As is often the case with business owners who have sold the company that they have dedicated the majority of their lives to, Andrew and Louise initially struggled to adapt to their situation post-sale. While from the outside it may have appeared that they had no reason to feel melancholy, a lot of our clients compare the sale of their company to bereavement, and so it is important for a financial planner to be sensitive to such feelings. Furthermore, with wealth comes responsibility, and both Andrew and Louise confessed that they were struggling with the expectations of those around them.
Following our initial meeting and the subsequent data gathering exercise, we built a cashflow model using our bespoke tool, asset and income modelling systems (or AIMS) to assess their current financial situation.
Our analysis indicated that Andrew and Louise were in a very strong financial position. However, it also highlighted that should Andrew’s earnings cease, they would need to use available capital to fund an income shortfall. Furthermore, with the size of their estate having increased substantially, they were obviously concerned with how it would be managed for the benefit of their children if they were they to die prematurely, and who should be there to support their children in this instance.
We typically recommend that clients retain a cash reserve of at least three years’ worth of expenditure. However, Andrew had already stated that he was likely to be interested in other business ideas in the future, and given their relative youth, they stated that they would be keen to consider other projects also, some of which may be philanthropic in nature.
It was therefore important that we set aside a substantial cash reserve, that not only covered their capital gains tax liability from the sale of the company, but would also enable them to fund any projects that captured their imagination in the future. We agreed that they should retain £6.1m on deposit, with £500,000 as their base cash reserve, £1.6m retained to pay their tax liabilities and the residual £4m earmarked for future projects.
This exercise highlighted the importance of thoroughly researching your client’s position and ensuring that you have a comprehensive understanding of their state of affairs
Having also accounted for gifting, this left approximately £6m to commit to a longer term investment programme that would provide an income as and when required, but which would also target overall growth with the aim of protecting their wealth against the effects of inflation.
Initially, we dealt with the more pressing estate planning issues. We engaged the services of a local firm of solicitors with a view to drafting new wills and ensuring that suitable executors, trustees and guardians were appointed. We also agreed that they should affect lasting powers of attorney and consider opportunities to mitigate inheritance tax (IHT).
We had originally considered making full use of their available nil rate bands, with both Andrew and Louise each gifting £325,000 to a discretionary trust. However, on undertaking a more thorough review of their situation, we discovered that they had both made chargeable lifetime transfers exceeding the nil rate band to an employee benefit trust within the last seven years, although the trust had since been wound up. This exercise highlighted the importance of thoroughly researching your client’s position and ensuring that you have a comprehensive understanding of their state of affairs. Further chargeable lifetime transfers of £650,000 would have resulted in an immediate inheritance tax liability of nearly £130,000.
Working closely with their solicitor, we were able to help Andrew and Louise put suitable new wills in place. In addition, we helped them to draft appropriate letters of wishes, the importance of which becomes apparent when one considers the impact that their premature death would have on their two young children, and we also met with their executors and trustees to explain the duties and responsibilities of such a role. The planning that had been undertaken had given Andrew and Louise peace of mind – if the worst were to happen, the trust structures that were included in the will would help to both support and protect their two children. They were also satisfied that they now had a team of advisers who would be there to offer support to the executors/trustees of their estate. Andrew and Louise were also keen to help family and friends and to consider making gifts to their favourite charities.
Using our cashflow tool, we were able to show them that they could more than afford to make both large, single gifts and smaller, regular gifts. Indeed, while their income exceeded expenditure, regular gifts out of excess income would be immediately free from IHT, as would gifts to registered charities. We helped them to put a structured gifting programme in place and developed a spreadsheet that they could use to track both income and expenditure.
We took the time to introduce them to our investment process, which helped them to gain a good understanding of general investment theory
Although they were unable to make more substantial gifts into trust immediately, once the seven year clock stops ticking on the aforementioned chargeable lifetime transfers, they will have considerable scope to establish large trust funds that could be used to further benefit their children and families, and which would also help to mitigate their IHT liability. We advised them that we would keep these options under review at future planning meetings. Having addressed their estate planning issues, we then turned our attention to investment planning and the ongoing management of Andrew and Louise’s wealth. Although Andrew and Louise had a broad understanding of financial risk, having run their own business and managed a property portfolio, they were new to the world of investment. We therefore took the time to introduce them to our investment process, which helped them to gain a good understanding of general investment theory, FPC’s investment philosophy and principles and how all of that is put into practice when building a portfolio for clients.
Once we were satisfied that Andrew and Louise had a better understanding of the investment process, we set about determining a suitable risk profile for their portfolio. Having assessed their risk tolerance, we established that Louise was slightly more risk averse than her husband. Additionally, it was clear from their cash flow model that they had a high capacity for risk, although our analysis indicated that they didn’t need to take a lot of risk in order to meet their objective of funding an income shortfall. Nevertheless, we agreed that they needed to take a degree of risk if they were to protect the value of their portfolio against inflation over the long term.
The rental income generated by their property portfolio meant that both Andrew and Louise were higher rate taxpayers and so we agreed that, where possible, it would be important to shelter any taxable income that would be generated by their investment portfolio from higher rates of tax.
We designed a tax efficient investment portfolio with two elements: a component that could be used to deliver tax deferred income and a component that would target long-term growth, but which would also be used to take advantage of their annual capital gains tax allowance on an ongoing basis. There was also obvious merit in utilising their ISA allowances and maximising pension funding for Andrew.
Any withdrawals that they may require would be delivered from a £2.2m onshore investment bond portfolio which targets an allocation to growth assets of approximately 50%. The tax deferred withdrawal facility would provide sufficient funds to cover any shortfall that may arise, while income and gains would be sheltered from higher rates of tax immediately. We also recommended that they invest £800,000 into a portfolio of actively managed unit trusts/OEICs held on a platform, targeting a 100% allocation to growth assets. We selected low yielding funds geared towards capital growth, which meant that we would be restricting dividends that would be subject to higher rates of tax and that we could actively tax harvest on an annual basis in a bid to use their annual capital gains tax allowance where possible.
We recommended that the residual £3m be invested into a ‘hybrid’ portfolio, targeting an allocation to growth assets of around 50%. The income producing assets would be held in an offshore bond, deferring tax on both income and any gains, and the assets targeting capital growth would be held in a unit trust/open-ended investment company portfolio on a low cost platform. We employed a passive strategy within both elements of the hybrid which enabled us to keep costs as low as possible.
Our own research and analysis has shown that active tax management can add around 1% per annum to the value of an investment portfolio over the long term. Furthermore, high investment costs can significantly reduce a client’s return. Overall, our recommendations resulted in annual provider and fund charges amounting to just 0.5%. Ultimately, we are keen to ensure that our clients keep as much of their investment return as possible.
Paul Welsh CFPTM App Chartered MCSIPaul is a CERTIFIED FINANCIAL PLANNERTM and a Chartered Financial Planner, as well as an affiliate of STEP. He has worked as a Paraplanner at the Financial Planning Corporation, a firm of Chartered Financial Planners based in Southport, Merseyside, since March 2010.Paul assists the firm’s partners in delivering a bespoke financial planning service to high net worth private clients, typically current and retired business owners and successful executives, and their families.