8 Other indirect investments Flashcards
The two types of life assurance contract are __ only and __ + __
- Protection only (e.g. term assurance)
- Protection + investment (e.g. whole of life, endowment)
What does MVR stand for?
Market value reduction
What is the aim of an MVR?
Prevent the value leaving the fund from exceeding underlying assets
When is an MVR applied?
Surrenders or switches out during adverse conditions e.g. stock market crash
What are the FCA’s requirements for selling with-profits policies?
Explain the bonus system & MVR
What are the two main types of with-profit policies?
- Unitised
- Conventional
What are the different pricing systems for unitised with-profit policies?
- Fixed price
- Variable price
How does a fixed-price unitised with-profit policy work?
Bonuses are added as extra units at the same price
How does a variable-price unitised with-profits policy work?
Bonuses are added as gradual increases in the unit price
True or false: in a variable-price unitised with-profits policy, the unit price may fall as well as rise
False. The unit price can only rise
What are the benefits of unitised with-profits policies for the investor?
- Bonus rate declared annually in advance
- Easier to see current value
- Can switch to other unitised funds
- May pay final bonus on death or maturity
Which are more popular, conventional or unitised with-profit policies?
Unitised
What is one advantage of conventional with-profit policies?
Bonuses are not directly linked to investment performance, as companies can use their reserves
What does ABI stand for?
Association of British Insurers
What are the ABI classifications for managed funds?
- Mixed Investment 0-35% Shares
- Mixed Investment 20-60% Shares
- Mixed Investment 40-85% Shares
- Flexible Investment
If the ABI classification of a managed fund is Flexible Investment, how much can it hold in equities?
100%
True or false: some evidence suggests new funds perform better in early years
True, possibly because small size makes dealing easier
How might fluctuating unit prices benefit an investor?
Pound cost averaging: if you pay regular premiums, they’ll buy more units when the price is low
Aside from MVA, do life offices charge for switching between funds?
Typically your first two switches are free, but any further switches are chargeable
What tax do policyholders pay for switching between funds?
None
What is the most basic type of life assurance savings plan?
Conventional with-profit endowment
What is the typical term of a conventional with-profit endowment?
Ten years (which is the minimum for qualifying status)
What type of premiums are paid on a conventional with-profit endowment?
Level premiums, usually monthly or annually
In a conventional with-profit endowment, what do premiums purchase?
A guaranteed sum on maturity or death, with bonuses added yearly + final bonus
True or false: there are virtually no new conventional with-profit endowments
True. They can more easily be bought second-hand
What is a low-cost endowment savings plan?
The basic/maturity sum (on which bonuses are calculated) is lower than the death sum
What is a low-start low-cost endowment savings plan?
Like a regular low-cost endowment savings plan, but the premiums increase over the term
In a low-start low-cost endowment savings plan, what is the maximum final premium?
Double the initial premium
True or false: unlike standard with-profit endowments, low-cost with-profit endowments are growing in popularity
False. Low-cost endowments are also going extinct
What does MIP stand for?
Maximum investment plan
What is a maximum investment plan?
A type of unit-linked savings plan for people who’ve maximised their ISA & pension contributions
__ can be written as endowment or whole-life policies
Unit-linked savings plans
The best return on a fixed-term savings plan is usually achieved by…
Letting the contract run until maturity
What is segmentation?
Writing a savings plan as a cluster of identical policies (e.g. twenty £5/mo plans instead of one £100/mo plan)
What is an investment bond?
A single premium life assurance policy, typically whole-life with no maturity date
What kind of life cover do investment bonds provide?
Nominal (e.g. 101% of the value of units)
Why are unit-linked investment bonds attractive to higher-rate taxpayers?
Liability to basic rate rate income tax is covered by tax paid within the fund
True or false: ‘income’ from investment bonds is not actually income
True. It is technically a return of capital
What is one advantage of unit-linked bonds over guaranteed bonds?
Flexibility – cash can be withdrawn as required
What characterises a distribution bond?
The income paid reflects the income generated, leaving the capital intact
What are the ABI requirements for a distribution fund?
- Assets: 20-60% equity
- Assets: at least 50% sterling
- Yield: at least 110% of FTSE All-Share
What could be a good investment for a cautious investor requiring income?
A distribution bond
What sort of fund might have a lock-in?
Guaranteed equity bond
What do guaranteed equity bonds typically guarantee on maturity?
Initial investment + a % of relevant index growth
Why are bonds suitable for trusts?
- Variety of bonds for different risk requirements
- No taxable income = less admin
- Lower rate of corporation tax for underlying life fund
- Up to 5% of original investment can be paid to beneficiaries annually w/ no additional tax
- Policies can be assigned to/encashed by beneficiaries
How do you calculate chargeable gain on an offshore bond?
Total gain x (days resident in UK / days policy has run)
What is an exchange-traded fund (ETF)?
Index-tracking fund listed on major stock market
What distinguishes an ETF from a pooled tracker fund?
- Traded like single shares through stockbrokers
- Prices updated throughout the day
How much stamp duty applies to ETFs?
None
What is a typical ETF management fee?
Low, less than 0.5%
What are the terms for investing in a subset of an index?
Sampling / optimisation
What does ETC stand for?
Exchange-traded commodity
What is an ETC?
Tracks underlying commodity, either directly or an appropriate index
What does ETN stand for?
Exchange-traded note
How does an ETN work?
Like ETF, but a bond (debt) issued by a bank – no interest, but pays index-linked returns
What is a property authorised investment fund (PAIF)?
An OEIC that mainly invests in property & pays no tax on property/rental income
What are the requirements for PAIFs?
- 60% of annual income must be property
- 60% of assets must be property
- No investor may hold more than 9% of NAV
What does REIT stand for?
Real estate investment trust
What are the basic requirements for REITs?
- Resident in UK
- Listed on a recognised stock exchange
- Closed-ended companies
- One class of ordinary shares
What are the two elements of a REIT?
- Ring-fenced letting business
- Other business, e.g. property management, subject to corporation tax
What are the profit/asset requirements for a REIT?
- 75% profits from tax-exempt rental business
- 75% tax-exempt assets, ignoring secured loans
What are three ways to invest in private equity?
- Enterprise investment scheme (EIS)
- Seed enterprise investment scheme (SEIS)
- Venture capital trust (VCT)
What is the tax relief for an EIS?
Income tax relief at 30% on investments up to £2m, provided shares are held for 3+ years
What is the upper limit when using an EIS for CGT deferral relief?
None
What is the maximum number of employees for a company to qualify for EIS?
250 employees, or 500 for KI companies
What is the main difference between EIS and SEIS?
SEIS = more tax relief for investing in younger (riskier) companies
What are the requirements for a company to qualify for SEIS?
- Unquoted
- > 25 employees
- > 2 years old
- > £200k gross assets
What are the similarities between a VCT and an investment trust?
Listed companies run by fund managers, shares traded freely
What is the CGT treatment of VCT shares?
Gains are not taxable, losses are not deductable
What are some requirements for a VCT?
- All money raised must be used in 2 years
- Must not retain more than 15% income
- 80% holdings are new shares from unlisted companies
Why might it be difficult to resell VCT shares?
Income tax relief is only available on subscriptions of new shares
What happens if an ISA holder ceases to be a UK resident?
They retain the ISA & tax benefits but cannot pay in any further money
What is the ISA subscription limit?
£20k p.a. across all ISAs (£4k for Lifetime)
What are stakeholder products?
Straightforward + good value products that can be sold through ‘basic advice’
What are the three stakeholder products that can be held in ISAs?
- Stakeholder deposit account
- Stakeholder MTIP (medium-term inv. product)
- Smoothed MTIP
What are innovative finance ISAs for?
Peer-to-peer lending
What is the difference between an exchange-traded vs OTC derivative?
OTC = tailored to client = more expensive & harder to trade
What does NYSE Liffe stand for?
New York Stock Exchange – London International Financial Futures & options Exchange
Are futures buyers short or long?
Long, as they hope prices will rise above their set price
What is variation margin?
Profits & losses paid daily to/from the clearing house and both sides of a futures contract
What is a strike price?
Fixed “exercise” price of an options contract
What is a call option?
Gives buyer the right to buy
What is a put option?
Gives buyer the right to sell
What is a European-style option?
Can only be exercised at expiry
What is an American-style option?
Can be exercised at any time before expiry (includes most UK options)
What do in-, out-of-, and at-the-money refer to?
The intrinsic value of an options contract
What is the time value of an options contract?
Value above the intrinsic value – represents hope for an increase in intrinsic value
What are the advantages of derivatives?
Quicker, lower dealing costs, and more liquid than underlying assets
What is “writing uncovered calls”?
Selling call options for assets you don’t own
What tax applies to derivatives?
CGT, or income if you’re classed as a trader
What derivatives are exempt from CGT for individuals?
Underlying asset = gilt or qualifying corporate bond
For CGT purposes, what happens when a call option is exercised?
The cost of the option is treated as part of the cost of purchase
For CGT purposes, what happens when a put option is exercised?
The cost of the option is treated as an allowable deduction from the sale proceeds
For CGT purposes, what happens when an option is allowed to expire?
This counts as a disposal, resulting in a capital loss
What are the two main uses of futures and options?
Hedging and speculation
True or false: hedge funds aim for performance relative to a benchmark
False, they aim for absolute returns
True or false: hedge funds have limited or even negative correlation with equity and bond markets
True
What are typical structures for hedge funds?
Offshore collective investment schemes or US limited partnerships
What are the main categories of hedge fund strategy?
- Long/short funds
- Relative value funds
- Event-driven funds
- Tactical trading funds
How do relative value funds work?
Arbitrage i.e. exploiting pricing anomalies between similar investments
Hedge funds may be appropriate for…
High-net-worth individuals with adventurous risk profiles
What are structured products?
Umbrella term for investment wrappers designed to offer tailored combinations of risk & return
What are the typical components of a structured product?
Capital protection + participation in return from riskier product
What are the three main types of structured products?
- 100% capital protection
- Partial / soft / contingent protection
- No protection
What are SCARPs?
Structured capital-at-risk products i.e. partial or no protection
What is an investment note?
A type of structured product that is listed on the stock exchange
What are the three main types of Shariah-compliant funds?
- Equity funds
- Commodity funds
- Ijarah funds
What are the maximum gross assets for a company to qualify for EIS?
- £15m gross assets before EIS
- £16m after EIS
What is the maximum 12-month VC for a company to qualify for EIS?
£5m, or £10m for KI companies
What is the maximum all-time VC for a company to qualify for EIS?
£12m, or £20m for KI companies
True or false: a loss on the termination of an ISA is deductible for CGT purposes
False, as ISAs are exempt from CGT
If investments are withdrawn from an ISA, what is their base cost for CGT purposes?
Their market value on date of withdrawal
Income & gains in a ‘continuing ISA’ are tax free until the earliest of…
- Distribution of the estate
- Closure of the ISA
- 3 years + 1 day from death
How much can be added to a ‘continuing ISA’?
Nothing
If your spouse dies, you inherit their ISA allowance…
On the date of death OR date when ISA investments are passed on, whichever is higher
What are the three basic types of CTF?
- Savings account
- Share account
- Stakeholder account
What is the annual subscription limit for a CTF?
£9,000
True or false: a child gains management responsibility for a JISA/CTF at 16
True, but withdrawals are not allowed until 18
What happens if a CTF is rolled over into an ISA?
It doesn’t count towards overall ISA subscription limit (but it is subject to LISA limit)
Who is eligible for a JISA?
Any UK resident under 18 who doesn’t have a CTF
What types of investments can be held in JISAs?
- Cash
- Stocks & shares
True or false: the qualifying investments for JISAs are more limited than adult ISAs
False, they are the same
True or false: a child can hold a cash JISA and a shares JISA at the same time
True
Who is allowed to pay into a JISA?
Anyone
What is the annual subscription limit for a JISA?
£9,000
Who can open a JISA for a child?
Those with parental responsibility, or children themselves at 16
True or false: a CTF can be transferred to a JISA
True
What are the age limits for ISAs?
- Stocks & shares: 18+
- Innovative finance: 18+
- Lifetime: 18-40
- Cash: 16+
- Junior: 0-18
If a child’s cash ISA returns __ p.a. on capital derived from parents, it’s taxable income for the parent
> £100
What is one way to invest in a stocks & shares ISA?
Transferring, within 90 days, from an approved share-incentive plan or savings-related share option scheme
If shares are transferred to a stocks & shares ISA, how does this affect the subscription limit?
The value of shares on the date of transfer counts towards the limit
When would an ISA manager receive distributions gross of tax?
- When 60%+ of the fund is bonds
- Property income distributions from REITs
If an ISA holds life assurance, what happens if the subscription is exceeded?
The policy must end, causing a taxable gain if the proceeds exceed the premiums
True or false: AIM shares qualify for ISAs
True
True or false: unlisted shares qualify for ISAs
False, unless acquired from share incentive plan or savings-related share option scheme
True or false: EEA securities & strips qualify for ISAs
True
True or false: non-UCITS retail schemes are eligible for ISAs
True, provided the funds can be accessed within 2 weeks
True or false: life assurance policies qualify for ISAs
True, provided they cover the investor’s life/health only
True or false: annuities & pensions qualify for ISAs
False
What are some requirements for a stakeholder cash ISA?
- No charges
- Max min deposit of £10
- Unlimited withdrawals within 7 days
- Interest rate no more than 1% below base rate
What are some requirements for a stakeholder MTIP ISA?
- Max annual charge of 1.5% (1% after 10 years)
- Max min investment of £20
- Max 60% in risky assets like equity & property
- Bid & offer prices must be the same & published daily
What happens if a stakeholder smoothed MTIP needs extra capital in its smoothing account?
Policyholders can be charged extra
How long do VCT shares need to be held to retain income tax relief?
5 years
How long do VCT shares need to be held to retain CGT relief?
No minimum
What is the income tax relief on VCT shares?
30% on investments up to £200k
How much can a VCT invest in a single company or group?
15%
Why might a friendly society policy have a higher return than an ordinary life office?
The friendly society fund does not pay tax on income or internal gains
How much can friendly society funds invest in equities?
Any amount
What are the age limits for friendly society policies?
None
What is the annual premium limit for friendly society policies?
£270, or £300 (£25/mo) if premiums are paid monthly/quarterly
What is a friendly society lump sum investment?
Lump sum buys a capital protected annuity which feeds annual premiums
When are returns on friendly society policies tax-free?
When taken after 7.5 years
What tax do life assurance funds pay on dividends from UK/overseas companies?
None
What tax do life assurance funds pay on non-dividend income e.g. interest, rental?
20%
What tax do life assurance funds pay on gains from gilts and corporate bonds?
None
What tax do life assurance funds pay on gains NOT from gilts/corporate bonds?
20% after indexation allowance
How can an insurance company offset its expenses?
Against its unfranked investment income
How much tax is paid when an offshore bond is encashed?
Starting: nil
Basic: 20%
Higher: 40%
Additional: 45%
When does the starting rate for savings income apply?
Any savings income in your first £5k – earnings are counted first
What is a typical term for a guaranteed income bond?
Up to 5 years
What do investors get from a guaranteed income bond?
Annual income + capital returned on maturity
What is a guaranteed growth bond?
Like a guaranteed income bond, but pays no income
True or false: guaranteed growth bonds are exempt from CGT on encashment
True
What kind of product allows investors to select a quarterly guaranteed level of protection between 95-100%?
Protected equity bond
Most regular premium life assurance policies taken out for investment purposes are…
Endowments
For a policy to be qualifying, no single premium may exceed…
1/8 the value of total premiums
What is the minimum term for a qualifying policy?
10 years
For a policy to be qualifying, premiums must be paid at least…
Annually for 10 years, or until claim
What is the minimum life assurance cover for a qualifying policy?
75% of total premiums
For a policy to be qualifying, premiums paid in any one year must not exceed…
- £3,600
- Twice the premiums paid in any other year
What is the key difference between a REIT and a PAIF?
A REIT is closed-ended whereas a PAIF is a type of OEIC
How long do EIS shares need to be held to be free of IHT?
2 years
When does EIS investment need to happen to qualify for CGT deferral?
One year before to three years after the gain
True or false: gains on REIT investments are exempt from CGT
False
What are the distributions from REITs?
- Ringfenced element, paid net of 20% tax
- Non-ringfenced element, paid gross, subject to usual dividend tax
What are the rules for the ringfenced element of REIT distributions?
- Non-taxpayers can reclaim the 20%
- Higher- and additional-rate taxpayers must pay extra
What are the exceptions to the three-year holding period for EIS income tax relief?
- Disposal to a spouse
- Death of the investor
What type of tax relief may be carried back to the previous tax year?
EIS income tax relief
What is the condition on unlimited EIS CGT relief?
It must be the only tax relief claimed on the investment
What are chargeable events for a non-qualifying policy?
- Death
- Maturity
- Full surrender, some part surrenders
- Assignment, except as a gift
ETFs are exempt from what type of tax?
Stamp duty
What are the requirements for an endowment policy to be qualifying?
- Term: 10+ years
- Premiums paid at least annually for 10+ years (or until claim)
- Cover: 75%+ of total premiums
- Premiums in any year must not be more than 2x any other year
- No premium is more than 1/8 total premiums
- Maximum annual premiums: £3,600
