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IMC IE Chapter 10 > 10.5 Tax Wrappers > Flashcards

10.5 Tax Wrappers Flashcards

1
Q

How are ISAs a form of tax wrapper?

A

They wrap around many types of investment and make them much more tax efficient.

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2
Q

Name 6 tax wrappers.

A
  1. Pensions
  2. ISAs
  3. Junior ISAs
  4. Life Company Funds
  5. Venture Capital Trusts (VCTs)
  6. Enterprise Investment Schemes (EISs)
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3
Q

List 3 tax benefits of pensions.

A
  1. Tax efficient funds, such as pension funds, pay no income tax or capital gains tax
  2. Up to 25% can be withdrawn as a tax-free lump sum on retirement (referred to as a pension commencement lump sum (PCLS)). The rest of the pension fund is used to provide for retired life and is taxable.
  3. Tax relief on each contribution at the investor’s highest marginal tax rate. This means that for every £100 contribution to a pension a higher rate taxpayer pays £60 and a basic rate taxpayer pays £80.
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4
Q

What is the main disadvantage of having a pension?

A

Your money is tied up and not accessible until later in life, at the moment the earliest is 55 years old.

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5
Q

What is the maximum contribution to a pension per tax year?

A

The higher of:
• £3,600
• 100% of an investor’s pre-tax earnings (up to a maximum of £40,000)

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6
Q

How much is the a maximum lifetime allowance?

A

£1,073,100 (this is index-linked)

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7
Q

What happens if someone pays above the maximum lifetime allowance?

A

Any value above this at retirement will be subject to a lifetime allowance charge of 25% on income or 55% on lump sums.

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8
Q

In which instances is the pension tax relief annual allowance reduced?

A

If ‘adjusted income’ (income plus employer pension contribution) is over £240,000 the pension tax relief annual allowance in the same year will be reduced. The allowance is reduced at a rate of £1 for every £2 that adjusted income goes over £240,000. The drop is limited so that the minimum tapered annual allowance is £4,000.

For example, someone with an adjusted income of £250,000 would have an allowance of £35,000.

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9
Q

Explain the lump sum payment.

A

Money can be withdrawn directly from the accumulated fund without having to buy an annuity or put the money into drawdown. 25% of the accumulated fund will be tax free. This is called an uncrystallised funds pension lump sum (UFPLS). One or more UFPLS payments can be taken over the retirement period and these can be regular or irregular payments. Any lump sum above the 25% tax-free amount is taxable.

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10
Q

Explain a lifetime annuity.

A

Some, or all, of the accumulated fund can be used to buy an annuity that will be payable until death. This option has always been available. The tax-free lump sum of up to 25% of the fund can still be accessed before the annuity is purchased. Any income from the annuity is taxed as income.

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11
Q

Explain flexi-access drawdown.

A

The accumulated fund can be put into a drawdown fund. From 6 April 2015, there are no limits on the amount taken from the drawdown fund each year. A tax-free pension commencement lump sum of up to 25% of a pension pot can be taken when the fund is put into drawdown. Any drawdown payments are taxed as income. Note: Once drawdown has been accessed, the annual pension allowance falls to £4,000. This is referred to as the money purchase annual allowance.

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12
Q

Explain pension flexibility.

A

Under the Pension Act 2008, investors now have the flexibility to take a lump sum payment or lifetime annuity or flexi-access drawdown. If a person dies before 75 years of age, they can leave their remaining defined contribution pension savings to any beneficiary tax-free. If death occurs after 75, the beneficiary will be subject to income tax on income and lump sums.

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13
Q

What are ISAs?

A

Individual Savings Accounts (ISA) have a big impact on investment income. ISAs are not products themselves, they are tax wrappers that protect investments from income tax and capital gains tax.

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14
Q

How much can be contributed to an ISA in tax year 2021/22?

A

In the tax year 2021/22, £20,000 in total can be contributed across the different individual saving accounts. All of the £20,000 could be placed into one of these types of ISAs or it could be split between them (subject to product limits).

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15
Q

What do Cash ISAs contain?

A

• Savings in bank and building society accounts. • Some National Savings and Investments products

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16
Q

What 6 things do stocks and shares ISAs contain?

A
  1. Shares and bonds listed on a recognised stock exchange 2. Shares from a save as you earn (SAYE) share option scheme or share incentive plan 3. Core capital deferred shares issued by building societies 4. Units or shares in unit trusts, OEICs or UCITS funds 5. Life insurance policies 6. Stakeholder medium-term products
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17
Q

Explain the Help to Buy ISA.

A

The Help to Buy ISA allows an initial maximum deposit of £1,200, followed by monthly investment of up to £200 per month. The account earns interest, and a bonus of 25% of the account is paid on completion of a house purchase, with the maximum bonus being £3,000. Help to buy ISAs were closed to new applications on 30 November 2019, although investors can continue to save into accounts opened on or before this date.

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18
Q

Explain the Lifetime ISA.

A

A Lifetime ISA was introduced in April 2017 and is available to adults under 40. There is an annual investment limit of £4,000 and a government bonus of 25% of the amount invested. The money can only be used as a deposit on a house or to save for retirement.

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19
Q

Explain Innovative finance ISAs.

A

Innovative finance ISAs allows loans to be made through authorised peer to peer lending platforms.

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20
Q

List 3 other additional features of ISAs.

A
  1. ISAs can be transferred to other providers – this preserves the tax wrapper, but may incur transfer costs 2. Since April 2016, savers can take money out of ISAs and replace it in the same year without it contributing towards their annual subscription limit with the exception of the Help to Buy and Lifetime ISA 3. If the ISA investor moves abroad, the tax benefits remain, but they are no longer allowed to contribute to their ISA
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21
Q

Who are junior ISAs available to?

A

The government introduced Junior ISAs (JISAs) from 1 November 2011. These are available to children under the age of 18 who were either born after 2 January 2011 or who were not eligible for a Child Trust Fund. Existing CTFs will continue to function for those eligible. For the purpose of the IMC exam, CTFs have the same features as JISAs.

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22
Q

What are the 4 key features of JISAs?

A
  1. A JISA can be opened by anyone with parental responsibility for the child (or by children themselves from age 16) 2. Maximum investment in a JISA is £9,000 per tax year which may be split between cash, stocks and shares 3. Any income generated in an ISA that a parent has funded will not be taxable on that parent 4. There is no access to the JISAs cash proceeds until the child’s 18th birthday
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23
Q

What is an offshore fund?

A

An offshore fund is essentially a unit trust, with the exception that it is domiciled overseas. As with a unit trust, investors’ money is pooled and then invested in the shares of companies and/or other assets.

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24
Q

Do offshore funds pay tax?

A

The fund itself also does not pay UK tax.

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25
Q

What are the two categories of offshore funds?

A

Offshore funds are classed as either reporting or non-reporting (‘roll up funds’).

26
Q

Explain reporting funds.

A

Reporting funds are those which have applied to HMRC for reporting status and report income. The distributions from such a fund are paid gross. Reporting funds distribute at least 85% of their income. Income is paid to investors gross and is treated as taxable income for UK residents. Any subsequent gains on the disposal of units are subject to capital gains tax.

27
Q

Explain non-reporting funds (‘roll up’ funds)

A

Non-reporting funds distribute less than 85% of their income. They usually reinvest (‘roll up’) their income and do not pay dividends. Gains on the disposal of units are subject to income tax, not capital gains tax.

28
Q

What do life assurance companies offer?

A

Life assurance companies do not just offer life protection, but also offer investments to their policyholders.

29
Q

What are life company bonds?

A

Investment life assurance companies offer their policy holders are called life company bonds. Although these are not bonds like the debt instruments. Instead, these bonds are linked to a portfolio of assets and the income and gain on the bond is determined by the performance of the assets under management.

30
Q

What happens when life company bonds take the form of endowment policies?

A

They offer a basic sum assured on death of the policyholder or on maturity of the policy.

31
Q

What are with-profits bonds?

A

Life company bonds which offer a basic sum assured plus regular bonuses.

32
Q

What are unit-linked bonds?

A

Life company bonds which offer the returns of a portfolio under management with no life assurance element.

33
Q

What has made investments into life company funds less popular?

A

Since the introduction of ISAs, investments into life company funds have not been quite as popular. One of the reasons for this is that the taxation of an investment in a life company fund is not as attractive for investors as the taxation of a collective investment scheme held in an ISA.

34
Q

What are the two types of life company policies?

A
  1. Qualifying
  2. Non-qualifying
35
Q

What are qualifying policies?

A

Qualifying policies are investments into a life fund that meet the qualifying rules. If an investment meets these qualifying rules, then there is no further tax to be paid on any payout from the policy – even for higher and additional rate taxpayers.

36
Q

What 3 conditions must a policy meet to be a qualifying policy?

A

To be a qualifying policy, a policy must:

  1. Be a regular premium policy – at least annual premiums (normally monthly premiums)
  2. Have an initial term of at least ten years (must be kept for 75% of the term or 10 years, whichever is the lower)
  3. For policies issued on or after 6 April 2013, premiums are restricted to £3,600 per year, with this limit applying across all policies owned by an individual
37
Q

What is the most common kind of qualifying policy?

A

An endowment policy

38
Q

What is an endowment policy?

A

A regular premium into a life fund and meets all the qualifying rules. Endowment policies are used as savings plans, some of which are aimed to build up enough of a value to repay a mortgage debt. However, investment returns are not guaranteed, and these policies can suffer shortfall risk.

39
Q

What is a single premium policy?

A

A single premium policy does not meet the qualifying rules. Any profits made from this policy will be taxable. An often-quoted example is a single premium life company bond. This is a portfolio-linked investment that tries to maximise returns over a medium to long period.

40
Q

How are life funds taxed?

A

Life funds have 20% tax charged within the fund. Should an investor in a single premium life company bond cash in or die (both chargeable events), then the return sum will be received net of 20% tax. This means higher rate taxpayers will have an extra 20% or 25% income tax to pay. Where qualifying policies have no more tax to pay, non-qualifying policies may incur this extra tax.

41
Q

List 3 examples of non-qualifying policies which are lump sum investments into a life fund.

A
  1. Investment bonds/insurance bonds
  2. Unit-linked bonds and with-profit bonds
  3. Distribution bonds
42
Q

What is the tax difference between an investment into a life company fund and an investment in a collective investment schemes?

A

An investment into a life company fund has 20% corporation tax deducted on income and gains made within the fund. This is different from investments in collective investment schemes that are exempt from tax on gains within the fund.

43
Q

Can the tax deducted from a life fund be reclaimed?

A

No! The 20% tax that has been deducted from a life fund cannot be reclaimed.

44
Q

What are chargeable events?

A

This is an additional tax to pay when an investor either cashes in their investment or dies.

45
Q

Why is it called a chargeable event?

A

It is termed a chargeable event because additional income tax may be chargeable for higher or additional rate taxpayers. This additional tax is income tax and not capital gains tax, therefore an individual cannot use their annual capital gains tax allowance to offset profits from Life Funds.

46
Q

What are the tax rules on gains from a life fund?

A

The Life Fund has already deducted 20% and, as some taxpayers are due to pay income tax at 40% or even 45%, they would be liable for an additional 20% or 25% income tax on gains made within their life fund.

Lower and non-taxpayers cannot reclaim the 20% tax paid but would not have any more tax to pay.

47
Q

What is the 5% rule for withdrawals from Life Company Funds?

A

When an investor makes a lump sum investment into, for example, a life company bond, there is a way to withdraw capital and defer tax liabilities on that withdrawal.

Withdrawals of up to 5% of the original capital invested can be made per year on a tax deferred basis. Tax deferred does not mean tax-free – instead these withdrawals are assessed for income tax when a chargeable event occurs, e.g. the investment is ultimately cashed in (or encashed) or the death of the policyholder.

48
Q

What are the 4 key features of this 5% withdrawal rule?

A
  1. It only applies to lump sum investments in life funds i.e. investment bonds, insurance bonds, with-profits bonds, unit linked bonds and distribution bonds
  2. Up to 5% of the original capital may be withdrawn each year on a cumulative basis and the income is tax deferred
  3. If more than 5% is withdrawn in any tax year, the withdrawal is classed as a chargeable event
    – Higher rate tax payers are due an extra 20%
    – Additional taxpayers a further 25%
  4. When the bond is ultimately encashed, the withdrawals and any gains are assessed together and taxed as income.
49
Q

What are the tax rules on offshore life assurance bonds?

A

Offshore life assurance bonds do not pay corporation tax on income and gains within the fund, although withholding tax on dividends is not reclaimable.

50
Q

Whare the Venture Capital Trusts (VCTs)?

A

Venture Capital Trusts (VCTs) are a type of Investment Trust that invests primarily in unquoted companies.
There are significant tax benefits to investing in a Venture Capital Trust.

51
Q

List 4 income tax benefits of Venture Capital Trusts.

A
  1. Maximum investment per tax year is £200,000.
  2. Income tax relief is at 30% (if held for five years). The relief is paid immediately, but could be clawed back if the holding period is not met.
  3. Therefore the maximum income tax relief is the lower of an investor’s total income tax liability and 30% of £200,000 i.e. £60,000.
  4. Dividends are tax free (no holding period requirement).
52
Q

List 2 CGT benefits of Venture Capital Trusts.

A
  1. No CGT is payable on disposals from a VCT (no holding period requirement)
  2. Losses are not allowable to use against gains
53
Q

What is the Gross Assets Test?

A

Enterprise Investment Schemes (EISs) can only invest in companies with total assets no greater than £15m before the issue of shares.

54
Q

What is a consequence of the Gross Asset Test?

A

It results in EIS investments only being allowed into fairly small companies.

55
Q

What do Venture Capital Trusts typically invest in?

A

Even smaller companies the EIS with even less of a track record.

56
Q

List 4 income tax benefits of EISs.

A
  1. Maximum investment per tax year is £1,000,000
  2. Minimum investment per tax year is £500
  3. Income tax relief is at 30% (if held for three years)
    - Therefore the maximum income tax relief is the lower of an investor’s total income tax liability and 30% of £1,000,000 i.e. £300,000
  4. Up to 100% of any investment into an EIS made each tax year may be ‘carried back’ to the previous tax year
57
Q

List 2 CGT benefits of EISs.

A
  1. Investments in EIS schemes do not incur capital gains tax (if held for three years)
  2. Losses (after considering income tax relief) can be offset against income or other gains

If assets are sold generating a taxable gain, capital gains tax can be deferred by investing in EIS shares. If the gain is used to purchase EIS shares, the tax liability on the gain can be deferred until the EIS shares are sold.

58
Q

What is the relationship between an EIS and inheritance tax?

A

An EIS is exempt from inheritance tax.

59
Q

What is a Seed Enterprise Investment Schemes (SEIS)?

A

SEIS run alongside EIS. They are targeted specifically at start-up companies.

60
Q

What are the tax benefits of a Seed Enterprise Investment Schemes?

A
  1. 50% income tax relief on up to £100,000 of investment per year
  2. Up to 50% of gains that are reinvested in a SEIS are exempt from CGT

IMC IE Chapter 10 (6 decks)

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