Case Study 1 Exam Questions Flashcards
What additional information do you need to ensure that Daniel and Sophia can generate a sustainable income throughout retirement?
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 pensionschemes?
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?
Did Daniel retire at or before the DB 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?
Explain to Daniel and Sophia how a lifetime cashflow model could be used to assist them in meeting their objective of ensuring they have a sustainable income throughout retirement? (Could be adapted to current cash flow and asked of Sanjeev and Maya for affordability)
It can identify shortfalls
Based on their current and future income and expenditure
Returns required from their investments to supplement existing
pension income
Stress-test existing pensions / investments
Apply range of growth rates based on their ATRs
Show impact of inflation
Show impact of withdrawals from investments
Can be adjusted as circumstances change over time
Identify the main factors and assumptions that you should discuss with Daniel and Sophia when formulating a lifetime cash flow model. (Could be adapted to current cash flow and asked of Sanjeev and Maya for affordability)
Target amount required now and in the future
Their ongoing health/ life expectancy/ potential long term care needs
Their attitude to risk (this impacts potential investment strategies) and capacity for loss
Any expected changes to their income
Expectations of inflation
Any significant lump sum capital requirements
Pattern of expenditure throughout retirement
Current/ likely tax rates
Any expected capital lump sums
Other non-pension assets, financial and non-financial
Provisions of their wills / intended lifetime gifting
Affordability – now and in the future of lump sum investments
Expected growth rate for any investments
Use of tax efficient wrappers, e.g. pensions, ISAs
Other potential sources of income / capital if downsize
Assumptions for charges
Explain to Daniel and Sophia the risks of relying solely on lifetime cash flow models. (Could be adapted to current cash flow and asked of Sanjeev and Maya for affordability)
Assumptions can turn out to be wrong
Figures are estimates only and will need regular reviews
Their objectives or circumstances may change
Availability of tax wrappers and allowances may be withdrawn
It does not take into account market risk
It does not consider liquidity risk
Outline the process an adviser should follow when advising Daniel and Sophia on their pensions arrangements.
Fact find
Risk and capacity for loss profile assessed
Client agreement and documents presented and signed
Obtain DB scheme details / analyse
Obtain State pension forecast
Check for gaps in record and which can be plugged
Carry out research
Formulate a recommendation
Present recommendation
Review
Explain briefly to Daniel and Sophia the purpose of a stochastic modelling tool, the type of information it can provide and how it can be useful for ensuring they do not run out of funds in retirement.
Analyse potential risks and returns
Compares ATR against current portfolio
Tool suggests asset allocation
To meet objective (e.g. to not run out of funds)
A forecast shows the potential future values
In a range of different market conditions
Indicates if they need to invest more / are on track / exceeding
State the limitations of using an asset allocation model for income planning.
It does not recommend an appropriate tax wrapper/does not take into account the client’s tax status
Charges are not taken into consideration
Questions asked not always relevant to the client’s circumstances
Different models produce different results
Underlying assumptions subject to change/based on historic data
Needs to be reviewed/only relevant at a specific point in time
Outline the key factors that an adviser should consider when advising Daniel and Sophia on their strategy for ensuring they have sufficient income throughout retirement.
Planned target income
Deferral of State pension (or not)
Possible return to part time work (or not)
Asset allocation
Maximising pension contributions now
Use of non-earner limit £3,600 once retired
Details of Daniel’s DB scheme pension / their workplace pensions
Use of allowances – ISA, CGT
Charges
Budget
Use of other assets
Priority of objectives
ATR
Willingness to use trusts
What they want to happen on 1st death in terms of pension fund /
protecting surviving partner
Identify any reasonable assumptions you might make in relation to Daniel and Sophia’s retirement planning.
That any gaps in State pensions will be filled if affordable
Willingness to defer State pensions if affordable
Unlikely to return to work
Willing to make additional contributions now using carry forward if necessary
Willingness to make regular contributions into pension schemes once retired, subject non-earner limits
That any ongoing contributions remain affordable
That they remain in good health
That the £200,000 will be invested for their retirement
That they are willing to use other investments to generate a retirement income when needed
That their tax status will remain the same throughout retirement
They have nominated each other as recipients of death benefits
from pension schemes (or that they will do so)
They will want to provide an income after 1st death
Evaluate the suitability and tax efficiency of Daniel and Sophia’s pensions for their retirement.
(NB sometimes suitability and tax efficiency are combined in the one question, sometimes they are separated out; same goes for pensions and investments.)
Daniel is a medium risk investor
His DB pension provides a guaranteed income
That escalates over time
And usually provides a spouse’s pension
Which will also escalate
Even if the scheme becomes insolvent
PPF protection is usually 100% for pensions already in payment, 90%
if Daniel retired before the scheme’s normal retirement age, 50% of
which can be paid as survivor’s pension to Sophia
Daniel’s DC pension is invested in UK growth which may match his
ATR
However, if he wishes to take an annuity, it may not suit this objective
Sophia is also a medium risk investor
Sophia’s DC pension is invested in UK treasury and fixed interest
which feels too cautious for her ATR
However, if she wishes to take an annuity, it may suit this objective
We do not know if the couple will receive full State Pensions
We should request a State pension forecast
And consider making voluntary Class 3 NICs if there are any gaps
Daniel is a basic rate tax payer once his current pension contributions are taken into account
Sophia is higher rate
By making larger pension contributions, Sophia may become a basic
rate tax payer
Both Daniel and Sophia would benefit from tax relief
If they made additional regular or lump sum pension contributions
Both appear to be able to take advantage of carry forward
Identify the key benefits and drawbacks of the following funds in the couple’s pension portfolio:
Typically you’ll only be asked about one fund per case study, but you won’t know which one until you get in the exam so we cover them all for you.
(Alternatively, the question could ask you to give reasons to retain (i.e. the benefits / ticks) or reasons to switch funds (drawbacks / crosses).
(Daniel - pension)
UK Growth Fund
Advantages
Adds diversification to his overall portfolio
Potential for growth / inflation protection
Actively managed
May be in line with ATR
May be in line with need for sustainable income in retirement
No currency risk
No political / regulatory risk
Should be able to switch easily
With no tax implications as in pension wrapper
Won’t be included in estate on 1st death as pension fund
Can be kept out of 2nd estate if remains within pension wrapper
Income and gains tax-free as in pension wrapper
Accessible as over 55
Disadvantages
Single geographic location – lacks diversification
May be single asset class – lacks diversification
May not be suitable if wishes to take an annuity in two years’ time
Drawing on pension funds less tax efficient than drawing from
investments as pension funds IHT free
Identify the key benefits and drawbacks of the following funds in the couple’s pension portfolio:
Typically you’ll only be asked about one fund per case study, but you won’t know which one until you get in the exam so we cover them all for you.
(Alternatively, the question could ask you to give reasons to retain (i.e. the benefits / ticks) or reasons to switch funds (drawbacks / crosses).
(Sophia – pension)
UK Treasury and Fixed Interest Fund
Advantages
Actively managed
Adds diversification to her overall portfolio
Spreads risk within the sector
No currency risk
No political/regulatory risk
May be in line with need for income in two years’ time
Should be able to switch easily
With no tax implications as in pension wrapper
Won’t be included in estate on 1st death as pension fund
Can be kept out of 2nd estate if remains within pension wrapper
Income and gains tax-free as in pension wrapper
Accessible as over 55
Disadvantages
Single asset class – lacks diversification
No geographic spread for diversification
May be too cautious for ATR
May not require the income at present
Income payments not guaranteed
Income payments may erode capital
Limited growth / protection from inflation
Charges may erode value of fund
Drawing on pension funds less tax efficient than drawing from
investments as pension funds IHT free
Identify and explain in detail the key client-specific factors that you’d take into account when assessing Daniel and Sophia’s capacity for loss in relation to their retirement.
As a couple they have a large emergency fund and are wealthy
They have secure sources of increasing income (Daniel’s DB
pension and their State pensions (at State Pension Age))
In addition, they have their investments and
Intend to release £200,000 of capital by downsizing
They are in their early 60s
They can tolerate some loss / volatility in their investments in the
longer term
We do not know what their expenses are
But they plan to retire in two years’ time
They have no debt
They have no IHT liability on 2nd death
They are in good health
Explain how carry forward works and how it could help Daniel and Sophia achieve their financial aims.
Annual allowance in current tax year is £60,000
Can carry forward unused allowance from previous 3 tax years
Up to £40,000 for 2020/21, 2021/22 and 2023/24
Could be less if individual is subject to a tapered annual allowance
Overriding limit – total contributions paid in current tax year (even if
they relate to a previous tax year) cannot be more than 100%
relevant UK earnings in current tax year to obtain tax relief
Neither appear to have used their full annual allowance in previous
tax years and can therefore make up for that this year if they so
wish / can afford to
Could use some of their excess cash now to achieve this
If wait until retire, they’ll be limited to an allowance of £3,600
Explain to Daniel and Sophia how their pensions will increase over time.
Their New State pensions will increase in line with the ‘triple lock’
In April each year, they will increase by the higher of the increase in Average Weekly Earnings, the increase in the Consumer Price Index (CPI) (for the previous September) or 2.5%
If they defer the State pension, when they restart their extra amount will increase in April each year in line with the CPI for the previous September
Daniel’s DB pension will increase in line with inflation, although this may be subject to a cap
The increases on their workplace pensions will depend on how they take their funds and the options chosen at outset
Explain briefly to Daniel and Sophia the following options available with DC schemes to provide them with an income in retirement, including any income tax and IHT implications for each of these options:
- Option 1 – lifetime annuity
- Option 2 – flexi-access drawdown (FAD)
- Option 3 – uncrystallised fund pension lump sum (UFPLS) - Option 4 – short term annuity
Option 1 – lifetime annuity
Take 25% PCLS
Use remaining fund to buy annuity (which may match ATR)
Income taxed under PAYE
Capital would not be included in estate and any capital guarantee
would be IHT free
Option 2 – flexi-access drawdown
Take 25% PCLS
Enter into flexi-access drawdown
Withdraw further funds as and when required either regularly or ad-
hoc
Income taxed under PAYE
Potential for tax-free gains on underlying fund
Fund outside estate
On death tax treatment depends on age – under 75 tax free, 75 plus
taxable
Fund can remain outside of estate on 2nd death by only taking out
funds as and when required May not suit medium ATR
Option 3 - uncrystallised fund pension lump sum (UFPLS) Take UFPLS as and when required
25% of each LS tax free
Remaining 75% taxed as income under PAYE
Potential for tax-free gains on underlying fund
Fund outside estate
On death tax treatment depends on age – under 75 tax free, 75 plus
taxable
Fund can remain outside of estate on 2nd death by only taking out
funds as and when required May not suit medium ATR
Option 4 – short term annuity
Provides guaranteed income
Retains some flexible income options within the pension Can benefit if annuity rates rise in future
Potential for capital growth remains on residual fund
IHT benefits remain on residual fund
Less administration
Can include spouse’s pension / value protection
Escalation to protect against inflation
No investment risk
May suit medium ATR
Explain to Daniel and Sophia the main issues that they should consider when deciding if they should use flexi-access drawdown (FAD) in retirement, rather than purchasing an annuity.
Flexi access drawdown (FAD) may not be suited to medium attitude to risk (ATR)/asset allocation/can invest in line with medium ATR.
Potential for growth.
Income is flexible/can change in line with requirements/ annuity is
inflexible.
Can use tax free PCLS/ can create tax efficient income/ tax
planning.
Retains tax free wrapper (CGT and Income Tax).
Complex/ongoing administration/reviews/ongoing advice.
Ongoing charges/adviser charges.
Income taken will restrict future contributions to £10,000 per
annum/money purchase annual allowance (MPAA).
Funds can deplete/income not guaranteed/investment risk/fund
performance not guaranteed.
Would they prefer a guaranteed income?
No tax on death before 75 / taxable at marginal rate after age75.
Improved death benefits / on death can pass to family/Inheritance
Tax (IHT) efficiency.
Can purchase annuity at any time/annuity rates may fall/rise/health
may change/enhanced annuity rate may be available in future.
Explain to Daniel and Sophia the factors to take into consideration when deciding whether to use a series of UFPLS to provide retirement benefits.
Flexible income
Improved tax-efficiency (only take funds when needed)
Personal circumstances may change
Flexible death benefits
Pension fund can be passed on IHT free
Annuity rates are likely to fall from current high
Potential for growth
May not need guaranteed income
State pension / other assets as back up
Possible emergency tax/month 1 tax implications?
Whether they would like to make future pension contributions (as
MPAA would be triggered and limit this)
State 6 advantages and 6 disadvantages of Daniel or Sohpia using flexi- access drawdown, rather than a lifetime annuity, to provide a sustainable retirement income.
Advantages
Potential for fund growth
Flexible income
Tax-efficient income
Tax planning (ability to keep income within a certain threshold)
IHT free
Annuity rates may improve
Flexible death benefits
Drawbacks
Increased fees
Investment risk
Fund may run out before they die
Ongoing advice/reviews required
Income not guaranteed
Triggers money purchase annual allowance
Mortality drag
Identify the key factors you should consider when establishing a reasonable rate of withdrawal from Daniel and Sophia’s pensions in the future should they go for flexi-access drawdown in retirement?
Income / capital needs in retirement
Income from other sources
Future tax position
SIPP investment strategy
Growth assumption
Economic conditions / inflation
Sequencing risk
Charges
Longevity
Death benefits free from IHT
Explain to Daniel and Sophia the impact of sequencing risk is and reverse pound cost averaging should they decide to enter flexi-access drawdown in retirement.
Funds being drawn down are exposed to sequencing risk
It refers to the greater impact an early loss has on a client’s capacity
to take withdrawals over the longer term
Running down a fund amounts to pound cost averaging in reverse
When the price of units is low, more of them are sold, when it is
high, fewer are sold
Taking regular withdrawals of capital exaggerates the impact of
fluctuations rather than smoothing them
What additional information would you require from Sophia to help her decide whether to continue the PMI cover post-retirement?
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 met their needs / what type of plan is it?
Is the premium competitive?
Affordability in retirement?
State the factors Sohpia should consider when deciding whether to continue the PMI cover post-retirement.
Premium
Affordability now and in the future (premium will rise as she gets
older)
Type of plan on offer (budget / standard / comprehensive)
Is the premium subsidised? (could she get better value elsewhere?)
Would she prefer to self-insure (use savings)?
Does she have higher priority needs that should be met first?
Views on NHS care?
Increased choice over private treatment
Excess / exclusions
Premium wasted if claims not made.
State the benefits and drawbacks for Sophia of continuing her PMI post- retirement.
Benefits
Age may prevent her taking out affordable cover elsewhere
Covers Daniel as well
Speedier treatment
Choice of hospital / consultant / treatment
Different types of plan available
Lump sum for overnight stay in NHS hospital
Benefits are tax free
May be affordable as in good health
Any pre-existing conditions that have developed since outset may be covered if she renews with the same provider / they would not be with a new provider
Drawbacks
May not cover pre-existing conditions
May not be affordable / premiums increase as she gets older
Covers acute conditions only
It does not cover emergency treatment or chronic conditions
It may only be a budget plan
There is no guarantee she’ll be offered a renewal next year
If she is, the price may rise significantly as a result of this year’s claim and any subsidy the employer may previouslyhave provided
Explain to Daniel and Sophia the three different types of PMI plans available.
Basic
Low cost but no extra benefits and limits on costs of treatment in year
May restrict choice of hospital
Premium reduced if insured pays first part of each claim
Cover restricted to accommodation, drugs and doctor’s fees
Excludes / restricts outpatient treatment, home nursing or private ambulance
May be discount for healthy lifestyles / discount gym membership
May suit those with small budget or those willing/able to pay proportion of costs to get cheaper cover
Standard
More items covered, longer claim periods, higher limits
Wider choice of hospitals
May include outpatient treatment and psychiatric cover
Consultant fees, diagnostics tests and physiotherapy included up to limit
May suit those with larger budget, wanting wider cover than basic plan but unable to afford comprehensive
Comprehensive
Most expensive but widest cover, longer claim periods, higher limits and widest choice of hospitals
Home nursing, private ambulance, parent staying with child, alternative medicine, dental treatment, overseas travel, cash payment if stay in NHS hospital all likely to be included
Outline the key issues that Daniel and Sophia should consider when planning a strategy to meet their long-term care costs
They have significant assets so will be self-funders
Life expectancy
The type of care they would like to receive (at home / in a care
home)
Estimated cost of long-term care
Care cost inflation
Budget
Eligibility for state benefits in the future (attendance allowance)
Whether they’d consider equity release
Use of a deferred annuity
Willingness to use existing assets to fund care
Recommend and justify the actions you would take to ensure Daniel and Sophia can generate a sustainable income in retirement.
Lifetime cash flow modelling
To determine the amount required
If affordability allows
Daniel and Sophia to consider making further regular pension contributions
Consider using carry forward to move funds out of cash
To benefit from tax relief of 20%/40% on their contributions
Maximising the potential for fund growth
And place further funds in IHT free wrapper
Daniel and Sophia to determine how they would like to take their pension benefits
Then ensure fund choices are in line with this, as well as their ATR
Review workplace pension fund performance
To ensure ongoing suitability
Draw income from other investments initially
So remaining pension funds can stay within pension environment
To benefit from further tax free growth
And to retain IHT benefits
Ensure completion of nomination forms for any pensions (and DIS)
This will ensure that there is no delay in the funds being paid out on death
And that they go to the intended beneficiary
Establish LPAs (if not done already)
To ensure decisions can be made for them in the event that they are unable to do so themselves
Why is it important to carry out regular reviews of Daniel and Sophia’s pension arrangements?
Changes in personal / financial circumstances / objectives/ATR
Impact of first death
Monitor performance / identify underperforming funds
Rebalance / change funds
Contributions stop at 75
Costs / charges / cheaper products
Non-earner threshold
Economic / legislative / tax changes
Identify the key factors that Daniel and Sophia should consider before downsizing.
Estimated equity released (is £200,000 accurate?)
Costs involved in sale/purchase (solicitors, legal fees, stamp duty)
Likelihood of finding a suitably located property?
At a price they are happy with / at the right time?
Likelihood of being able to sell their property?
At a price they are happy with / at the right time?
Prepared to rent if unable to find property at time of sale?
Additional costs involved (rent, storage, removals)
Or take out a bridging loan?
Additional costs involved (secured loan, higher interest rates and fees
than normal mortgage)
Risk of a crash in the property market
Time / admin / stress that will be required / involved
What happens if daughter moves in the future?
What are the main benefits and drawbacks to Daniel and Sophia of downsizing?
Benefits
House may be too large for their current needs
Bigger homes are more expensive to maintain
Energy costs and council tax bills are higher
Therefore cost savings can be made by living in a smaller property
Do not leave the property market entirely
Has a physical asset that will hopefully increase in value to pass on to their daughter and grandchildren.
Should retain benefit of RNRB through downsizing addition
Creates a lump sum that can be invested for tax efficiency
Downsides
May struggle to adapt to living in a smaller property
Size of savings on maintenance and bills may not be as large as anticipated
Impact of savings minimised by reduction in income due to being retired
Emotional attachment to their property, may be reluctant to sell it.
May feel that they will be depriving their daughter of an inheritance.
Expensive: estate agent fees, stamp duty land tax, legal fees, removal fees, decorating costs.
Easier to achieve the optimum results from trading down in a more buoyant market
Capital released subject to investment risk
May not grow as much as would’ve done had remained in property
Outline the main drawbacks of investing a £200,000 lump sum.
(NB other questions relating to the investing of the lump sum feature under the next financial aim)
Risk of capital loss
Market timing risk
Loss of liquidity
No option for pound-cost-averaging
Cannot use ISA allowance
Could generate taxable gains for Daniel and Sophia
Remains in estate for life / up to 7 years (depending on investment)
Explain to Daniel and Sophia the impact on their RNRB if they do downsize.
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. If only part of the home is left to the daughter/grandchildren, then the available RNRB will be calculated on the value of that part.
What additional information would you require from Daniel and Sophia to help them improve the tax efficiency of their financial arrangements?
NB. To avoid repetition, we’ve focused on income tax, CGT and IHT in relation to investments only as we’ve already covered off pensions in Financial Aim 1.
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 Daniel and Sophia’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?
Evaluate the tax efficiency and suitability of Daniel and Sophia’s investments.
(NB sometimes suitability and tax efficiency are combined in the one question, sometimes they are separated out; same goes for pensions and investments.)
The couple have not yet used their ISA allowances for the current tax year
Assuming affordability allows, they should keep topping up their ISAs
They could fund this from their excess cash holdings
Providing accessible tax-free income in retirement
The deposit savings account may enable Sophia to use her £500 personal savings allowance
Thereafter, interest is taxed at 40% as a higher-rate taxpayer
The deposit savings account may enable Daniel to use his £1,000 personal savings allowance
Thereafter, interest is taxed at 20% for a basic rate taxpayer
To minimise the amount of tax payable at the higher rate, the couple could open two single accounts, with Sophia’s holding just enough to
use her PSA, and the rest in Daniel’s
Any gift from Sophia to Daniel must be outright and unconditional to be
effective
Neither Daniel nor Sophia have investments that enable them to use their dividend allowances (£1,000 dividend allowance in 2023/24, £500 in 2024/25)
Nor their CGT annual exempt amount (£6,000 in 2023/24, £3,000 in 2024/25)
They may therefore wish to consider investing some of the £200,000 into a collective investment scheme, such as a UT or OEIC for tax efficiency
The collective could then be used to Bed and ISA in future tax years
To minimise CGT liability
And maximise funds held in ISA environment
As they are married, the surviving spouse would benefit from the Additional Permitted Subscription on first death
Keeping the funds of the 1st to die within the ISA environment
Providing tax free income and gains over time
Daniel is a medium risk investor
His UK Equity ISA may be in line with this
However, his pension is also invested in a UK Growth fund suggesting
little in the way of diversification outside the UK
Sophia is also a medium risk investor
Her S&S UK Gilt ISA may be too cautious for her
And her pension is also invested in UK fixed interest assets suggesting
little in the way of diversification in terms of asset class or location
S&S ISA holdings for Daniel appear to exceed the FSCS limit of £85,000
Some of his capital is therefore at risk in the event of default
The couple have £100,000 in premium bonds plus £110,000 in other cash accounts (£210,000 total on deposit)
Which seems a lot given their ATRs
And lacks protection from inflation
The couple should keep their investments under review to check performance, alignment with ATR and confirm the likely future adequacy
Identify the key benefits and drawbacks of the following funds in the couple’s investment portfolio:
(Alternatively, the question could ask you to give reasons to retain (i.e. the benefits / ticks) or reasons to switch funds (drawbacks / crosses).
Typically you’ll only be asked about one fund per case study, but you won’t know which one until you get in the exam so we cover them all for you.
Stocks and Shares ISA – UK Equity Income (Daniel)
Pros
Adds diversification to his overall portfolio Potential for growth / inflation protection Actively managed
May be in line with ATR
May be in line with need for sustainable income in retirement No currency risk
No political/regulatory risk
APS applies as married
No restrictions on access
Should be able to switch easily
With no tax implications as in ISA wrapper
Income and growth free from tax
Using ISA funds rather than pension reduces estate for IHT
Cons
Single geographic location – lacks diversification Single asset class – lacks diversification
Holding within estate for IHT purposes
Holding exceeds FSCS limit
Stocks and Shares ISA – UK Gilt (Sophia)
Pros
Actively managed
Adds diversification to her overall portfolio
Spreads risk within the sector
No currency risk
No political/regulatory risk
May be in line with need for income in two years’ time
Should be able to switch easily
With no tax implications as in ISA wrapper
Income and gains tax-free as in ISA wrapper
No restrictions on access
Additional permitted subscription available as married
So ISA benefits are retained after 1st death
Using ISA funds rather than pension reduces estate for IHT Holding within FSCS limit
Cons
Single asset class – lacks diversification No geographic spread for diversification May be too cautious for ATR
May not require the income at present
Income payments not guaranteed
Income payments may erode capital
Limited growth / protection from inflation
Charges may erode value of fund
Will be included in estate for IHT purposes
Outline the process you would follow to enable you to review the performance of Daniel and Sophia’s investments.
Letter of authority / obtain details
Confirm date of purchase
Confirm base costs / further investments / withdrawals / switches
Identify any reinvested income
Calculate gain
Assess asset allocation
Identify suitable benchmark
Compare against benchmark
Review charges
Compare to risk-free return
Review risk rating on fund (volatility)
Assess funds against ATR and capacity for loss
The couple are uncertain as to whether their investments are as tax efficient as they could be. What additional information would you require to advise them on whether to surrender, switch or retain them?
Amount of original investment
Date of original investment
Any other capital sums invested
Details of any previous encashments
Performance
Charges
Asset allocation
Suitability for Daniel and Sophia
Use of CGT annual exempt amount
Any CGT losses to carry forward
Willingness to gift / use trusts for tax efficiency
Identify the key issues that you should discuss with Daniel and Sophia when advising them on the ongoing suitability of their ISA holdings.
Asset allocation
Do they need the income?
Simple admin
Charges? Performance?
Suitability of fund?
How to fund current year’s allowance?
FSCS issue for Daniel and potentially Sophia in future
Comment on the suitability for the couple of holding such a large amount of cash.
The holdings are within the FSCS protection limit
So fully protected in the event of the provider failing
Interest may not be competitive and may be fairly low
Meaning there is limited opportunity for growth
Meaning there is little protection from inflation
Meaning the real value of the cash will start to fall
We do not know whether the interest rate is fixed or variable, nor
whether it is competitive
Their ATR is medium
Such a large cash holding is not in line with this
Comment on the suitability for the couple of holding £100,000 in Premium Bonds.
Treasury backed guarantee
So fully protected in the event of the provider failing
Prizes are tax free
So investment is tax efficient
Prizes are not guaranteed
Meaning there is limited opportunity for growth
Meaning there is little protection from inflation
Meaning the real value of the holding will start to fall
They do not appear to need access to such a large cash sum at
present
Both ATRs are medium
Such a large cash holding is not in line with this
Outline the key factors that an adviser should consider when recommending a suitable strategy for Daniel and Sophia’s large cash holding.
Objectives
Diversification
Timescale
Emergency fund
Ethical concerns / ESG
ATR
Performance and charges
Willingness to use trusts
Use of tax wrappers and allowances
What they want to happen on 1st death
Ongoing reviews
Explain to Daniel and Sophia how and why they should consider drip-feeding some of their cash holdings into ISA wrapped actively managed UK and global funds.
To use ISA allowance in future tax years
So it is not wasted (use it or lose it)
Potential for tax-free growth / hedge against inflation
If require immediate income, choose high-yielding fund
Additional tax-free income in retirement
Provides greater diversification
Benefit from fund manager expertise
Asset and geographic diversification
(Cash) Current cash is losing real value
(Cash) Does not match their ATR, but can chose a fund that would
Matches capacity for loss as have other assets
Benefit from pound cost averaging
Outline to Daniel and Sophia what would happen to their ISAs on death.
On death, ISA becomes deceased’s ‘continuing ISA’
Cannot add further funds
Tax free until earlier of estate being administered, ISA closed or 3 years and one day from death
The surviving partner can invest the higher of the value of the continuing ISA on death or on the date when the ISA wrapped investments are passed on to them as an APS
This protects the ISA wrapper
And is in addition to the surviving partner’s own ISA allowance
The surviving partner must register the APS with a provider
They can transfer the holdings ‘in specie’
Or they can sell holdings and transfer cash to ISA up to value of APS
APS can be used the later of up to 3 years from date of death
Or up to 180 days after estate is wound up
Identify the key benefits for Daniel and Sophia of investing some of their current cash holdings into a jointly held Onshore Investment Bond.
They have excess cash holdings.
Tax-deferred income available of up to 5% per annum of original
capital
Cumulative withdrawals. (so can wait until retirement)
Equivalent of Basic Rate Tax deducted within Bond/top slicing/no tax
due until chargeable event occurs.
Tax-efficient income for Sophia as she is Higher Rate taxpayer.
Can assign to Daniel as he is a Basic Rate taxpayer/no further tax
liability for Daniel.
Wide choice of investments/diversification/fund switches.
Growth potential/inflation protection.
Matches attitude to risk/cash does not match attitude to risk.
Jointly-held so Bond continues on first death/no tax on first death.
Can assign segments/can set up in Trust.
Not considered in long-term care assessments.
Explain to Daniel how he could obtain a tax-efficient lump sum from an investment bond and access to capital in the future
Take 5% tax deferred withdrawals
Of original investment amount
These are cumulative
Daniel is a basic rate tax payer
Providing encashments do not push him into high rates of tax
There will be no income tax to pay
Daniel can use top slicing relief
Daniel can adjust income to meet his needs
Can encash entire segments / policies if needed
Depending on the size of the gain he may be able to encash the whole bond without further liability to tax if the top sliced gain falls within his basic rate tax band)
Could use loan trust so growth is outside of Daniel’s estate
Or discounted gift trust
Bond usually exempt from long term care assessment
Comment on the suitability of a purchased life annuity to meet Daniel and Sophia’s need for a tax-efficiency.
Can buy with tax-free PCLS / deposit funds
Tax is less than if had purchased lifetime annuity which is taxable in
full (rather than part tax-free, part taxable as savings income)
Interest element may be slightly more than can be achieved on
deposit
Starting rate and/or personal savings allowance can be used to offset
the tax, then remainder taxed at 20%/40%
Provides a guaranteed income
Giving the couple security of income
Can be indexed
To keep pace with inflation
Though this will reduce the amount paid initially (and generally need
to survive 20 years for it to be worthwhile)
Meaning less income
Funds outside estate for IHT purposes (unless choose capital
protection)
Reducing any potential IHT liability
However, may not match their medium ATR
Interest rates are relatively high meaning the annuity itself should
provide very a reasonable amount of additional income
Inflexible as once set up cannot change
Explain to Daniel and Sophia how a purchased life annuity is taxed.
Split into capital and interest element
Capital content return of capital and is fixed at outset
Based on purchase price
Calculated by dividing the purchase price by number of years
annuitant expected to live at outset
Only interest element is taxable as savings income, usually deducted at source
Interest element paid net of 20% basic rate tax
Personal allowance, starting rate for savings income, personal
savings allowance can be used against the interest element, thereafter basic rate liability met at source, higher rate owe additional 20%, additional rate a further 25%
Fill in form R89 if not liable to tax / reclaim
No liability to capital gains tax
Not usually included in the estate on death (unless capital protection
is chosen and the remaining fund is returned to the estate)
Income from interest element cannot be used to fund gifts under
normal expenditure exemption
Explain to Daniel and Sophia how a discounted gift trust works and how it could be used to mitigate IHT and boost their retirement income.
(Although Daniel and Sophia do not have an IHT liability at present, given they will have a lump sum to invest in addition to potentially moving their funds out of cash, there is the potential for growth to exceed the £1m limit in time therefore including a couple of questions on DGT and loan trust just in case.)
Take out investment bond
Ideally JL2D for most tax efficiency
Daniel and Sophia to be trustees along with their daughter
Assign bond to DGT (discretionary or bare)
Calculate discount, meaning value for IHT is less than the amount
gifted
Up to 5% income can be taken to boost retirement income
Can defer income to begin with (to provide additional income later)
CLT if discretionary trust, no immediate charge to tax if below NRB
PET if bare trust, no immediate charge to tax
Fall out of estate completely if survive 7 years
Outline to Daniel and Sophia the potential benefits and drawbacks of using a discounted gift trust.
Discount will reflect their good health
Falls out of estate after 7 years
Any growth outside their estate
If use discretionary trust, no immediate charge to tax if kept under
NRB, no periodic/exit charges if kept under NRB
Can act as trustee to retain element of control
But, income is fixed from outset
Once cumulative 5% used, no further income came be taken
Irrevocable
Lose access to capital
May incur set up costs
Explain to Daniel and Sophia how a loan trust operates and the benefits of such an arrangement for them.
Establish discretionary trust
Settlors should be trustees
Retain control of capital
Identify beneficiaries (surviving partner, children, grandchildren)
Make capital loan to trustees
Repayable on demand so remains in estate
No immediate charge to IHT (as no IHT transfer has taken place)
Growth immediately outside estate
Can be held in Investment Bond
Can take 5% withdrawals over 20 years
Without immediate charge to tax
Trust may suffer periodic / exit charge if value after deduction of loan
exceeds NRB, but this is unlikely
Recommend and justify the recommendations you would make in respect of ensuring Daniel and Sophia’s financial arrangements are tax efficient.
(See Financial Aim 1 in relation to tax efficiency of pensions)
Both to use their ISA allowances each year
Maximising the funds held in tax-free environment
That can then be used to supplement retirement income when
needed
Easy access which may suit if their income and expenditure pattern
changes
Consider moving excess cash to ISAs/UT/OEIC/onshore bond
To reduce exposure to inflation risk and increase growth potential of
both capital and income
Both of which will be tax free (ISA) / will enable them to use tax
allowances (UT/OEIC/onshore bond)
Consider drip feeding lump sums over the years into ISAs from any new collective (Bed and ISAing)
Future income and gains tax free
Maximising performance
Uses up CGT annual exempt amounts
Saving further tax
Transfer a larger proportion of the deposit account to Daniel
To maximise use of allowances / reduce tax paid at the higher rate
Consider moving some funds out of cash/fixed interest and investing in purchased life annuity / onshore bond
To provide tax-efficient income in retirement (both)
To provide a secure income in retirement (PLA only)
Choose escalation option (PLA only)
To protect against inflation (both)
To protect against future IHT (PLA)
To protect against future IHT (DGT/loan trust)
Identify what should be covered in a review relating to Daniel and Sophia’s investment holdings.
IHT liability
Investment performance
Suitability of fund choice
Adequacy of income yield
Asset allocation given their risk profile / rebalance?
Asset allocation given investment performance (rebalance?)
Fund charges
Changes in economy / market conditions
Changes in tax/legislation
Explain in detail how downsizing relief could be used on the new property on the second death of Daniel and Sophia
*If the house is transferred to the survivor, he/she would inherit their spouse’s RNRB of £175,000.
*On second death the executors could claim £350,000 RNRB provided the house is left to their daughter(or grand children)
*RNRB is restricted to the value of the house so if less than £350K Down sizin grelief can be claimed.
*The amount of relief is the value at date of death/£350,000 (the maximum RNRBincluding transfer)
*The percentage is deducted from 100% and applied to £350,000
*This is the “Lost RNRB”
*This would be in addition to the normal NRB.
*It is available to pass assets other than the houseto their daughter without being subject to IHT
Explain a Discounted Gift Trust
They would purchase a Joint Life second death Insurance Bond.
This would be underwritten and split into two parts.The majority (probably in this case due to their health and age) would be outside their estate.
*They could withdraw 5% of the original SA as an income. No tax would immediately be paid on this.
*Meets their need for sustainable income.
*The remainder would be placed into a discretionary trust.
*Their daughter and grandchildren could be potential beneficiaries.
This would be a CLT but no immediate tax as below NRBOutside estate after 7 years.
*And unlikelyto incur exit or periodic charges.
The downside is:
*They lose access to the capital
*Relies on investment growth to fund the 5% withdrawal
*They should be spending the incomeotherwise it increases theirestate
