Case Study 2 for Dylan and Susan

Question 1

Ensure that they have adequate income in retirement

What further information would you need before you could advise Dylan and Susan in this area?

Answer 1

 When are you planning to retire?
 What level of income/capital sums will you need in retirement/How will your
outgoings change?
 Has either of you ever been members of any other schemes? If yes, do you have
recent valuations/illustrations of likely benefits?
 GPP/PP charges
 Contribution history
 Investment returns on both pension funds?
 Would you want a guaranteed level of income/protection against inflation?
 What is your attitude to risk/capacity for loss in this area/Have you done any risk
profiling?
 What other funds are available through your pension schemes?
 Would you use income from your investments to supplement your pension
income?
 Are you expecting any further inheritances?
 Would you consider downsizing/releasing equity from your property?
 Have you completed BR19s/obtained statements of your State pension
entitlement and at what age they become payable?
 Have you made nominations for your pension benefits?
 What is your current expenditure?
 Are you prepared to increase your pension contributions?
 Susan - Would your employer match any increase?
 Would you consider making lump sum contributions?

Question 2

State the key factors that a financial adviser should consider when advising on an investment strategy for Dylan and Susan

Answer 2

 Current expenditure / future expenditure
 Planned retirement date
 Requirements for income and capital
 Inflation and interest rates
 Charges
 Budget
 Asset allocation and fund choices
 Contribution history
 State pension forecasts
 Capacity for loss

Question 3

Describe the process an adviser could use to ensure there are sufficient funds under Dylan and Susan’s existing pensions to provide their required level of target benefits

Answer 3

 Establish the income required, allowing for inflation
 Calculate the fund required based on assumed/agreed annuity rate
 Allow for pension commencement lump sum requirement
 Calculate existing benefits at NRD using assumed or agreed growth rate
 Include ongoing funding
 Calculate the shortfall and the increased contributions required
 Ongoing reviews needed

Question 4

Explain how Dylan and Susan’s State pension entitlement will be calculated and how they could potentially increase any shortfall in entitlement to the new State Pension

Answer 4

 To receive any new State Pension they will need a minimum of 10 qualifying years
 To receive a full new State Pension they will both need 35 qualifying years
 This could be through NI contributions or credits
 Their entitlement under the pre-6th April 2016 State Pension rules was calculated
as at 5/4/2016 – this is their starting amount (also known as the foundation
amount)
 If this exceeded £155.65 the excess is their protected payment
 The protected amount will be paid in addition to their new State Pension
 The protected amount will increase each year in line with CPI (not the ‘triple lock’
that will apply to their new State Pension)
 They will become entitled to their State Pensions somewhere between age 66 and
67 depending on when their birthdays occur
 Could pay voluntary Class 3 NICs to fill any gaps in NI record

Question 5

Explain in detail why Dylan and Susan should consider increasing their contributions into their current pension arrangements

Answer 5

 Increased pension pot/meets objective of adequate income in retirement
 Can match ATR
 Pound cost averaging on monthly contributions
 Susan has a significant amount of earnings in the higher rate tax band/consider
single premium
 Flexible options on retirement/FAD/UFPLS/annuity
 As over 55 can access funds at any time
 IHT free fund/flexible death benefit options/IHT planning
 Tax free growth
 Utilise carry forward
 Dylan will get basic rate tax relief on contributions
 Susan
o 40% tax relief on contribution/carry forward
o Salary sacrifice may be available/reduced employee NICs
o Low cost scheme/no adviser charges
o Reduced administration/contributions deducted from salary/discipline

Question 6

How can Susan utilise carry forward to increase her pension contributions

Answer 6

 She can carry forward any unused annual allowance from the last three years
 She must use the current year’s annual allowance first of £40,000
 She is contributing 5% of £80,000 and her employer contributes 10% of £80,000
 Tax relievable additional contribution for 20/21 = £28,000 (£40,000 - £12,000)
 Both her and her employer’s contributions count towards the annual allowance
 She can then utilise the unused annual allowance from 2017/18 first
 Then from 2018/19 and 2019/20
 She cannot pay more than her income in this tax year of £80,000

Question 7

Comment on Susan and Dylan’s existing fund choice within their current pension arrangements

Answer 7

 Dylan UK equity Fund
o Lack of asset and geographical diversification /increases volatility
o Good growth potential
o No currency risk
o No protection against interest rate fall/market crashes close to retirement
if considering annuity purchase  Susan balanced multi–asset fund
o Offers diversification/reduces volatility within one fund
o Balanced fund may not match attitude to risk (medium-high) o Asset allocation expertise
o Uses wider range of assets/investment strategies

Question 8

Explain to Dylan why it may be beneficial to use a SIPP for his pension funds

Answer 8

 Wider investment choice/can hold cash/diversification
 Online access/ease of admin/can monitor performance
 Easier to match ATR
 Potential for higher returns
 Could access DFM for bespoke investment solution/target objectives/match
ATR/reduce ongoing involvement
 Allows Dylan to access to range of benefit options e.g. flexi‐access drawdown, phased
retirement

Question 9

Arrange for their estates to be passed to their intended beneficiaries in a tax efficient manner using appropriate trust arrangements!

Outline the factors an adviser would need to consider before gifting Dylan and/or Susan’s assets into trust

Answer 9

 Affordability/Income needs/capital needs/now and future
 Employment and retirement plans
 Dylan and Susan’s views on
o Making gifts during lifetime/how much prepared to gift
o Using life assurance to mitigate any IHT liability
o Would they want to be able to access their original capital but not any growth
it might achieve
o Giving up access to capital in return for an income
o Retaining control of assets
o Who benefits and when/class of beneficiary/Osian/children/unborn
grandchildren
 Further
 ATR/capacity for loss in this area
 Do beneficiaries have any ethical/religious/moral considerations
 Gifts in the last 7 years
 Current wills

Question 10

Comment on the suitability of Dylan assigning his existing investment bond into trust to mitigate their future IHT liability and consider an alternative way he can use his investment bond to reduce his potential IHT liability

Answer 10

 Will take the value out of the estate after 7 years as a PET or CLT
 Trustee tax rate 45% on gains so additional tax due on chargeable event/gains
 Trustees can assign policy to beneficiary at later date/gains then taxed at beneficiary’s
marginal rate
 On assignment, new owner will be deemed to be the owner from day 1 of investment
 Will not benefit from the fact Dylan is BRT so no additional tax due on gains as
assignment is not a chargeable event
 Need to consider current fund performance/fund choice/charges
 Can switch funds without triggering tax liability
 Trustees can utilise 5% tax deferred withdrawals
 Loss of control over assets
 Alternatives
o Assign the policy outright:
 Assignment must be outright/unconditional
 Gains taxed at recipient’s marginal rate
 Transfer would be a PET/can use annual exemptions
o Full encashment to realise gains/invest in a new bond to gift into trust
 Unlikely additional tax due on gains as BRT/top slicing
 Need to consider: Initial Charges/Exit Charges/Annual Charges,
 Fund availability
 Trustee tax on gains only calculated from day 1 of new bond

Question 11

Explain in detail how Dylan could use his investment bond within a discounted gift trust to mitigate an IHT liability.

Answer 11

 Dylan could gift his investment bond into trust - either a discretionary trust or a bare (absolute) trust
 If a bare trust is used the gift is a PET/if a discretionary trust is used the gift is a CLT
 The gift is discounted according to underwriting principles and the entitlement to
regular payments
 The discount is an immediate reduction in the estate
 He is in good health so discount will be larger than if he wasn’t
 The remaining value of the gift is in his estate until 7 years have elapsed and as he is in
good health he is likely to survive 7 years
 Dylan as settlor has a right to an income for the rest of his life (or until the fund runs
out) – the trustees use the 5% withdrawal facility to provide this income – if this is
kept within the 5% there are no income tax consequences
 The investment bond is held within the trust for the ultimate benefit of the
beneficiaries (these could be Osian and/or grandchildren) and therefore grows
outside the estate of Dylan
 This product provides a secure income as the DGT provides an income for life -
however Dylan must appreciate that he does not have access to the capital.

Question 12

Outline the benefits and drawbacks of Dylan using his investment bond within a loan trust to mitigate their IHT liability.

Answer 12

 Benefits
o Access to capital/bond is loan to trustees/ Dylan can demand the loan is repaid at any time
o The growth is outside of the estate.
o The trustees can use the 5%s to provide an income
o Identify/change beneficiaries
o Discretionary trust protects beneficiaries in case of bankruptcy or divorce
 Drawbacks
o Any outstanding loan is always in the estate so
o if 5% was taken each year it would take 20 years for the full IHT effect. o Trust may suffer periodic/exit charges if discretionary trust used

Question 13

Recommend and justify why Dylan and Susan should draw up new wills to ensure that their intended beneficiaries receive their residual estates on second death

Answer 13

 Current Wills unsuitable and do not meet objectives
 Currently leave all assets to survivor on death
 Survivor can write new will on first death/could re marry/disinherit children
grandchildren/mirror will becomes invalid
 Consider including an immediate post death interest trust in their wills
o Surviving spouse entitled to income/right to live in property during their lifetime o Their respective children are the ‘remaindermen’ and receive assets on second
death
o Only assets held individually in Dylan and Susan’s name can be used this way in
their respective wills o RNRB not lost
 Consider writing Wills so on 1st death assets up to the NRB goes into a discretionary trust.
o The surviving spouse could be a trustee and a beneficiary of the trust o Osian and grandchildren are beneficiaries of the trust
o RNRB may be lost

Question 14

Explain how the use of spousal by-pass trusts could reduce a future IHT liability

Answer 14

 If death occurs with uncrystallised pension funds, the fund value often paid to spouse
 This money is then included in that spouse’s estate on death/increases the IHT liability
 Death benefit should be paid into a spousal by-pass trust
 This is a discretionary trust set up by the pension scheme member
 Spouse can be trustee as well as a potential beneficiary
 Osian/grandchildren can be among potential beneficiaries
 Beneficiaries can receive income/capital/loans from the trust at trustee’s discretion
 As they have no right to benefit the value of the trust is not included in their estate
 The maximum IHT saving would be fund value x 40%

Question 15

Ensure that their investments are suitable for their needs

What further information would you need before you could advise Dylan and Susan in this area?

Answer 15

 Level of emergency fund
 Investment returns received
 Interest being received from deposit account
 Capacity for loss
 Would you use income from your investments to supplement your income in
retirement?
 Are you expecting any further inheritances?
 Objectives for investments
 Dylan unable to use his dividend allowance
 Dylan unable to use his CGT annual exempt amount
 Susan is a higher rate taxpayer yet OEIC in her name, deposit monies in her name

Question 16

Recommendation

1. Continue to fund ISAs
2. Transfer majority of deposit account to Dylan who is a BRT and to Cash ISAs
3. Transfer majority of OEIC to Dylan’s name
4. Leave some of OEIC investments in Susan’s name
5. Consider VCT, EIS, SEIS (see generic section for more details)

Answer 16

Justification

1. No further income tax or CGT liability
2. Less income tax/Dylan is BRT so has £1,000 personal savings allowance (PSA)
   Susan only has £500 PSA as HRT
   ISA income free of tax
3. Income taxed whether received or re- invested
   Susan is HRT/will incur higher rate tax on dividends(32.5%)/Dylan as BRT will pay 7.5%/£2,000 dividend allowance
   Make use of both their CGT exempt amounts
   Interspousal transfer
4. Enable Susan to use annual CGT exempt amount to ‘bed and ISA’
   £2,000 dividend allowance
5. Tax relief on amount invested, tax efficient vehicles (income tax and/or CGT)

Question 17

Explain to Susan how the income and capital gains on her OEIC is likely to be treated for tax purposes.

Answer 17

 Susan is a higher rate taxpayer
 Income taxed as dividends at 32.5%
 Above the £2,000 tax free dividend allowance
 CGT on gains on disposal at 20% as HRT
 Can use her annual CGT exempt amount
 Losses can be offset against gains

Question 18

State the benefits of Dylan retaining his investment bond - 8 points

Answer 18

 Can be assigned/put into trust
 Potentially no further tax liability on gains as currently BRT
 Bond taxed internally at basic rate
 Can switch funds without triggering tax liability/reduced admin
 Potential to utilise top-slicing if appropriate
 May not be subject to Long-Term Care assessment
 5% tax deferred withdrawals/segmentation
 Does not affect dividend allowance/utilises PSA

Question 19

Comment on Dylan and Susan’s current cash holdings within their portfolio

Answer 19

 Emergency fund/Liquid assets
 Sufficient/excessive cash
 Amount in cash does not match stated ATR
 Default risk as Susan’s holding exceeds FSCS limits (temporary high balance due to
inheritance only lasts 12 months):
 £85,000 single/£170,000 joint accounts
 Likely low interest rates/Lack of potential for growth
 Inflation risk
 Majority of interest taxed on Susan who is HRT

Question 20

Comment on Dylan and Susan’s current funds within their investment portfolio and justify steps that could be taken to ensure their portfolio is more suitable:
FTSE tracker, multi asset fund, global equity fund

Answer 20

 FTSE tracker
o Good potential for growth/suits ATR
o Low cost/cost effective
o No geographical diversification/asset diversification o Simple to follow performance/review
o Performs poorly in falling markets
o Lack of control
o No active management/no alpha
 Multi Asset fund
o Offers diversification/reduces volatility within one fund o Asset allocation expertise
o Uses wider range of assets/investment strategies
o Minimises need to review
 Global Equity Fund
o Good potential for growth/Matches ATR o No asset diversification
 Managed Fund
o Uses wider range of asset classes/managed asset mix/minimises need to
review
o Potential for growth/managed risk/may not suit ATR
 Recommendations:
o Increase geographical and asset diversification/can reduce risk & volatility o Consider passive funds in geographical regions where passive funds have
traditionally done well e.g. USA
o Consider some exposure to active funds in emerging markets
o Consider increasing range of asset classes/different assets perform well in
different market conditions:
o Property (potential for long term growth)
o Consider some exposure to Fixed interest (good in times of declining interest
rates/reducing inflation)

Question 21

State the main factors that would typically influence a client’s attitude towards investment risk

Answer 21

 Timescale
 Income/expenditure/disposable income/affordability
 Assets/investments/level of wealth
 Liabilities
 Amount of investment available
 Age of investor
 Experience/understanding of market/investments
 State of health
 Objectives of investment/income or growth
 Change in personal circumstances eg job change, children

Question 22

State 8 factors that an adviser should take into account when reviewing their investments at their next annual review meeting.

Answer 22

 Personal circumstances/changes/health/family/retired
 Change personal views ethical/religious/social
 Income/outgoings/budget/inheritances/new money/tax status
 ATR/capacity for loss
 Investment returns/growth/rebalance/performance
 Use of tax allowances
 New products/changes to legislation/taxation
 Economic position/market changes
 Charges/fees

Question 23

What are the benefits of Dylan staying self-employed rather than incorporating his business?

Answer 23

 Profits not in public domain
 Simplicity
 Less administration/lower costs
 No employer NICs/reduced NICs
 All profits can be used for pension contributions
 No costs for setting up a limited company

Question 24

List the main features of the Residence Nil Rate Band (RNRB)

Answer 24

 The individual must own a property that’s included in their estate
 The home, or a share of it, must be inherited by direct descendants eg children or
grandchildren
 Unused RNRB can be transferred between spouses/civil partners
 The RNRB is £175,000
 The RNRB is tapered if the total value of the estate is more than £2 million

Question 25

ISAs can be transferred between husband and wife on death. Explain what would happen in the event of death.

Answer 25

 On death, ISA becomes ‘continuing account of a deceased investor’
 No further funds can be added but income and gains remain tax free up to the
earlier of the estate being administered, the ISA being closed or 3 years from date
of death
 Spouse inherits a one-off additional allowance - an Additional Permitted
Subscription (APS)
 The APS equals the higher of the value of the ISA on the date of the investor’s
death or the value of the ISA on the date it stops being a continuing ISA.
 Where an investor held ISAs with several companies, a separate APS will be
available for each.
 Survivor can use their ISA allowance in the normal way, in addition to any APS.

Question 26

Recommend and justify ways to minimise Dylan and Susan’s liability to IHT

Answer 26

 Ensure wills are up to date
 Make use of annual £3,000 allowances (carry forward for one year if not used)
 Make use of £250 small gifts allowance
 Make use of gifts out of normal expenditure exemption
 Consider making potentially exempt transfers
 Charitable donations/political party donations
 Leaving 10% to charity means
reduced IHT rate of 36%
 Consider EIS and SEIS as medium to high risk investors
 100% business relief for IHT after 2 years