permitted, but care would have to be taken to ensure the gain on any shares sold remained below the annual CGT exemption. Indexation will only apply on gains until 5 April 1998, so short-term gains will be taxed at a higher rate, (40 per cent) than long-term gains, (24 per cent).

Mrs Williams has been contributing the maximum pounds 250 per month to a Esop share save scheme with her employer. The first tranche of shares is due in the next tax year, and any encashment could possibly utilise both of their annual CGT allowances. The shares have benefited greatly from the rise in banking stocks in recent months.

They have sufficient death-in-service and income protection benefits in the event of illness, provided by their employers. However, they do not have a will. This is a number one priority for them.

Their combined estate is more than the inheritance tax exemption limit of pounds 223,000 (from 6 April), and a lack of some simple estate planning at this stage, such as planning to use at least part of the first nil rate band, could end up costing their children some of their inheritance, particularly if the more penal inheritance tax regime expected under Labour is introduced in the next few years.

They should also address the issue of long-term care in old age. The role of the state is being greatly reduced and, although we are awaiting the Royal Commission report on this, this is an issue of growing importance for many people like the Williams.