Realising capital without being taxed

NAME: David and Yvonne Richards

DATES OF BIRTH: 7-6-1966 and 2-9-1963 respectively

OCCUPATIONS: Manager/ housewife

BACKGROUND: David and Yvonne live near Cambridge and have two young children, Lauren, aged four, and William, who will be one in May. David earns pounds 33,500 and has a company pension scheme through his employer, which also provides death in service and a widows benefit.

Using the Save As You Earn share option scheme at his workplace, David has built up quite a substantial nest egg, the first tranche of which can be exercised this September. However, there are tax implications to share option schemes and the two other schemes he has cannot be exercised for a few years. Yvonne works one day a week, which brings in a small salary to help with general living expenses.

They have moved house a number of times and are in the throes of completing their latest move. They have a large mortgage of approximately pounds 100,000. They have very little money in the building society and David has a personal accident policy.

THE PROBLEM: David and Yvonne want to reduce their mortgage because they feel rather exposed with their high level of debt at the moment. They also want to ensure they are making the most of their pension arrangements and are looking to build up a sum in the building society and to start a longer-term savings plan to help with Lauren's and William's education at university. They have both made wills.

THE ADVISER: Tim Cockerill, investment director of Whitechurch Securities, a firm of independent financial advisers, based in Bristol.

THE ADVICE: The key to achieving David's and Yvonne's objectives is through reducing their mortgage. As they have no spare money in the building society their only route to do this is through the share option scheme.

In September, when the first tranche of David's share options becomes available they will have in the order of pounds 34,000, but if they were to realise all of that money they would face a capital gains tax bill of approximately pounds 5,000.

In order to minimise their liability to tax David should look to gift to Yvonne the maximum number of shares possible at the time the scheme is exercised to enable her to use her capital gains exemption, which will be pounds 6,500.

David can obviously use his exemption in the same way. In addition, he can transfer pounds 3,000 from the share option scheme into a single-company PEP and that would then allow him to raise money free of taxation. As a rough estimate (because of fluctuating share prices) they will have approximately pounds 20,000 that they could use to reduce their mortgage.

In reducing their mortgage they would then reduce their monthly payments by something in the order of pounds 120. However, my recommendation would be to reduce the mortgage by pounds 16,000 and retain the balance of pounds 4,000 in their building society to act as a buffer against unforeseen expenses. This would still reduce their monthly payments by about pounds 100.

The alternative is to use all of the money to reduce the mortgage. As Yvonne and Richard no doubt realise, these figures can be juggled several ways.

Their building society account is with Woolwich and they will benefit from free shares which in turn could be sold and the money held in the building society account.

However, there is a tax implication and transferring these into a general PEP should be considered. This buffer is very important because if they need any money at short notice they could sell the shares without capital gains tax liabilities. They have 42 days from receipt of the shares to do this.

Having reduced their outgoings they could then use the additional money in a number of alternative areas. David needs to ascertain how much additional contribution he can make to his pension fund and while I would not recommend a commitment to further funding of his pension scheme at this stage, because finances are pushed to the limit, it is important to know exactly where you stand. Yvonne is only earning pounds 2,500 per annum, and again I would not recommend a pension contribution at this stage.

They should consider a further pounds 100,000 of life cover as Yvonne does not have any and because of their mortgage.

Finally, any spare money they have at the end of the month could be put into a regular savings PEP with a view to this being a long-term investment for the education of their children. The PEP is tax free and it is flexible in that you can increase, decrease or stop contributions and start them without penalty. They are obviously longer-term investments but well worth considering.

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