6 - Characteristics, risks, behaviours and tax considerations of investment products. Part 2 - Other indirect investments including life assurance-based products Flashcards
What is an MVR on a with profits policy?
Market value reduction - usually applicable for surrenders or switches or in times of adverse market conditions
What are the two different types of unitised with profit policies?
Fixed price and variable price
Fixed - unit price is the same and number allocated through the year increases by a % of the annual bonus rate
Variable - unit price is increased through bonuses and guaranteed not to fall
What are the advantages of unitised with profits investments?
Bonus rate is declared annually in advance
It is easier to understand the value of the investment
Switches can be made to other unit-linked products (may be subject to MVR on switches)
The insurance company has less overall committment of reserves than traditional with profit funds
A final bonus may be payable on death or maturity
What are the characteristics of a conventional with profits policy?
Bonus declared annually in arrears
Investor can see the build up of funds by the bonus declaration
However, cannot easily calculate the current value of the policy
How do companies try to maintain a good balance in the free asset ratio?
Retain enough in good years to smooth out in poor
Provide each generation of policy holders with the appropriate returns
What are the advantages of with profit policies?
Provide access to equity markets for the risk averse
Bonus is not always linked to market performance - companies use reserves to cushion
They generally outstrip inflation
In some cases they allow investors to participate in company profits
Have ownership rights in the life office (and will benefit if demutulalised)
What are the disadvantages of with profits?
They lack transparency
Returns can be dependant on the companies subjective view of long term investments
They might be inflexible and give poor returns on early surrender or if MVR applies
What should policy holders consider if they have a closed with-profits policy?
Strength of the insurer Asset allocation (high fixed securities are likely to perform worse that equity funds) Current bonus rate Long term performance of the fund Surrender value Penalties such as MVR How long until the end of the policy
What are the consequences for an investor remaining in a closed fund?
Policy holders may incur no penalties to exit (such as MVR free anniversaries) taking their fair share of the fund, which weakens the overall fund
Investors need to weigh up the option of exiting and re-investing
What is the benefit of pound cost averaging to a policy holder looking to cash in their policy?
A saver will receive a better return if the fund has been at a low price during the term of the policy and rises just before encasement as they will have a greater number of units.
The units will have been bought on average at a lower cost than those who have had a steady increase.
Which types of funds are more unique to life assurance policies?
With profit funds
Guaranteed income and growth bonds
Property funds with asset holdings rather than property shares
Mixed or managed funds, providing a balance on investments
What is tha cap on MIP contributions (maximum investment fund)?
£3600
What is the guaranteed sum assured for a unit linked policy?
75% of the premiums paid over the life of the policy or up to the age 75 for whole of life
When are fixed term endowments generally most suitable?
When an investor can commit the funds for the full term of the policy
What are the characteristics of a high income bond?
Offer a high level of income but do not guarantee the return of the capital
Return of the capital will depend on the performance of one stock market index or an average of two or three
Provided it meets set targets, the capital will be returned, if not it may be less than the original investment
What is the benefit of an onshore unit linked bond to an investor in terms of tax paid?
Liability to basic rate tax is covered by the tax paid within the fund and the investor may take 5% without an immediate tax liability. (for 20 years or until the capital has been returned)
What does the ABI require of a distribution bond in terms of asset content?
max 60% equity
min 50% sterling based assets
yield at least 110% of FTSE all share index
How does a distribution bond operate differently to a untised bond?
There is a clear definition between income and capital
Income is taken in the form of payments direcrtly as a result of income from the bond - no units are cashed in
Unit prices will fall in line with pay out on distribution date
Taxation is the same as unit linked bondds - i.e. 5% allowance rules apply
Regarded as medium to long term as exit penalties are high
Appropriate for a cautious investor
What is the difference between a guaranteed equity and protected equity bond?
With protected equity bond the investor can choose at reguar intervals, how much of ther equity is protected, typicall between 95% and 100%
What is the tax advantage of holding bonds as investments for trustees?
The underlying life company would pay corporation tax on income at a lower rate tahn the trustees would pay on income.
What is the tax rate on trust income under £1,000 and over £1,000?
- 5% on dividends and 20% on other income under £1000
38. 1% income tax on dividends and 45% on other over £1000
When might there be a chargeable gain on an investment bond?
more than 5% withdrawn per year
full encasement
death of the life assured
How is a chargeable gain calculated for an offshore bond?
Number of days resident in the uk/number of days the policy has left to run
What are the two calculations that take place for encashement of an offshore bond?
The basic rate tax calculation is carried out at 20%
(subject to personal allowance and savers starting rate of £5000)
The higher or additional tax calculation is undertaken times the number of relevant years to determine the total higher rate payable on the gain (subject to top slicing)
How does top slicing differ for on shore and off shore bonds?
Offshore, it is always calculated back to the start date of the policy, onshore to the last chargeable event
Why are on shore bonds sometimes preferable to off shore?
Off shore bonds do not qualify for indexation relief and therefore taxed at 40 and 45% respectively
Some offshore income may be subject to witholding tax
Charges offshore are generally higher
An offshore bond has no tax to deduct the management expenses so reduces the gross roll up (onshore deductible from the fund for tax purposes)
An onshore bond for a higher rate payer 20% is charged on the net return vs 40% for offshore of the gross return
How does a friendly society benefit in terms of tax on income?
It does not pay any
What are the investment limits for tax exempt products within friendly societies?
£270 per year, or £25 per month for monthly/quarterly investments therefore £300
Parents and children can have their own policies
What are the genreal taxation rules for life assuance funds?
Dividends are exempt, uk or overseas
All other income is taxed at 20%
Capital gains are taxed at 20% after indexation allowance
What is the criteria for a qualifying life policy?
Term at least 10 years
premiums payable at least annually for least 10 years
Min life cover 75% of total premiums
premiums payable in one year must not be more than double in any other year
no premium more than one-eighth of the total premiums over the term
Limit of £3600 premiums per annum from 6/4/13
When would tax be payable on surrender?
If the surrender value exeeds the gross premiums, at the payers top rate minus basic rate
If the payer is basic rate, after top sliced gain, no tax liability
What tax is payable on a qualifying policy at maturity?
Free of any annual taxes provided:
It is in the hands of the original life assured
If it is surrendered after 10 years
What are the chargeable events for non -qualifying policies?
Death Maturity Surrender or final encasement Part surrenders Assignment for money
Can the 5% allowance for non-qualifying policies be carried forward to use in future years?
Yes it can
what are the 5 steps to calculate a taxable gain of a policy?
- Calculate the total taxable income for the year & ID how much falls into Starting rate for savings/personal savings allowance/nil, higher. additional rate bands
- Calculate the tax due across all bands, deduct the basic rate which is treated as already paid
- Calculate the liability to tax on the annual equivalent by dividing the gain by the number of years
- Calculate the liability to tax on the annual equivalent - deduct basic rate treated as paid and multiply by full policy years
- Deduct step 4 from step 2 to give the top slicing relief due
How could you use independant taxation to reduce tax liability?
Assign the bond to spouse before the surrender is made
An assignment is not a charegable event and is free of CGT and IHT (Uk domiciled)
If a person is claiming universal credit/child tax credit, what might be the implications if adjusted net income exceeds £50K?
It could reduce or eliminate the eligibility
When would there not be a chargeable gain on the sale of a qualifying life policy?
Is sold after 10 years
Would there be a CGT liability for the buyer at maturity of a qualifying policy?
yes, as they are not the original beneficial owner
What are the tax disadvantages of investment bonds?
A non-tax payer cannot claim back tax paid within the fund
As very few investors are subject to annual CGT, for most clients investing in life assurance policies will involve paying CGT on gains within the fund
They could be postponing tax liability if they expect the rate they are paying to rise in the future
Are exchange traded funds eligible for inclusion in ISA’s?
Yes
What is the difference between an ETN and a ETF?
An exchange traded note has no portfolio of investments and do not own anything, they are using derivatives to track the index
What are the main conditions of a PAIF (property authorised investment fund)?
at least 60% of income must be from the exempt property income investment business
the value of the assets involved must be at least 60% of the assets held at the accounting period
its shares must be widely held - no more than 10% per investor of NAV funds
What is the tax position of a PAIF?
The point of taxation moves to the investor from the fund, in the same way a direct property investment would
It can only be an OEIC
What are the conditions for a fund to qualify as a REIT (real estate investment trust)?
75% or more of the total gross profits must be from property rental business
the value of the tax exempt part must be at least 75% at the accounting period
they cannot have excessive debt financing - interest on borrowing must have 125% cover by rental profits
In what ways are VCT’s similar to investment trusts?
Both are listed companies run by fund managers who are generally members of larger investment groups
Investments in both can be made by subscribing for new shares when a trust is launched or by purchasing shares from other investors once the trust is established.
If an ISA holder moves abroad, can they keep their ISA?
Yes, but they cannot add to it
How hold do you need to be to invest in a
Cash ISA?
Stocks and Shares Isa?
Cash - 16
Stocks and shares - 18
under 40 for a lifetime ISA
What are the four types of ISA?
Cash
Stocks and Shares
Lifetime
Innovative finance
What type of shares can you transfer into a stocks and shares ISA?
Shares from an approved incentive share scheme or SAYE
must be transferred within 90 days of emerging from the scheme
What types of investment are eligible for ISA?
Shares Small & medium enterprise securities Corporate bonds Listed bonds Gilts and similar government securities (EEA) Unit trusts and OEICs Units and shares within a recognised UCITS UK investment trusts Non UCTIS (without access restrictions) SAYE shares & approved schemes Units in stakeholder investments Life assurance policies Core capital deferred schemes Certain securities such as retail bonds
What are the three stakeholder products that can be held in an ISA?
Deposit account
Medium term investment product (MTIP)
Smoothed MTIP (similar to a with profit policy)
What are the conditions for a stocks and shares ISA?
annual charge limited to 1.5% for first 10 years & 1% thereafter
Minimum investment cannot be higher than £20
no more than 60% in riskier funds
The buy and sell price of shares in the fund must be the same & published daily
What are the main types of ISA available?
Unit trust and OEIC Investment trust Managed Self select Corporate Derivative based Cash Help to Buy Innovative finance Lifetime
What are the government bonuses for help to buy ISA’s?
£50 for every £200 saved up to £3,000 max
If £12K is saved, boosted to £15K
What is the government bonus for a Lifetime ISA?
bonus of 25% of investmed amount up to £1000 per year
What other charges may be levied by ISA managers?
Early encashment penalties
Commission
Dividend collection fee
Report charges
Can you transfer part of a current years’ ISA?
No - you have to transfer the whole of the current year but can transfer part of a previous year
If you transfer from a Lifetime ISA to another type of ISA, is there a penalty?
Yes, 25% withdrawal fee
What are the time limits for ISA transfers?
15 days for Cash & Cash Lifetime, 30 days for others
What happens to an ISA on death?
It becomes a continuing account of the deceased. No further money can be added but retains tax status. Must be closed within 3 years of the date of death to retain tax free status
Can a partner within a civil partnership or marriage inherit an ISA allowance?
Yes, they can inherit a on-off additional allowance at the higher value at date of death or when passed on
What types of Junior ISA can be held?
Cash and stocks and shares
What is the subscription limit for a junior ISA?
£4368
When could a person hold both a cash and junior ISA?
between 16 and 18
What are the three types of Child Trust Funds?
Savings
Share accounts
Stakeholder accounts
Why is a PLA (purchased life annuity) more tax efficient than a pension annuity?
The capital element is tax free as it is considered as a return of the original capital, a pension annunity is taxed as full income
What are the two types of derivatives that are traded on exchanges?
Futures and options
What position is a buyer and a seller of a future said to have?
Buyer has the long position - they agree to buy at a future date at a future price - hoping prices will rise
Seller has the short position - they agree to sell at a future date at a future price - hoping prices will fall
What is marking to market?
The daily revaluation of the contract mirroring changes in the price of the underlying asset
What is the EDSP (exchange delivery settlement price_
The closing price of the futures price at the time of delivery, which matches the cash price of the underlying asset
What is the difference between a call and put option?
Call option is the option to buy the underlying asset
Put option is the option to sell the asset
The seller is obliged to meet the obligation placed on them by the buyer
The seller of a call optoon must sell to the option holder
The seller of a put option must buy from the option holder
Who would pay any margin payments - the buyer or the seller?
The seller
What are the options open to option holders?
Exercise the option
sell the option before expiry
let the option expire
What are the two component part of an option’s value?
Intrinsic value - the value above or below the agreed strike price
Time value - the amount an investor is prepared to pay for an option above its value in the hope it will change before expiry
What are the two major uses for hedging?
To protect an existing exposure against future adverse movements
To try to profit by correctly forecasting future price movements
What options might a fund manager have if he expects markets to rise and hasnt got funds to invest straight away?
Wait until the money is received and buy at the higher price
Borrow funds to invest and repay with interest when funds are received
Use derivatives - i.e. buy futures or buy call options
If a fund manager belives a market is going to fall and doesn’t want to sell part of the portfolio, how could be use derivatives?
He could sell futures
He could buy a put option
What are the benefits of using futures?
Lower dealing costs
Speed of dealing
Liquidity - trading any volume at any time without dramatically affecting market prices
What is the risk for the buyer of both call and put options?
limited to the premium paid
What is the reward for buyers of options?
Unlimited - the higher the price of a call option above the exercise price, the the greater the reward
For a put option the greatest reward would be if the price fell to zero
What is the largest risk for a writer of an option?
If they do not own the shares or assets as they may then have to buy them in the market if the option is exercised
How is the profit from derivaties taxed for an investor?
Classed as CGT (unless the underlying asset is a gilt or qualifying coroporate bond)
What is a hedge fund?
A pooled investment, where a fund manager invests in various traded securities inorder to provide positive returns
What are the two main uses of futures and options?
Hedging and speculation
Why do most hedge funds set up off shore?
To limit set up, regulatory and administration costs
What are the four broad hedge fund strategies?
Long/short funds
Relative value funds
Event driven funds
Tactical trading funds
What are the benefits of investing in a structured product?
A wide range of underlying assets are available
There is no exposure to a partilcular managers style or ability (unless linked to an specific fund or portfolio)
The degree of upside participation will be explicitly stated
A level of capital protection is generally included
The risk and return are fixed and transparent
What are the drawbacks of structured products?
Caps on participation may limit returns in a strong market
Kick out features can mean a product matures early
Returns may be diluted by averaging of index measurements
If the product cannot be sold in the secondary market, maturity could take place in a falling market and profits could be impacted
Most retail products are fixed term and early encashment may be prohibited or costly
Falls in markets could be significant enought to lose its capital protection
What risks should be considered when buying a structured product?
Return - exactly how any when it will be calculated
Risk Profile - risks to capital, assets within the investment, provisions, FSCS cover available (£85K limit)
Costs & Tax implications
Encashment - early penalties, transparency of pricing, liquidity in secondary market
Credit risk - creditworthiness of issuer, counterparties, rating of zero-coupon bond or other instruments used, protection of collateral
What are the two most important effects of Sharia Law on investments?
There are restrictions on paying interest (Riba)
They must not make investments in gambling, alcohol, pork products, tobacco or other items that go against muslim values
What are the three types of Sharia compliant funds?
Equity - returns through capital gains, dividends need to be approved by a Sharia board
Commodity - To buy Halal commodities at a fixed price to resell for profit, however futures are deemed as gambling
Ijarah - holds tangible assets such as property and receives income such as rent.
What is a sukuk?
A Sharia compliant bond, which is asset based. the Sukuk is issued to the subscriber and represents proportional ownership of the asset
What are investment notes?
Structured products that once issued are listed on the LSE. They offer the investor the opportunity to sell theri note and take profits early if the market rises before maturity
What are the disadvantages or unit trusts/OEICs?
Further management charges are payable in addition to intial and AMC levied by the groups
Changes in the portfolio of funds may be expensive (due to buy-sell proce spread & intial charge made by OEICs)
There is little direct involvement by investors
Changing investment managers may involve higher costs
What are the advantages of Investment trusts rather than unit trusts/OEIC’s?
The cost of purchasing shares is generally lower
The AMC of an older investment trust is generally considerably lower
Investment trusts can provide a higher level of income if there is a discount to NAV (which there generally is), therefore you can buy a higher volume of securities and therefore a greater level of income
There are several different types of trust securities that have specialist uses, such as split capital trusts
What are the advantages of Investment trusts rather than unit trusts/OEIC’s?
The cost of purchasing shares is generally lower
The AMC of an older investment trust is generally considerably lower
Investment trusts can provide a higher level of income if there is a discount to NAV (which there generally is), therefore you can buy a higher volume of securities and therefore a greater level of income
There are several different types of trust securities that have specialist uses, such as split capital trusts - which divide the investment returns into differnt classes (whereas OEICs and UT’s only have one)
Shareholder pressure can cause a change in performance or replacement of a manager
They can borrow to invest, OEIcs and UT’s cannot
Which is said to be a higher risk, Investment trusts or Unit Trusts and OEIC’s?
Investment trusts
- the level of discount to NAV could grow meaning there may be more investors trying to sell than buy (UT’s and OEICS cannot fall below the value of the underlying investment)
- as a trust can borrow, it could increase the volitility of the trust and therefore its risk profile (UT’s and OEICS has tighter restrictions)
If a fund is a UCTIS fund, what is the implication in terms of investment of the funds assets?
The fund manager has more flexibility on how the funds are managed. This inclues the ability to leverage, sell, short and use derivatives
