Case Study 1 - Max Flashcards
Outline to Max the key issues that may result in him** failing** to meet his plan to generate a sustainable and tax efficient income in retirement
[11 points]
- Timescale to retirement [Capacity for loss]
- Overexposure and concentration to UK equities - diversification risk
- Pension date and retirement date may be misaligned
- Only has state pension (no secured pension)
- High inflation possibility
- Reduced Interest rates?
- Currently HRT payer - more income tax liability
- Reducing AEA tax liability on disposal of shares
- Reducing dividend allowance - higher tax on dividends
- Market downturn
- Changes to health/no income protection
Fact finding [Generic]
State the additional information a financial advisor would require to allow them to advise Max on the suitability of his financial arrangements to meet his long term retirement needs
[22] [Get 12 at least]
- Family health history
- Current expenditure/future expenditure in retirements
- Future inheritance?
- Intended retirement date if not September
- Views on inflation
- Views on economic risk
- Priority of objectives
- State pension entitlement (BR19)
- Workplace pension - what funds can be invested in?
- Views on flexibility vs secured income
- Affordability to make additional pension contributions
- Emergency fund?
- Income from OEICS, S&S ISAs, investment truists / lOSSES
- Isa allowance for the year
- Details of platform/costs
- Interest rates on cash holdings
- Notice on deposit account
- Charges on funds
- CFL
- Experience of investments
- LPA?
- Does he hold health and financial POA for mother
Fact finding [Specific]
State the additional information that Max’s financial advisor would require to advise on his objective to adjust his invesment portfolio to generate an additional sustainable income throughout retirement
18 - Get 10
- Intended retirement date
- Required income in retirement/flexible or lump sum income needed
* Purpose of each investment [are they all intended to support income?] - Flexible income or secured income?
* Performance/returns/benchmark
* Fund charges
*** Switching/timescales **
* Features/charges of platform
* Where are OEICs and investment trusts held? can they be transferred to ISA? - Inflation protection
* Gains on OEICS/withdrawls for CGT allowances
* Income from OEICS, S&S ISA, Investment trusts - Use of annual ISA allowance
- Any expected income? Downsizing?
- Experience of investing?
- Views on existing investments
* Views on diversifying investments from equities
* Are funds passively/actively managed
Outline the factors an advisor should consider and process they should follow when recommending a fund switch
14
- Disclose Status fee/client agreement
- Fact finding - know your client
- Assess ATR/CFL
- Timescales - when is Max retiring
- Charges
- Performance
- Selection of funds
- Asset allocation
- Funds should match ATR and timescale
- Present Max with documentation/recommendation
- Include any risk in recommendation
- Get client permission
- Suitability letter to Max
- Annual review
State the main factors that might affect Max’s attitude towards investment risk in the run up to his retirement
13
- Current Age
- Retirement age
- Single/reliant on one income
- Income and expenditure needed in retirement
- State pension entitlement
- Lack of other secured income
- Vesting plans vs secured income
- Sequencing risk
- Significant assets/ CFL
- Large emergency funds
- No liabilities as we know
- Good health
- Objectives
Explain the benefits to Max of a current cash flow statement when devising his financial plan
7
- Considers his expenditure needs [shows difference between expenditure and income
- Highlights area for cost reduction
- Will consider retirement needs and identifies opportunities to fill gaps whilst still working
- can be used to analyse future cash flow in retirement
- Can stress tests for inflation protection
- Will identify point of run out of money UPFLS/FAD
- Enables Max to learn impact of high expenditure
State the benefits and drawbacks of using an asset allocation model when devising an investment strategy for Max
5, 6
Benefits
* Match his Adventurous ATR/reblance
* Consider past and expected future returns
* Considers volatility
* Identifies issues in current portfolio
* can include geographical/sector allocations and asset allocation
* can conisder income/growth requirements
Cons:
* Does not recommend appropriate tax wrapper for Max’s position
* Charges are not considered
* Questions aren’t always relevant
* Different models different results
* Underlying assumption on historic data
* Needs to be reviewed
Client review [Generic]
Identify the key issues that a financial advisor should discuss with Max at the next annual review
13
- Still working on retirement date?
- Did he defer State pension?
- Changes to any views/objectives
- Changes to income/expenditure
- Tax status
- Any inheritance received
- Changes to ATR/CFL
- Use of tax allowance/pension contributions
- Emergency fund still there
- Any changes to portfolio/ asset allocation/ performance/ rebalancing
- New products available/ economic changes/ market conditions/ available
- Changes to health? He is in good health
- Any changes to Will/LPA position
Explain to max the importance of conducting a review of his investments and reviewing them on a regular basis thereafter
11
- Pension fund retirement date misaligned to reality of retirement date
- Reduce risk and provide income with current objective
- Review and monitor lack of diversification - all in UK equities
- Monitor income and capital needs - to ensure tax efficiency
- ATR/CFL may change in run up of retirement
- Review allowance in current year CGT annual exempt amount /ISA
- Review performance/charges
- Circumstances may change
- Ensure income and dividends from OEICs and shares match ongoing needs to take dividend income, reivnest or take montlhy income from them
- Indivdual shares and OEICs require regular monitoring
- Political/economic/taxation changes
Outline the factors Max’s financial advisor would need to consider when advising him on an appropriate strategy to meet his retirement income objectives
18
- Intended retirement date/phasing
- Longevity - he is in good health
- State pension entitlement (BR19)
- Capital and income retirements now vs retirement
- Flexible or secured income
- Adventourous ATR/CFL
- Fund choice available (active/passive/allocation)
- Tax position - Currently HRT may be BRT later
- Inheritance from mother?
- Purpose of assets will they be used as retirment income
- cash flow analysis
- Existing pension provision
- growth assumptions and stress test
- inflation assumption
- yield on shares/performance
- investment trust - premium or discount
- Platform features
- Interest on cash holdings
Outline the factors that Max’s financial advisor would need to consider before advising him whether to increase contributions to his workplace pension scheme
6
- Current expenditure
- Level of income now vs retirement
- 40% Tax relief on contributions within higher rate band - tax free fund growth
- 25% Tax free PCLS within lump sum allowance may not be a higher rate tax payer so income tax at basic rate
- Access to significant other investments which are not as tax efficient
- Can access pension fund as he is past min retirement age
Outline the process a financial advisor would use to evaluate the adequacy of Max’s retirement position
7
- Establish income required allowed for inflation
- Calcualte fund required based on assumed withdrawl rate
- Allow for PCLS requirement
- Calculate existing benefits using assumed growth rate
- Include ongoing funding
- Calcualate shortfall and increased cont required
- Ongoing reviews needed
Explain to Max how his state pension entitlement will be determined
9
- Recieve SP at 66
- Min 10 years needed to recieve any state pension
- Full rate 2023/2024 - £221.20
- For a full new state pension (35 years)
- Qualifying years can be met through contributions or credits
- Starting amount calculated at 5/4/2016
- Triple locked pension increased by higher of earnings, prices
- Taxed as earned income
- Option to defer
Explain to Max the process for claiming his state pension and rules should he consider deferring
8
- Max will need to actively claim his state pension
- Can be done by post, phone or online
- If not claimed then deferral is automatic
- Increased by 1% for each 9wks of deferral/min 9 wks of deferral
- In additional to annual increases
- Can be done once pension is in payment
- No lump sum option available
- If max passes away after reaching state pension can claim 3 months
Explain how a salary sacrifice arrangements works and how this may be used to maximise the tax efficiency of Max’s pension arrangements
12
- Max signs a written agreement with employer
- Agreement normally cannot be revoked
- Salary reduced by amount of pension contribution
- May reduce DIS benefit
- May impact state benefit entitlement
- May impact future salary increase
- Employer puts this into pension scheme as employer contribution
- Saves NICs
- Increase his pension cont without affecting his net pay
- More tax-free growth within funds
- Greater PCLS entitlement
- Administratively simple
Comment on the suitability of Max current investment and pension holdings
9
- Pension fund does not match planned retirement date
- Asset allocation may be inappropriate and not suit vesting plans
- Equity focus match ATR
- Lack of asset diversification
- Currency risk on global equity funds
- Sig volatility on self-managed portfolio
- Offer little protection as he approaches retirement
- Potential to outperform inflation over longer term
- Only appears to use actively managed funds, no passive investments
Explain to Max why diversification is important
5
- Reduce risk in portfolio
- Some assets are not strongly correlated
- Downside of investment can be offset by upside of another
- Sector diversifcation reduces risk with specific areas of economy
- Geographical diversification spreads risk of across number of different economies
Outline the factors Max advisor should consider when determining whether he should consolidate his investments onto the platform
12
- Ease of transferring assets onto platform
- Range of providers/tax wrappers/funds available
- Limitation of platforms - what is not available
- Does it have acess to same funds/shares as OEICs and indivdual shares
- In specie transfer allowed?
- Does platform offer ISA - what are rates
- Exit charges/Entry charges
- Platform charges
- Performance is easier to obtain
- Can apply asset allocation strategies across different tax wrappers
- Online switching easier
- Charges/discount for large portfolio
*
Outline the factors a financial advisor would need to take into consideration when reviewing potential options to ensure Max’s savings and investment portfolios is tax efficient as he approaches retirement
13
- Use of ISA allowance
- Annaul allowance pension cont - 60k limited to earnings (60k)
- Pensions offer tax relief/ tax free income and growth, PCLS but income taxable, IHT free
- Max currently HRT, likely to be BRT in retirement
- PSA - 500 can be 1000 if pension cont makes him BRT
- Interest from cash savings taxed at 40%
- NS&I premium bond prizes are tax free
- Dividend allowance reducing to 500 in 2024/2025
- OEICs and shares produce dividends taxed at 33.75% over DA
- Investment bonds offer 5% tax deferred income
- Gains on OEICs and investment trusts subject to CGT 20% above AEA
- CGT reduces to £3000 in 2024/2025
- AIM shares are IHT efficient but limited benefit as estate is going to charity
Recommend and justify a range of actions that Max should take in order to achieve his objective to generate an additional and sustainable income in retirement
8
1. Max should defer his state pension until he finishes work
* Does not need income at present
* Would be paying HRT on SP
* Deferring increases ecured income in retirement, assisting sustainability
* Likely to be BRT on retirement
* Good health so likely to benefit more in deferral
2. Consider investing some of his cash deposits/premium bond into fixed rate bonds
* Too much money held in cash (77k)
* Premium bonds do not offer guarantee returns
* He is higher tax rate payer
* Defer interest until he is retired/BRT
3. Sell some of the the smaller companies shares
* These are very high risk
* He is looking to de-risk/unlikely to meet risk profile in retirement
* He can use his CGT annual exempt amount
**4. Use bed and ISA **
* ISA income is free of income Tax and gains are free of CGT
* OEICs and investment trusts are less tax efficient
* uses CGT AEA
5. Make additional monthly pension contributions to his workplace scheme
6. Consider annuity purchase
7. Switch funds to suit vesting needs/reduce volatility
* Smaller company shares are very high risk
* Heavy exposure to equity market and UK in particular
8. Increased exposure to fixed interest/gilt and property funds
* Adds diversification of asset classes and lowers the volatility of the portfolio
* Fixed interest/gilts can be indexed linked to protect inflation
Explain in detail why Max should consider increasing his pension contributions into his employer workplace pension scheme
13
- Increased pension pot/meets objective of sustainable income in retirement
- 40% tax relief on contributions
- Potential for tax-free income and growth
- His other assets are not as tax efficient (40% tax savings income, 33.75% on dividend over DA and potential for CGT on OEICs, investment trusts and shares)
- Extend basic rate band/ could regain £1,000 PSA
- Flexible options onretirement/ FAD/UFPLS/annuity
- Can use pension to provide tax-efficient income via annuity
- No admin done by employer
- Limited time frame to cont £3,600 if no relevant UK earnings
- Wide range of funds to match ATR
- Employer may cont to NIC
- Flexible death benefits - tax-free on death before 75
- Other assets can be used prior to acessing the more tax-efficient pension
32
Explain the benefits to Max of increasing his monthly pension contributions as an alternative to making a lump sum contribution
6
- Pound cost averaging
- Benefit from investment volatility
- Can stop and start contributions/flexibility/convenience
- Assists with budget
- Reduces risk of poor investment timing
- Contributions increase if salary increase
Explain why max should consider securing part of his retirement income with an annuity purchase
12
- Matches his desire to reduce level of risk
- Provides Guaranteed income for life
- Match essential expenditure/budgeting
- He is in good health so value for money/long payment period
- No cost/needs for ongoing advice
- He hasno other guaranteed pension provision other than state pension
- Can buy capital protection/guarantee
- Single life offers a higher annuity rate as no spouse pension requred
- No investment risk
- No advice cost
- Sufficient liquid assets elsewhere
- No dependence hence inheritance not a concern
Outline why Max should consider deferring his state Pension entitlement
6
- Does not appear to require the income whilst working
- Will save higher rate tax
- Likely to be a BRT in retirement
- Increase pension by 1% for each 9 weeks deferred
- Increased secured entitlement helps achieve sustainable income
- In good health so more likely to live long enough to benefit from deferral
Outline the factors Max’s financial adviser should consider and the process they should follow when recommending a fund switch within his pension
11
- Fact finding/ knowing your client/ client agreement
- Assess ATR/CFL
- Timescale
- Charges
- Performance
- Fund choice available
- Asset allocation/diversification
- Select fund to match ATR
- Present Max with documentation
- Obtain client permission/implement
- Suitability letter/recommendation letter to Max
Outline the Key factors max financial adviser should consider when advising him whether to retain the smaller company shares held within his ISA
8
- Smaller companies are extremely volatile
- Can offer better long term growth potential than more established businesses
- Growth focused - may not meet income need
- Lack of diversification
- Over-exposure to UK small cap
- IHT relief for AIM ISA unlikely - majority estate going to charity
- Max wants to de risk
- Requires ongoing maintenence
Explain the key factors Max’s financial advisor should consider when advising on whether his NS&I premium bonds are suitable to meet his longer term objectives
9
- High level of cash-based holdings does not match ATR
- No guaranteed income/interest on premium bonds
- No potential for capital growth
- Unkown returns
- Inflation risk - returns may not match inflation
- Suitable for short-term not long-term
- Capital guaranteed
- Offers potential for large-tax free prizes
- Gambling element may suit adventourous ATR
Explain to Max the concept of sustainable withdrawl rate (SWR) and the relevance of this to his retirement income planning
7
- SWR rate is rate of withdrawl max can take from his portfolio annually without being at risk of exhausting funds
- FCA guideline 4%
- Depends on returns/risk and health
- Max is soon to retire - decumulation phase
- Needs to ensure that rate of withdrawl does not prematurely deplete his assets
- Allowing for a lifespan longer than statistical life expectancy - he is in good health
- Less relevant if needs were covered by secured income
Explain to Max why he should consider investing his ISAs into global collective investment funds with a range of asset classes than individual UK equities
9
- Country diversification/heavily exposed to UK small cap market
- Increase use of other assets - he is overweight in equities
- Diversification lowers volatility
- Smaller companies are more volatile may not meet his objectives
- Benchmarking/sector/fund comparison
- Can use tracker funds which are lower funds than actively managed funds
- Active managers do not always outperform
- Can match ATR/CFL
- Can match objectives
Explain to Max the difference between an OEIC and an investment Trust and why both investments may be suitable to provide additional income in retirement
IT, OEIC, Both
Investment trust -
* Closed ended/fixed number of shares
* Discount/selling at premium
* Could trade at discount if Max wants to sell
* Investment trusts are companies with PLC board that oversees actions (more protection added layer of control)
OEICs-
* Open-ended
* No bid/offer spread
* Units can be created or cancelled
* OEIC investments controlled by fund manager
Both -
* Both allow investors to pool money together in shares/bonds/assets
* Can generate income stream
* Uses dividend allowance
* Likely to be BRT - Div 8.75%
* Can switch to fixed interest funds - uses PSA
* Encashments to use CGT AEA annually
* If held on platform easy to sell/rebalance/bed and ISA
Recommend and justify the actions that Max could take immediately to improve the tax efficiency of his existing financial arrangements
5
Make additional Pension contributions
* Surplus income
* 40% tax relief on cont
* Extends basic rate band/PSA
* Tax free growth/income
* 25% PCLS
Uses Cash deposits/premium bond funds to purchase fixed-rate bonds
* Premium bonds may return nothing
* Can potentially defer payment of interest until lower tax rate payer
* Cash ISAs and NS&I premium bonds are tax-free products
Defer his state pension
* Does not look like he needs income
* Currently HRT
* By deferring can receive higher secured income when BRT
Ongoing use of ISA/bed and ISA
* Tax free income within wrapper
Use of CGT AEA
* £6000 2023/2024, £3000 2024/2025
* Can stagger disposals
* Opportunity to rebalance portfolio
Explain why pension and ISA contributions should be used by Max to maximise the tax efficiency of his portfolio
Pension contribution
* Receive tax relief at highest marginal rate
* Can contribute up to 100% of relevant UK earnings (60k)
* Tax free income/gains and growth
* PCLS potential to reinvest into ISA
* Paid tax free to brother on death pre-75
ISA
* Tax free income and growth
* Can contribution 20k per annum
* Can bed and ISA shares and OEIC
Explain in detail to Max how a lasting power of attorney may be set up and why he should consdier doing so, as well as any restrictions that may apply
13
- Can cover decisions on property and financial affairs
- Cover decisions on health and welfare
- Can set up either one or both
- Needs to register with office of the public guardian - fee payable
- A property and financial affairs can be used as soon as registered - if max does not want he needs to say
- Not possible to use health and welfare LPA until Max has lost mental capacity
- Must be certificate from prescribed person confirming that Max understands LPA - also no pressured
- Max can appoint his brother to be LPA
- Attorneys can be appointed jointly
- Health and welfare covers medical treatment
- iF LPA not in place then application made to COURT of Protection for Deputyship order which can be expensive
- Depuity is appointed by court rather than family
- Putting LPA in place ensures Max’s wishes are met/provides peace
Outline to Max the duties expected of him as attorney under his mother’s LPA and potential consequences if he shall fail
7
- Required to make decisions/act out of her best interest
- Decisions in line with authority in LPA
- Consult with mother if she has capacity/ others who may have interest in affairs
- keep his affairs separate from hers
- Maintain confidentiality
- Avoids conflict of interest
- Failure can incur fines/penalties/ prison
Outline to Max the difference between him and his brother appointed as attorneys for mother, jointly or jointly and severally
Jointly - if one dies/disqualified LPA lapse
Jointly and severally - can make decisions together or separately - if one dies LPA continues
Explain the benefits that would be payable from Max’s workplace pension to his brother in event of his death
6
- Benefits are paid at discretion of scheme admin
- As brother is named beneficiary on nom form, death benefits would go to him
- Lump sum return of fund
- Annuity/beneficairy drawdown dependant on scheme
- Tax free on death before 75 subject to lump sum allowance
- Tax as income on death post 76
Explain to Max how any inheritance Tax liability would be calculated on his estate
- IHT is payable on an estate in excess of the NRB (325000) at 40%
- Not have RNRB as only applies if home is inherited by direct descendants
- Gifts to charity free from IHT
- As over 10% of net estate going to charity IHT charged at 36%
- 100,000 within NRB so IHT free
