Case Study 2 - Key Notes Flashcards
Identify the additional information a financial adviser would require to advise Ravi and Chloe on the suitability and tax efficiency of their current financial arrangements.
16 marks
tips:
- think of key areas and then what is missing for each one e.g. mortgage, pension, employment, savings, investments, general points
Family
Expected age of dependence for the children / any more family additions planned.
Options if anticipated family support is not available in three years’ time / any other assistance available such as availability of child care vouchers or tax free childcare.
Guardianship details for the children.
Assets and investments
Amount of emergency funds required.
Performance and costs of ISA accounts /funds.
Any other loans or debts.
Use of current tax allowances - ISAs / CGT annual exemptions.
Objective of their £1,000 (x 2) regular investments
Pensions and employment
Workplace pension scheme retirement ages / desired early retirement age / level of income required in retirement (if known).
BR19 State Pension entitlement and State Pension Age.
Job security and likelihood of salary increases.
Chloe’s plans for returning to work in three years’ time: part time or full time / type of work / likely salary.
Options for pension switches within pension funds.
Whether either employer allows increased contributions to workplace pensions and whether these would be matched 9although matching does not appear to be a feature for Ravi)
Availability of salary sacrifice for Ravi.
Willingness to increase pension contributions.
Performance and costs associated with current pensions.
Current status of pension nomination forms / trusts.
Mortgage
Views on mortgage repayment / current monthly repayments and likely payments following end of fixed rate in December 2023.
Thought on extending mortgage term.
Willingness to use gift from Ravi’s parents to pay lump sum off mortgage.
Meeting needs
Disposable income available to put towards objectives, both now and when Chloe returns to work.
Requirement for any costs incurred to be guaranteed or reviewable.
Any expected inheritances.
Identify the additional information you would need from Ravi and Chloe in regards to the suitability of their Stocks and Shares ISAs.
8 marks
tips
- current provider
- objectives of saving
- where it could be used and their thoughts
•Confirmation of the objective for the funds they are saving in their ISAs.
• Whether they are looking to utilise future ISA contribution allowances in this or future
tax vears.
•Affordability of funding the ISAs, now and when Chloe returns to work.
•Willingness to use their ISAs as a mortgage repayment vehicle.
Requirement for access to the savings built up.
Reasons for selecting the Asia Pacific equity and Global infrastructure funds.
• Confirmation of the risk profile and make up of the funds / details of of securities included
• Fund performance details.
• Charges applicable to the funds.
• Whether they are satisfied with the customer service from their current provider.
Comment on the current overall tax position of Ravi and Chloe’s financial arrangements.
20 marks
tips
- what you see, don’t see, implications
• After taking into account Ravi’s pension contributions he is close to being a higher rate taxpayer (currently under the higher rate tax bracket by 1,820).
• Chloe is a non taxpayer whilst off work caring for the family.
• They each have a Personal Savings Allowance of 61,000.
• Chloe has her full 0% savings starter rate band of 65,000 available.
The deposit account income is unknown, but with the value held in the accounts and the current level of interest available for cash deposits, it is likely that the amounts will be within their respective PSA allowances.
If they do have interest above their PSA allowances, this will currently be subject to 20% income tax for Ravi up to his available remaining 61,820 basic rate band / 40% on anything above.
•For Chloe, the first $17,570, made up of her PA and her 0% savings starter rate, will be taxed at 0%.
The couple are considering taking actions to mitigate the impending increase in mortgage costs, so the 5100,000 may not stay on deposit for long.
• Their stocks and shares ISAs are not subject to income or capital gains tax.
• They both currently have a dividend allowance of 61,000. They currently have no investments that make use of the dividend allowance.
• They currently have no investments subject to Capital Gains Tax, so are unable to utilise their annual CGT exemptions.
• They have not fully utilised their ISA allowances for the current tax vear.
• They are not making use of NS&I tax - free Premium Bonds.
• Ravi is a member of his workplace pension scheme. He contributes 5% of his salary and his employer contributes 3%, so it appears that his employer does not match his contributions.
• His 5% pension contribution (62,550 gross) reduces his adjusted net income (ANI) for the purposes of calculating the High Income Child Benefit tax charge to 648,450.
•If savings income takes Ravi over the £50,000 ANI threshold, he will start to have a tax charge set at 1% of the Child Benefit that Chloe is receiving for every £100 of adjusted net income between 650,000 and £60,000.
• In that case, if Child benefit is claimed, Ravi would be required to repay this via the High Income Child Benefit Charge.
• Chloe can still claim Child Benefit to ensure she has NIC credits whilst off work caring for the family until their youngest child is 12.
• They are not maximising contributions to pensions. Including employer contributions,
Ravi has 64,080 going into his pension and Chloe is contributing nothing.
• Subject to affordability, they have capacity to increase this.
• Increased pension contributions for Ravi would reduce his adjusted net income and could move them further away from the application of the High Income Child Benefit tax charge.
• Their estate is not at a value that would be liable to IHT.
Ravi and Chloe want their financial arrangements to be more suitable and tax- efficient.
Explain the key factors that a financial adviser should consider when recommending a suitable strategy for their financial arrangemen its to become more suitable and tax efficient.
15 marks
tips
- list what have then consider factors relating to them
• Personal obiectives.
• Their expectations of any new money they may receive, such as inheritances.
•Which of their savings and investments they are prepared to take in to account for their retirement planning, or to use in the event of illness or death.
• The potential for employer-matching within Ravi’s workplace pension scheme, and availability of salary sacrifice.
• Affordability / budget to make additional pension contributions prior to retirement, or to contribute further to their ISA investments.
• Likelihood of Ravi staying with current employer.
• Expectations of future salary for Chloe.
• Level of emergency fund required.
• Requirements for income / capital in the event of death / serios illness / long term illness.
.The level of funds required for their retirement.
. Their plans to pay off the mortgage, and their thoughts on the rates that will be
available at the end of the fixed rate.
D
•Willingness to make capital repayments on their mortgage / willingness to use the gift from Ravi’s parents to reduce the mortgage debt.
• Objectives for the funds held within their ISAs, and willingness and capacity to continue to fund these in future years.
• Capacity for loss, attitude to risk and previous investment experience.
• Charges associated with their holdings.
• The reasons behind selecting their current funds within the ISAs and pensions.
• Investment performance of pensions and ISAs.
•Willingness to change the ownership of the assets.
• Willingness to use trusts.
•Planned use of tax wrappers / use of tax allowances so far.
• Their tax status now and when they retire.
•Plans for their property / likelihood of moving or needing more space for the family.
•Provisions included in their Wills (when written).
Comment on the suitability of Ravi and Chloe’s investment and pension fund choices for their financial objectives. Include comments on their deposits in your answer.
18 marks
tips
- ‘suitability’ means:
ATR.
Access.
Taxation.
Ravi and Chloe are high risk investors.
All of Ravi and Chloe’s non-deposit based fund choices:
have at least some global geographic diversification
are subject to currency risk.
have the potential for higher yields.
can provide real returns.
can be a hedge against inflation in the long term.
Ravi’s pension range of UK and global managed funds.
We do not know the assets held within the UK and global managed funds.
Managed funds are likely to be low to medium risk, however this could be increased by the geographic diversification, being UK and global.
So, the fund may not be in line with his attitude to risk, depending on the equities within the fund.
Managed funds often have below average returns as a result of the fees charged / many managed funds produce yields that are below the long term rate of inflation. This could make the fund less suitable for his long-term retirement objectives.
Chloe’s pension global equity fund
Being global, the fund may have a high level of currency risk. This may produce gains and losses over and above market changes, due to changes in currency exchange rates.
Its risk profile will depend on the exact asset allocation within the fund, but is likely to be medium to high risk, so may be in line with her high ATR.
Ravi’s stocks & shares ISA in Global infrastructure funds and Chloe’s stocks & shares ISA in Asia Pacific equity funds
Their ISAs provide tax-efficiency, and any dividends received will not be subject to income tax.
They do not have other non-ISA assets that produce dividends, so their DAS remain unused. So, they are not saving additional income tax on up to £1,000 each (their DAs) by holding the equity funds in an ISA environment.
Ignoring their unused DAs, for Ravi, who is close to the high rate tax threshold, holding the funds in ISAs may save him 8.75% or 33.75% income tax on dividends. As a non or basic rate taxpayer, it will save Chloe 0% or 8.75% income tax.
Ravi’s Global infrastructure funds are likely to invest in companies that specialise in power, transportation, water, telecommunications, etc.
Because of the non-cyclical nature of infrastructure (most people need the things it produces for most of the time) it can produce stable yields.
Such funds do introduce additional specific risks such as:
- Regulatory risk; including legislative changes in different countries.
Construction risk; higher-than-expected costs.
- Merchant risk.; the risk that variable production costs are sometimes higher than sale prices.
This may mean that Global infrastructure funds could be in line with Ravi’s high ATR, depending on the exact asset split.
Chloe’s Asia Pacific equity fund is likely to be a high risk fund. It could have high volatility and be focussed on one asset class, so lack diversification. It will also be exposed to currency risk. This fund would appear to match her high ATR.
Due to the trading volumes, their investment funds are likely to be liquid for most of the time, so could be realised to meet their financial aims if needed, such as being available in an emergency.
Cash deposits
Ravi and Chloe currently have £125,000 in deposit-based accounts. They also have £40,000 in a cash ISA.
£100,000 is the gift from Ravi’s parents, which appears to be on deposit pending a decision on the most appropriate use of the funds.
Including the ISA, this leaves £65,000 in cash. This is a relatively high level; possibly more than they need to have access to in an emergency.
Cash is a low-risk but liquid environment, which is not in line with their high ATR. They should keep funds within this environment limited to what is needed in the short to medium term.
They are unlikely to be getting any great return from the cash funds, and its value will be eroded by the effects of inflation.
Describe how Ravi’s maximum tax-relievable pension contribution for the current tax year would be established (no detailed calculations are required).
8 marks
tips
- think of all rules
Start with the current annual allowance (£60,000) and the current tax year.
Calculate pension input amount for the current year.
This will be Ravi’s plus his employer’s contributions into his workplace pension
scheme.
Made in the relevant pension input period (likely to be the relevant tax year).
So this should be the 8% of his salary of £51,000 = £4,080
Made in the relevant pension input period (likely to be the relevant tax year).
Deduct the pension input amount from the current annual allowance.
To give the remaining allowance for the current year.
He would be able to use carry forward from previous tax years, assessing the amount of pension input, and remaining annual allowance for each year in the same way as above, but with a maximum annual allowance of £40,000 for each of the years..
Ravi will be restricted to contributing a maximum of 100% of his relevant earnings of £51,000 for this tax year.
There would be an annual allowance charge if this exceeds the available carried forward annual allowance from the current and previous 3 tax years.
He would need to use this years allowance before using previous years, starting with the furthest year back.
Ravi and Chloe are currently holding the £100,000 gift from Ravi’s parents in their joint deposit savings account.
State the additional information you would need to know before advising Ravi and Chloe on the potential IHT implications of the gift.
8 marks
Split of gift between parents (one parent / 50:50 etc)
Potential for gift to be considered a gift out of income.
Parents’ use of annual exemptions in year for gift and preceding year.
Date gift was provided.
Parent’s health / likelihood to survive 7 years and avoid the gift becoming a failed PET.
Other lifetime transfers made in last 7 years.
Position of gift in IHT calculation if parent(s) were to die.
Amount of likely IHT.
Possibility of funding a gift inter-vivos policy in trust (by Ravi or his parents) / underwriting considerations.
Thoughts on funding potential IHT if gift had been used, for example to pay off part of the mortgage.
a) Explain to Ravi and Chloe how Lifetime ISAs (LISAs) would operate for them.
10 marks
b) Explain to Ravi why a Lifetime ISA (LISA) may not be suitable for him as a long-term saving vehicle.
6 marks
Ravi and Chloe can each make a maximum payment of £4,000 per annum to a LISA.
They must be under 40 to start a plan, which at 32 they both are / can contribute to age 50.
Each year until they are 50, a bonus will be paid that equates to 25% of their annual contribution. So if maximum investments are made, this would be £1,000 a year.
They already own their own home (not first time buyers) so would only be able to use a LISA for retirement purposes, when the proceeds would be tax free.
The contributions count towards their overall £20,000 ISA limit.
They can invest in a wide range of funds, that can be aligned to their high-risk ATRs.
They can access the funds from age 60.
Should they withdraw prior to this they would be subject to a 25% penalty, essentially clawing back the bonus paid.
Adding a reliable 25% to their contributions is a valuable benefit that can help improve the suitability and tax-efficiency of their current financial arrangements and be an option for part of their regular savings plans.
LISA - unsuitability reasons for Ravi
The contribution is limited to £4,000 p.a.
There is no tax relief on contributions. If Ravi were to become a higher rate taxpayer (he’s not far off already) pension tax relief would be higher than the bonus on a LISA.
There is a limited number of product providers, which will limit his fund choices.
Ravi (and Chloe) already own a house, so he would not be able to use LISAs for this purpose.
Ravi cannot withdraw monies from a LISA without penalty until age 60.
If he does access his LISA before 60, there will be a 25% penalty on withdrawal.
There would be charges or advice costs to set up a new plan.
He will only be able to contribute and receive bonuses up to the age of 50.
Legislation may change affecting LISA funding and bonus payments.
Ravi and Chloe have heard that there are benefits to investing regularly rather than via a lump sum. Explain why this is the case to them.
7 marks
Investing a lump sum is highly impacted by market timing.
If markets fall, for example just after investing their £100,000, their single premium investment could see a significant drop in value.
Making regular contributions in to savings or pension contracts can reduce risk and enhance returns.
Risk is reduced, as the chances of investing at the top of the market or just before a significant fall are lessened.
When markets are high, the fund already purchased by past regular premiums will be worth more.
When markets are low, the regular premiums will be able to purchase more shares or units due to the low price.
This has the effect of offsetting the effects of market volatility.
As long as the average price of selling units or shares is greater than the average price of buying units or shares, you’re in profit.
This approach is known as pound cost averaging.
Investing on a regular basis can also help with liquidity, as it doesn’t require giving up access to a lump sum that might be earmarked for another use.
Recommend and justify the actions that Ravi and Chloe could take to improve the tax-efficiency of their existing savings and investments.
15 marks
Ravi and Chloe should have an agreed amount of cash held on deposit as their emergency fund.
Ideally they should reduce the holdings in taxable cash-based holdings, so that interest received fits within…
their £1,000 personal savings allowances
and Chloe’s available personal allowance and 0% savings starter rate.
They should look at holding some funds in Chloe’s sole name to facilitate this.
Any interest above these allowances would be subject to income tax at:
20% for Ravi currently, but 40% if he becomes a higher rate taxpayer
20% for Chloe as a basic rate taxpayer.
Ravi and Chloe should maximise their £20,000 ISA allowances on an annual basis.
They will benefit from the income tax and CGT relief available.
This will currently save them 20% / 8.75% in income tax and 10% in CGT.
When either die, the survivor will benefit from their contributions via additional permitted subscription (APS).
Contribute to Junior ISAs (£9,000 annual limit) or pension savings (£3,600 gross annual limit) on behalf their two children.
These funds would not break the parental settlement rules;
They would allow tax free growth for the children’s future needs
This is also in line with their other actions around protecting their children.
The couple should look to utilise the tax free benefits available from NS&I Premium Bonds.
They will have immediate access but reduce the potential for savings tax for interest received over their respective personal savings allowance.
The could win a tax free prize of up to £1 million monthly!
Invest an amount agreed with the couple in OEICs or similar collective investments.
This would enable them to have dividend income that can use their £2,000 dividend allowances which are not currently being utilised.
This kind of investment, would also enable them to benefit from utilising their CGT exemptions which are currently unused.
Invest some of the funds on deposit into an EIS / VCT or SEIS in Ravi’s name.
This is in line with his high ATR.
It will enable his income tax bills to be reduced by 30% (EIS / VCT) or 50% (SEIS) of the amount invested.
The investment will benefit from growth that is free of CGT either immediately (VCT) or after 3 years (EIS / SEIS).
This leaves their CGT annual exemptions to be used for other investments.
Ensure pension nomination forms are in place, Wills are kept up to date, and appoint guardians for their children.
This Will ensure their pensions are paid direct to the survivor on first death, making their preferences clear to pension trustees.
Their Wills will continue to reflect their personal wishes and make the most of any new tax breaks introduced by subsequent governments.
They can appoint guardians for their two children rather than leaving this to the state.
Both Ravi and Chloe should contribute further to pensions, as they are not fully utilising the £60,000 annual allowance limit and current have relatively small pension pots.
This would enable the couple to progress towards retirement whilst building up further funds in an income tax and CGT efficient environment.
This would increase the amount of funds that are outside of their estate for IHT purposes, which may be relevant in the future.
They could utilise any available carry forward amounts.
Identify the additional information a financial adviser would require to advise Ravi and Chloe on the affordability of maintaining their regular savings plan, once their fixed rate mortgage comes to an end.
14 marks
Whether they have views on shortening or lengthening the current term.
Interest rates offered from their current provider / deals available on the general market.
Current and prospective mortgage repayments once fixed rate ends.
The couple’s view on their current mortgage provider.
Whether they have an objective for the money saved in ISAs and for their future ISA savings / willingness to use for financial objectives.
Current level of disposable income.
Views on the likely earnings that Chloe will have when she returns to work / ease of her finding employment / basis - full or part time.
Job security for Ravi / likelihood of salary increases.
Attitude to risk in regards to their mortgage repayment (could be more cautious than their general ATR).
Views on fixed versus variable mortgage rates.
Views on using some / all Ravi’s parents gift to repay some of mortgage.
Expected age of dependence for children / any more family additions planned.
Views on inflation / other economic factors.
Performance / costs associated with current ISA accounts.
Any expected inheritances / other funds from family.
Any other loans or debts.
Use of current tax allowances - ISAs / CGT annual exemptions.
Ravi and Chloe are concerned at the prospect of future rises in mortgage payments when their fixed rate expires.
List the key factors that a financial adviser should consider before giving advice on the options that are available to them to manage their budget.
12 marks
Term.
Amount outstanding.
Mortgage payments basis.
Interest rate now, and future options.
Currently monthly repayments / difference between current and future monthly repayments.
Equity in the property.
Budget / affordability.
Personal preferences.
View on interest rates going forward, especially at the end of the current fixed rate in December 2023.
Lender charges.
Availability of overpayment facility.
Decreasing term assurance policy death benefit / premiums / term.
Protection needs.
ATR in relation to their mortgage.
Objectives for current ISA funds and future ISA contributions.
Desire for early repayment.
Likelihood of further money from family / inheritances.
Comment on the current situation that Ravi and Chloe are in, with regard to the affordability of their future mortgage and ISA savings.
10 marks
Ravi is the sole breadwinner and is currently a basic rate taxpayer, but close to the higher rate threshold.
Chloe is not working, but is looking to return to work in three years time when James starts school.
They have a £200,000 repayment mortgage with a 20 year term remaining.
The mortgage is due to finish when the couple are 52, which is below the minimum pension age for both at age 58.
The mortgage is currently fixed at a rate of 3%, this would make their monthly payments around £1,110 a month.
Their fixed rate in due to end in December 2023 and there are no extended early repayment charges.
They will be able to switch to a new rate without a penalty from their existing lender at this point.
They will have the option to choose a new rate with their current provider or remortgage to another provider.
There may be costs involved in securing a new rate or remortgaging.
Their home is worth £370,000, so their mortgage represents a 54% loan to value (LTV).
This is likely to make them eligible for some of the best mortgage deals as this is a low loan to value.
They currently have sufficient disposable income to save £1,000 each into their Stocks and Shares ISA’s each month.
Ravi’s parents have recently gifted Ravi and Chloe £100,000 to help them with their mortgage or to invest for the future.
Fixed rates currently available on the market for their mortgage and LTV are around 5.3%.
Should they keep to the same term and repayment method, this would increase their mortgage payments to approximately £1,355 a month. (a £245 a month increase).
To keep the same level of payments (£1,110 a month), they would need to reduce their mortgage balance to £164,000 (a £36,000 capital repayment).
With a low LTV, lenders may be prepared to alter their repayment method to an interest-only basis.
They have ISA savings that can be used against an interest-only mortgage.
Their current protection policy is suited to repaying a repayment mortgage on death.
It would not be appropriate if the terms of the mortgage were changed, such as the length of time or the repayment basis.
Replacement protection policies would be likely to incur greater costs and be subject to underwriting.
Their stocks and shares ISAs are not subject to income or capital gains tax.
Ravi and Chloe’s fixed rate mortgage is due to expire in December 2023.
Outline the options that the couple have in relation to this.
6 marks
They could secure a new rate deal from their current lender; this could be fixed or variable.
With market rates available, this is likely to increase from their current 3%, meaning that Ravi and Chloe would pay more per month.
They could remortgage to another lender who may offer them a better rate.
This is still likely to be more per month than their current mortgage, and may incur further fees to transfer.
They could extend the term of their mortgage to keep the costs down; the mortgage is currently due to finish when they are 52, which is earlier than minimum pension age.
They could convert part or all of the mortgage to interest-only, which will make the monthly interest payments lower. This will require them to have a way to pay the capital element off at the end of their mortgage. This could be from their investment holdings / ISA savings.
They could use some or all of the money from Ravi’s parents to lower their mortgage balance to reduce future mortgage costs back down to the same or lower cost per month than their current monthly payment.
They could look for an offset mortgage where they could allocate some of the funds from Ravi’s parents before they need to use them, whilst reducing their mortgage payments.
They could use a number of these options combined together.
Ravi and Chloe currently have a repayment mortgage. One option they have is to change this to an interest-only mortgage.
State four benefits and four drawbacks of converting the mortgage to interest-only for Ravi and Chloe.
8 marks
benefits
An interest-only mortgage would reduce their monthly outgoings.
This would increase their disposable income that could be used for other objectives.
They could utilise their Stocks and Shares ISAs as a repayment vehicle.
This makes their mortgage more aligned to their high ATRs.
The decrease in mortgage costs could help to offset the increase due to the fixed rate ending.
This would help with their concerns around managing their budget.
They would benefit from the potential growth available by redirecting the savings into investments.
drawbacks
They would need to allocate money to a savings vehicle or use their ISA investments, which means that these are not available for their other objectives.
They would not have the peace of mind that the mortgage balance is reducing and will be completely paid providing monthly payments are maintained.
The investments used to build up a fund to repay the mortgage may not achieve their goal. This introduces shortfall risk to their mortgage.
The level of equity within the property would increase at a slower rate, and if house prices reduced substantially they could risk being in negative equity.
The costs of maintaining appropriate protection for an interest-only mortgage is higher than for a repayment mortgage, and their current policy would no longer be suitable as this is a decreasing term protection.
Their overall interest costs over the mortgage term would be higher.
Ravi and Chloe currently have a £200,000 repayment mortgage.
(a) Outline six reasons why they should retain this mortgage type.
6 marks
(b) Outline six reasons why Ravi and Chloe should consider switching their repayment mortgage to an interest-only basis.
6 marks
The couple will pay less overall mortgage interest over the term.
Their relative debt levels decrease each year with their house equity increasing annually.
As long as payments are maintained, they are exposed to no investment or shortfall risk; they are physically repaying their mortgage month by month.
They have the peace of mind of knowing the mortgage is guaranteed to be repaid.
Not many lenders now favour the interest-only mortgage basis.
Switching to an interest-only mortgage and using other assets such as their ISAs could affect their other objectives and future needs.
Reasons to switch to an interest-only mortgage
The couple’s monthly payments would decrease, giving them more disposable income for other financial aims.
They currently have Stocks and Shares ISAs valued at £155,000, so these could be used as possible repayment vehicles.
They are also paying £1,000 a month each into the plans, meaning that within 2 years they would have sufficient funds in their ISAs to repay the mortgage (£155,000 + (2 x £24,000)) = £203,000
The level of savings they would need to allocate over 20 years to achieve the £200,000 if not using already built up funds would be around £310 a month each (assuming a 3% growth rate).
They could repay the mortgage earlier if their ISAs grow well.
They would have tax-efficient investment growth potential as no income or capital gains tax is levied on ISA growth.
ISA monies are easily accessible if the couple have an emergency; liquid investments.
More of a match for our couple as high risk investors.
Explain in detail to Ravi and Chloe why using their stocks and shares ISAs as a repayment vehicle alongside an interest-only mortgage may be suitable.
12 marks
The ISAs are tax-efficient, as they are not subject to income tax or CGT.
There is potential for growth within the funds due to gross roll-up, meaning that their mortgage could be paid in advance of the current term, saving them interest costs.
They could make withdrawals in order to reduce the balance each year in line with any amount of allowable capital repayments, as there is good liquidity within the ISA funds.
They are paying a low interest rate on their mortgage of 3% until December 2023 and the growth potential of the funds within an ISA is likely to exceed this rate.
This method of repayment is in line with their high ATR.
They are able to contribute up to £40,000 a year into ISAs, which they are not fully using / they currently already have £155,000 in ISAs.
They have flexibility to amend payments to the ISA to reflect their circumstances, so whilst Chloe is not working they could contribute less, increasing contributions when she returns to work, and affordability is easier.
With the interest rate of 3% likely to increase on expiry of the fixed rate, they would have flexibility to alter their ISA contributions to cater for any increase in costs.
Saving regularly into their ISAs will enable them to benefit from the effects of pound cost averaging.
They can choose funds to match their high ATRs.
Once the fixed rate ends, there will probably be no early redemption penalty, so they could reduce their mortgage balance then.
Early repayment of their mortgage will allow them time to focus on their other financial objectives, such as retirement, or costs associated with their children.
On first death, the balance of the ISAs will be able to continue to the surviving spouse under the additional permitted subscription rules, maintaining the tax efficiency.
Explain in detail to Ravi and Chloe four benefits and four drawbacks of using all of the gift of £100,000 from Ravi’s parents to reduce their mortgage balance at the end of the fixed rate.
12 marks
Benefits
Their outgoings would immediately reduce, even with the increase in mortgage interest rates. Their new mortgage payments would still be below their current level (a £100,000 mortgage on 5.3% would be around £677 a month, against their current payments of £1,110).
They would reduce the money on deposit. This reduces the possible impact on Ravi’s tax situation with a lower interest amount being assessed against his PSA. This helps to keep his level of income below the higher rate threshold, and the threshold for reclaim of Child Benefit.
The funds on deposit are low risk and not suitable for their high ATR.
They will save on interest payments throughout the term of the mortgage.
They will have increased affordability for other financial objectives, such as being able to maintain their monthly ISA savings.
There will be less protection required, which will reduce these costs.
Their credit score will improve, giving them better chances of being eligible for further lending later on.
Drawbacks
They will not have the £100,000 to use for other objectives such as their or the children’s future needs.
They will not have the option to invest the £100,000, and are therefore missing out on future potential investment growth.
There is a loss of liquidity; in an emergency, they may be unable to borrow these funds back and have less liquid assets to call on, such as if Ravi were to lose his job.
Use of the full £100,000 may not align to the reasons for the gift from Ravi’s parents, and there may be emotional attachment to the funds.
The funds were from Ravi’s parents and the mortgage is in joint names.
Outline the main benefits of using cash flow modelling to analyse the impact of the upcoming mortgage rate change, alongside the affordability of maintaining the ISA monthly payments, with Ravi and Chloe.
8 marks
Different scenarios can be calculated, looking at the options they have for their mortgage.
The impact of upcoming changes can be built in, such as Chloe’s return to work.
It can highlight periods when the amount they can afford to pay into their ISA savings changes.
Allows Ravi and Chloe to take actions now to prevent a budget deficit or to maximise opportunities.
It can highlight options to repay the mortgage early and free up disposable income for their other objectives.
Highlights periods where income or capital is in deficit / surplus.
Analyses different scenarios with impacts of needing a higher level of income or when money could run out, such as in retirement.
Can give them visual clarification of their circumstances which can be easier to use to see the impact of their decisions.
Allows them to focus on making decisions about their future.
Can demonstrate the impact of increased inflation on income and capital.
And the effects different scenarios have on levels and requirements.
Pinpoints areas of finance where costs can be cut to help with budgeting.
Identifies potential issues or opportunities.
Gives Ravi and Chloe the opportunity to discuss with an adviser how to plan for and / or overcome potential shortfalls.
Ravi and Chloe want to improve the use of their tax allowances.
What additional information will a financial adviser need in order to advise Ravi and Chloe in this area?
12 marks
Interest being received from their current account / joint account.
Their thoughts over the investment of the £100,000 received from Ravi’s parents.
When are they intending to move, invest or use the £100,000?
Willingness to invest this £100,000 in either name, despite gift being from Ravi’s parents.
Willingness to transfer ownership of investments.
Availability of option to increase contributions through Ravi’s workplace pension scheme / salary sacrifice.
Ravi’s contribution history to his pension scheme.
Chloe’s likely role / hours when returning to work in three years time / likely income levels.
Whether Chloe is claiming Child Benefit for Rina and James.
Willingness to use the Marriage Allowance to transfer some of Chloe’s personal allowance to Ravi.
Willingness to continue to save into their ISAs.
Use of maximum allowable contributions for ISAs this tax year / plans going forward. (Currently saving £1,000 each per month, which is £12,000, are they using the other £8,000 of the ISA allowance?).
Willingness / budget to make pension contributions for Chloe currently.
Any other inheritances other than the £100,000 from Ravi’s parents.
Pension nomination forms status.
Planned provisions in their Wills.
Any CGT losses previously registered.
Ravi and Chloe want to improve the use of their tax allowances.
What factors will a financial adviser take into consideration in respect of this aim?
10 marks
Rates of interest payable on their accounts.
Use of ISAs for this and future tax years.
Receipt of Child Benefit payments.
Pension contribution history / option to increase pension contributions for Ravi / make some for Chloe.
Objectives for the £100,000 gift from Ravi’s parents.
The availability and use of the Marriage Allowance.
Investments that provide a dividend income.
History of investment holdings, and any previous CGT losses.
Willingness to make charitable donations.
Willingness to update nomination forms on pensions.
Willingness to transfer ownership of assets.
Affordability of increased mortgage costs.
Options available at end of mortgage fixed rate.
Ravi and Chloe want to improve the use of their tax allowances.
Comment on their current situation in regards to the use of their tax allowances.
20 marks
Ravi
Ravi has non-savings income of £51,000.
After his pension contribution of £2,550, he has taxable income of £48,450
This puts him £1,820 away from being a higher rate taxpayer.
His ISA is free of income tax and CGT.
Chloe
Chloe is not in paid employment.
She is eligible to claim Child Benefit which is £2074.80 for 2023/24.
This is paid tax free.
This qualifies her for National Insurance credits towards her Single Tier State Pension.
Savings income
We do not know the interest amount being received from the current and deposit account.
These accounts are held jointly so any interest received will be allocated 50:50.
Providing Ravi stays as a basic rate tax payer, he will have a full PSA, so the first £1,000 of his share of the interest will be taxed at 0%.
He will then have £820 of his basic rate band left where interest will be taxed at 20%.
If he exceeds £1,820 in interest, his PSA will reduce to £500 meaning £500 more of the savings interest will be taxable at 20%, with anything above £1,820 taxed at 40%.
Chloe has her full personal allowance unused + a full PSA of £1,000 + eligibility to the 0% starter rate band.
This means that she could receive £12,570 + £5,000 + £1,000 = £18,570 of savings interest per annum currently without having to pay any income tax / saving 20% income tax.
Holding the account in joint names is not utilising these allowances efficiently.
Dividend allowance
Neither Ravi nor Chloe have any investments that are producing dividend income, so their dividend allowances of £1,000 are going unused.
High Income Child Benefit Charge
Ravi’s adjusted net income leaves him £50,000 - £48,450 = £1,550 away from starting to have a High Income Child Benefit Charge.
If the savings income takes him over the £50,000 threshold, he will start to have a tax charge set at 1% of the Child Benefit that Chloe is receiving for every £100 of adjusted net income between £50,000 and £60,000.
ISA limits
Ravi and Chloe are both paying £1,000 a month into their ISAs.
This totals £12,000 each per tax year.
The ISA limit is £20,000 per tax year each.
So, they appear to be missing out on £8,000 of this limit each tax year each.
Pensions
Ravi is paying in 5% of his earnings into a workplace pension scheme, so £2,550 / employer paying in 3% of his earnings, so £1,530. Total £4,080.
Ravi has an annual allowance of £60,000, for contributions into a pension scheme, with his personal contributions restricted to 100% of his earnings in order to get tax relief / he is not fully utilising the limits he has available.
Further pension contributions would impact on his net adjusted income for the purposes of assessing the High Income Child Benefit Charge.
Ravi doesn’t appear to be utilising salary sacrifice. If he did, he would pay a lower amount in National Insurance, as it wouldn’t be due on the amount sacrificed.
His current fund value is £72,000, which is growing free of income tax and CGT.
He is nowhere near the lifetime allowance, which is currently set at £1,073,100.
Chloe is currently not paying into a pension scheme.
Even though she is not working, she can contribute £3,600 gross or £2,880 net per tax year and receive the tax relief on this.
Charity
They are not contributing to charity.
This can have the effect of reducing net adjustable income for the purposes of assessing the impact of High Income Child Benefit Charge.
NS&I
They do not hold any tax free NS&I products such as Premium Bonds.
CGT
They do not appear to have any investments that have a CGT liability.
This means that the annual exemption of £6,000 for the 2023/24 tax year is unable to be utilised.
They do not appear to have any previously registered losses that could offset a future CGT liability.
IHT
Their estate is not currently above the IHT threshold
They do not currently have Wills in place which could determine if their property was to be left to direct descendants / this would determine the availability of the RNRB.
JISAs
There is no mention of savings accounts for the children.
They will be able to pay in £9,000 per tax year per child into a JISA.
This will grow free of income tax and CGT.
It will be available to the children when they reach 18, when any amount they use from the fund will be free of income tax and CGT.
