Case Study 1 Analysis Flashcards
‘Daniel and Sophia, both aged 63, are planning to retire in the next two years. They are married and have one daughter and three grandchildren. They are both in good health’
Our analysis
First financial aim is to ensure they can generate a sustainable income throughout retirement. Our first step then, could be to perform a lifetime cashflow analysis to compare how much
income / capital they need with how much their pensions and investments can provide.
We’re told in the next paragraph that the couple both have workplace pensions. We therefore need to know what options are available from these schemes at retirement, e.g. lifetime annuity, flexi-access drawdown, UFPLS and what options would most suit Daniel and Sophia bearing in mind their attitudes to risk and capacity for loss.
Additional information needed - pensions
How much income and/or capital will they need in retirement in today’s terms?
Do they intend to work part-time in retirement?
What pension options are available from their workplace pension schemes?
Views on inflation and willingness to take risk in this respect?
Their State Pension forecasts and when it becomes payable?
Contribution history and willingness to meet any gaps?
Paragraphs 2, 3 and 4
‘Daniel and Sophia are both employed and work full time. Daniel is an engineer and receives a gross salary of £42,000 per annum. He is a member of his employer’s workplace pension scheme. Both Daniel and his employer contribute 6% of his gross salary to the scheme. Daniel’s pension fund has a current value of £250,000 and is invested in a UK growth fund. Daniel’s employer does not offer any other employee benefits.
Sophia is a senior manager and receives a gross salary of £58,000 per annum. She is a member of her employer’s workplace pension scheme and contributes 5% of her gross salary to the scheme. Her employer contributes 3% of her gross salary to the scheme. Sophia’s pension fund has a current value of £300,000 and is invested in a UK treasury and fixed interest fund. Sophia is also a member of her employer’s death-in-service scheme which will pay out three times her basic salary on death whilst in service. She also receives protection under the company’s comprehensive Private Medical Insurance scheme, which also covers Daniel as her spouse.
Just over a year ago, Daniel began drawing a pension income from a former employer’s defined benefit pension scheme. This pays him a gross annual income of £10,000.’
Our analysis - Daniel
While Daniel’s gross salary places him in the basic rate tax band, his DB income pushes him into the higher rate tax bracket. (£42,000 + £10,000 = £52,000)
However, he currently contributes £2,520 (£42,000 x 0.06) into his workplace pension,
meaning he remains a basic rate tax payer overall.
With his employer making a matching contribution, this leaves £54,960 (£60,000 - £2,520 - £2,520) of his annual allowance for 2023/24 available. In addition, there is likely to be the potential to use carry forward. We should also find out if salary sacrifice is an option.
We need to consider the suitability of a UK Growth fund for Daniel in relation to his attitude to risk (ATR), capacity for loss (CFL) and financial aims.
With regards to Daniel’s DB scheme, as this is already being drawn from, the most relevant information we need now is what happens to the income on Daniel’s death (e.g. is there a spouse’s pension for Sophia) and how much does the pension increase by each year. However, if Daniel began drawing before his employer’s normal retirement age, he should be aware that in the event of his scheme entering the Pension Protection Fund, he would only be entitled to 90% of his benefits. Sophia would then be entitled to 50% of the reduced amount as a survivor’s benefit. If he started drawing on or after normal retirement age the entitlement is 100%.
Our analysis - Sophia
Sophia’s gross salary places her in the higher rate tax band.
She currently contributes £2,900 (£58,000 x 0.05) into her workplace pension.
With her employer making a contribution of £1,740 (£58,000 x 0.03), this leaves £55,360 (£60,000 - £2,900 - £1,740) of her annual allowance for 2023/24 available. In addition, there is likely to be the potential to carry forward. We should also find out if salary sacrifice is an option.
We need to consider the suitability of a UK treasury and fixed interest fund for Sophia in relation to her ATR, CFL and financial aims.
While Sophia’s death in service of £174,000 (£58,000 x 3) will cease when she leaves service, there may be an option for her to continue the PMI cover. This may be attractive if affordability allows as they are both in good health at present and it includes cover for Daniel too. We could therefore be asked questions relating to the pros and cons of PMI, as well as the suitability of continuing with the PMI cover. (If DIS is tested, it’s likely to relate to Sanjeev’s DIS in Case Study 2).
Additional information needed - pensions
Did Daniel retire at or before the scheme’s normal retirement age?
Solvency of Daniel’s DB scheme?
Escalation of Daniel’s DB pension?
Availability of spouse’s pension under DB scheme on Daniel’s death?
Are higher matching contributions available from Daniel’s employer?
Is salary sacrifice available from Daniel/ Sophia’s employer?
Is Daniel/ Sophia willing to make additional regular contributions?
Is Daniel/ Sophia willing to make additional lump sum contributions?
Affordability of contributions based on cash flow analysis
Willingness of Daniel/Sophia to contribute to pensions once non-earners to benefit
from tax relief / remove funds from their estate for IHT purposes/ boost their income
in later retirement?
Asset allocation within each pension fund?
Fund performance to date?
Possibility of switching funds to align with stated ATRs?
Capacity for loss?
Pension fund charges?
Projections of existing funds to retirement age?
Options available at retirement under each scheme and how they intend to take
benefits?
The extent to which they’d be prepared to rely on their other assets?
Likely tax position in retirement?
Have they nominated each other as beneficiaries of death benefits?
What would they like to happen after first / second death?
What type of schemes are the workplace schemes (GPP or occupational DC)?
Additional information needed - PMI
Desire to use private healthcare in the event of illness?
Willingness to use other assets to fund private healthcare?
Is a continuation option available?
Does the cover meet their needs / what type of plan is it?
Is the premium competitive?
Affordability in retirement?
Paragraph 5
‘Daniel and Sophia own their home which is now mortgage-free. This has a current value of £480,000. They are considering selling the property soon after retirement with a view to moving to live nearer their daughter. This would release capital of approximately £200,000 as they plan to purchase a cheaper property. They have no debts or liabilities.’
Our analysis
The couple’s second financial aim is to consider the issues relating to downsizing (trading down) their property in retirement.
Although we’re told that this would release capital of £200,000, we cannot assume that the couple have considered the costs involved in the process, nor what will happen to house prices over the next two years. We therefore need to think about the factors Daniel and Sophia need to consider in relation to downsizing (essentially, the pros and cons).
We should also consider their options in relation to their lump sum. We could be thinking onshore bond, collectives and/or purchased life annuity:
Onshore bond; could be used to provide a tax efficient income in retirement, using the 5% deferred withdrawals feature. (Could use in conjunction with discounted gift trust / loan trust to mitigate any future IHT issue, although this does not feel like an issue at present.)
Collecitves; could enable them to use their dividend allowances (£1,000 each in the current tax year) and/or their capital gains tax annual exempt amount (£6,000 each in the current tax year). Future ISA contributions could then be Bed and ISA’d from the collective investment vehicle for maximum tax efficiency.
Purchased life annuity; could be used to provide a tax efficient income in retirement, enable them to use their personal savings allowances (and starting rate for income tax if applicable). Annuity rates are still quite high at present.
Additional information needed - Downsizing
How do they feel about downsizing?
Does the £200,000 take into account the costs of buying and selling both properties?
Would they consider investing the £200,000 in a tax efficient way?
Paragraph 6
‘Daniel and Sophia have a range of stocks & shares ISA holdings which are invested in UK equity and bond funds. They have not yet used their ISA allowances for the current tax year as they are considering their affordability in this area, and how best to use their current cash holdings to maximise tax-efficiency.’
Our analysis
We need to consider the suitability of UK equity and bond funds for the couple’s ISAs in relation to their ATR, CFL and financial aims. We should note that all of their holdings are UK-based, there is no geographical diversification in their pensions or investments.
Using their ISA allowances should be a priority if affordability allows. To determine this we can perform a current cash flow analysis (although we feel this is more likely to be tested in relation to Sanjeev and Maya).
The couple’s final financial aim is to improve the tax-efficiency of their current financial arrangements and this ties in with their desire to consider how best to use their current cash holdings.
Additional information needed – Tax efficiency
The precise breakdown of asset allocation (cash, fixed interest, property, equities) for each fund?
The level of diversification / geographical split within the asset allocation?
Liquidity of the portfolio?
Fund performance?
Whether Daniel and Sophia’s stated attitudes to risk vary in terms of their various
objectives?
The extent to which the couple’s investments match their stated attitudes to risk?
Fund choice (or lack of)?
Fund charges/exit penalties?
Held on platform/directly held?
Capacity for loss for Daniel and Sophia?
Objective/income/growth/timescale?
Use of personal savings allowance / dividend allowance?
Use of CGT annual exemption amount?
Does either of the couple have any CGT losses to carry forward?
Willingness to make changes to portfolio to match stated ATR / improve performance
/ meet objectives?
Willingness to use tax-free products?
Willingness to transfer ownership of investments to maximise use of allowances?
Paragraph 7
‘Daniel and Sophia have up-to-date Wills which leave all assets to the survivor on first death and then to their daughter on second death.’
Our analysis
We should confirm with the couple that their Wills reflect their current wishes. There’s no mention of Lasting Powers of Attorney so while it may not be tested, it does appear to be a gap.
Paragraph 8
‘Daniel and Sophia have a medium attitude to risk and neither of them has any interest in Environmental, Social and Governance (ESG) investments. Daniel and Sophia have the following assets:
Our analysis
The deposit savings account will enable Daniel and Sophia to use their personal savings allowances (PSA) (£1,000 Daniel, £500 Sophia). Interest in excess of these will be charged at 20% for Daniel (assuming he remains within the basic rate tax band) and 40% for Sophia. If the interest exceeds Sophia’s PSA, it may be worth having two sole accounts with a smaller holding in Sophia’s so that she can use up her PSA with any excess taxed on the larger holding in Daniel’s name.
The couple have maximised their premium bond holdings. The prize fund rate is currently 4.65%, although there is no guarantee of winning a prize. Prizes are, however, tax free, which meets the couple’s need for tax efficiency. As part of our prep, we should consider the pros and cons of the couple’s Premium Bond holdings. NS&I products are backed by HM Treasury and so the FSCS limit is not relevant here.
The combined deposit and Premium Bond holdings mean the couple have a significant cash holding which exposes them to inflation risk. Consideration should be given to moving some funds out of cash and into assets that can potentially grow in value and beat inflation.
As mentioned earlier, we need to consider the suitability of UK equity and bond funds for the couple’s ISAs in relation to their ATR, CFL and financial aims. Daniel’s S&S ISA is in excess of the FSCS £85,000 limit for investments. Sophia’s is close to the limit and given we have ISA investments to make for the current tax year we need to be mindful of this and may wish to consider using a different provider.
We can see from our IHT analysis, that there is no IHT liability on second death at present. However, we need to keep an eye on this as the situation could change, for example, after first death if death in service or pension funds are paid directly to the survivor.
The full RNRB may not be able available if the couple downsize prior to their death. But the
estate may be able to claim a downsizing addition to make up for the amount of RNRB which
has been lost providing downsizing takes place after 7 July 2015 (which it will) and the
former home would have qualified for the RNRB had it been held until death. The new
residence must pass to their daughter or grandchildren for the downsizing addition to apply.
