Chapter 11 - Financial Advice

Question 1

Budgeting means as an individual you are less likely to:

Answer 1

End up in debt
Less likely to be caught out by unexpected costs
More likely to have a good credit rating
More likely to be accepted for a mortgage or loan
Able to spot areas where they can make savings
Able to save for planned spending

Question 2

Before borrowing it’s important to consider

Answer 2

The interest rate and the annual percentage rate
How much will be repaid in total
Any penalties that may occur for missed or late payments
The cost per week or month and whether this may vary

Question 3

Critical illness cover

Answer 3

Designed to pay a lump sum in the event that a person suffers from a wide range of illnesses

Available to those aged 18-64 and often must end before 70th birthday

Question 4

Income protection cover

Answer 4

Designed to pay out an income benefit when a person is unable to work for a prolonged period due to sickness

Premiums usually very expensive

Key features include:
Circumstances under which a benefit will be payable are clearly defined
Policy provides regular income after certain waiting period. Income will generally be 50-75% of pre tax earnings and they aren’t subject to tax
Once claim is made the insurance company may extend or decline eg failure to follow medical advice

Question 5

Mortgage protection cover

Answer 5

Designed to ensure that payments that are due for a mortgage continue to be paid if the borrower is unable to work because of an accident, sickness or unemployment

Protection will be on a level basis, so regular reviews are needed so that the cover reflects the payments due as mortgage interest rates change

The amount of benefit payable can be reduced to take account of income from other sources and there may be limits on the maximum amounts that will be paid so the amount may not cover the mortgage payments

Question 6

Accident and sickness cover

Answer 6

Can provide income or lump sum payments in the even of an accident

Care needs to be looked at in detail at the exclusions and limits that apply. These may include the following:

The amount of cover may be lower of a set amount or a maximum percentage of the individuals gross monthly salary
The waiting period between when an individual becomes unable to work and when the benefits start maybe 30/60 days

Question 7

Medical insurance - key features

Answer 7

Costs that are covered are usually closely defined
Limits on what will be paid out per claim
Standard care that can be dealt with by a persons local doctor may not be included
Exclusions for pre-existing conditions

Question 8

Business insurance 2 main types

Answer 8

Public liability insurance
Indemnity insurance

Question 9

Examples of business insurance uses

Answer 9

Providing indemnity cover for claims against the business for faulty work or goods
Protecting loans that have been taken out and secured against an individuals assets
Providing an income if the owner is unable to work and the business ceases
Providing payments in the event of a key member of the business dying to cover impact on profits
Providing money in the event of death of major shareholders or partners so that remaining shareholders can buy out their shares.

Question 10

Investments and saving

Key considerations when comparing returns on accounts include the following

Answer 10

Advertised rates do not always represent the true rate actually earned

Tax treatment may vary

May be a minimum and maximum which may restrict the usefulness of an account

Attractive accounts may only be available for funds that are new to that savings institution and not from existing accounts with the same firm

May be penalty charges if withdrawals are made or early encashment is needed, reducing returns

High quoted returns may only last for a limited period to be replaced by lower rates

Question 11

Later life planning example

If someone is 25 and wants to know size of retirement fund that they need to build up for their retirement which they expect to be at age 65. They estimate they will need a pension income of £25k and they will assume a return of 4% a year is responsible. So how much will the retirement fund be?

Answer 11

25k/0.04 = £625k

So next step is how much will need to be saved per year

Question 12

Estate planning

Answer 12

Making sure the client takes appropriate steps to ensure that their accumulated wealth passes to their intended beneficiaries and is as tax efficient a method as possible

Question 13

Estate planning - the balance sheet can be used to direct the client to consider

Answer 13

Whether they need to execute a power of attorney to protect their interests when they are incapable of managing their affairs

Whom they wish to inherit their estate and whether there are any specific gifts they wish to make which should be expressed in a will

The extent of any liability to inheritance tax that may arise and whether action should be taken to mitigate this

Question 14

Tax planning: the adviser needs to establish the following

Answer 14

Clients residency and domicile
Clients income tax position
How tax will affect any investment income
Any tax allowances that can be utilised
How tax will affect any gains or losses made
Eligibility for any tax free accounts
Opportunity for deferring any tax due

Question 15

Tax planning is called

Answer 15

tax mitigation = involves minimising tax liability

Question 16

Tax avoidance

Answer 16

Generally the legal exploitation of the tax system to one’s own advantage to attempt to reduce the amount of tax that is payable by means that are within the law, while making full disclosure of the material information to the tax authorities

Question 17

Tax evasion

Answer 17

The general term for efforts by individuals, companies, trusts and other entities to evade the payment of taxes by illegal means

Question 18

Offshore considerations

Answer 18

Each country has its own rules which determine an individual’s liability to tax on income, gains and on assets liable to inheritance tax or wealth tax

Question 19

Most countries tax systems can be categorised as worldwide or territorial based systems of taxation

Answer 19

Under the world wide based system, residents of that country are taxed on worldwide income and capital gains examples are the US & UK.

Under the territorial based system, residents only taxed on income and gains arising in that country

Some countries extend the tax base of residents to include overseas income and gains but only if such income or gains are remitted to the country of residence

Question 20

A legal person

Answer 20

Is an individual or entity that is recognised as having legal rights and obligations such as having the ability to enter into contracts to sue and to be sued.

Question 21

Individuals acquire their legal status as a legal persons when

Answer 21

They are born but their legal capacity to enter contracts or otherwise exercise their rights is limited in certain circumstances eg when under 18 as a minor

Question 22

Attorneys and deputies

Answer 22

A person who has legal capacity and can authorise someone else to act for them by executing the power of attorney which is a legal document that authorises someone to act on their behalf

Question 23

Ordinary power of attorney

Answer 23

Authorises on or more persons, known as attorneys to make financial decisions on an individual’s behalf or to undertake specific actions.

Individuals may use these for a number of reasons

Question 24

Lasting power of attorney

Answer 24

If an individual wants someone to act on their behalf, should there come a time when they no longer have the mental capacity to make their own decisions they can execute a lasting power of attorney

There are 2 types
1 for financial decisions
1 for health and care decisions

Question 25

Deputy order

Answer 25

When someone becomes mentally incapable of managing their financial affairs, they have not made an LPA, a deputy needs to be appointed. This requires an application to the court of protection to appoint a deputy to make ongoing decisions on behalf of that person

Question 26

Wills and intestacy

Answer 26

A will is a legal document that tells the world what is to happen to an individuals assets

A will is regarded as essential for everyone but particularly so in the case of a family with young children and in cases of second marriage

If no will is made, the legal system will determine who inherits. When a person dies without leaving a will they are described as having died intestate and a set of intestacy rules will determine who is to inherit.

Question 27

Personal representatives

Answer 27

When someone dies someone will need to collect their assets, settle any debts and distribute the balance to whoever is entitled to the reminder

Where the deceased leaves a will they may appoint someone to deal with their affairs on death. This person is known as the executor of the estate and they may apply for grant of probate

Where there is no will left then no executor is named, or if the named executor does not wish to act, someone else needs to be appointed to deal with the deceaseds affairs. This person is known as the administrator of the estate and they apply for a grant of letters of administration

Question 28

A grant of probate or grant of letters of administration is

Answer 28

A legal document that bears the deal of the court and formally confirms the appointment of the executors or administrators

Once issued the grant is then registered with each financial institution and is official proof of the appointment of the executor or administrator

Question 29

Partnerships

Answer 29

Exists when 2 or more commence in business together with a view to making a profit

Question 30

3 types of partnerships in UK

Answer 30

Conventional partnership - not a separate legal entity from its owners. Partners are responsible for their own and each others debts

Limited partnership - at least one must have unlimited liability

Limited liability partnership - corporate version of a partnership. An LLP is a separate legal entity to its members and so may hold land and property in its name

Question 31

Agency

Answer 31

Refers to a set of rules designed to smooth functioning of the business by setting out the scope of the authority granted to an agent

In relationship between a principle and agent, the function of the agent is to create contact between the principle and third parties or to act as the representative of the principle in other ways

Key point is the power of the agent to bind their principle in a contract which the agent makes on their behalf. Sometimes without the principle being aware

Question 32

Ownership of property - 2 types

Answer 32

Real and personal property

Question 33

Personal property

Answer 33

Includes possessions of any kind as long as they are movable and owned by someone

Question 34

Real property is

Answer 34

Fixed permanently to one location, includes the land it’s built on

Question 35

Joint ownership

Answer 35

Where assets are held in joint names the surviving joint owner takes the deceased share automatically

The surviving owner needs to register the death certificate with the bank and they should transfer the asset.

Question 36

Alternative type of joint ownership is tenancy in common

Answer 36

This is where an asset is owned by one or more individuals, equal or unequal shares

If one owner dies, their share of property doesn’t pass to the surviving owner. It goes to whoever they state in their will

Question 37

Insolvency

Answer 37

Where the liabilities of a business or individual exceed their assets or where they are unable to repay their debts as they fall due. A term used to describe all types of financial failure.

Question 38

An individual can be declared bankrupt if

Answer 38

They owe more than £5k to any creditor
Usually lasts a year

Question 39

With companies, two main processes are encountered

Answer 39

Liquidation and administration

Question 40

Liquidation

Answer 40

Legal ending of a limited company
Business will be removed (struck off) from companies house register

Question 41

Administration

Answer 41

Where a company is placed into administration an insolvency practitioner is appointed to take control of the company. The administrator will devise a plan to
Restore company’s visibility while coming to arrangement with its creditors
Realise the company assets to pay a particular creditor
Sell the business as a going concern on the basis that more money can be made from assets than if firm was liquidated

Question 42

The financial planning process, 5 stages

Answer 42

Determine clients requirements

Formulate the strategy to meet client objectives

Implement the strategy to meet client objectives

Implement the strategy by selecting suitable products

Revisit the recommended investments to ensure they continue to meet client needs

Periodically revisit the client objectives and revise strategy

Question 43

Main responsibility of the adviser

Answer 43

Helping clients to decide and prioritise objectives

Documenting clients objectives and risk tolerance

Determining and agreeing an appropriate investment strategy

Acting in clients best interests

Keeping products under review

Carrying out necessary administration and accounting

Question 44

Time and money is spent on training advisers in communication. Key techniques that need to be honed in on

Answer 44

Establishing rapport with client

Make it clear early on the purpose of the client meeting

Explaining information collection exercise is to ensure quality of advice

Using everyday terminology and explaining jargon when it has to be used

Checking understanding

Establishing priorities and getting client to confirm their agreement

Guiding and controlling the pace of interviews with the client

Question 45

The purpose of gathering information about the client is clearly so that financial plans can be devised and appropriate recommendations made. Types of recommendations include:

Answer 45

Personal details
Financial details
Objectives
Risk tolerance
Liquidity and time horizons
Tax status
Investment preferences

Client knowledge and experience in relation to investments
Level of investment risk that a client can bare financially

Question 46

Attitude to risk

Answer 46

Represents a clients personal opinion on the risks associated with making an investment based on their prior knowledge and experience

Question 47

Risk tolerance

Answer 47

Personality characteristic best described as a clients willingness to accept certain level of fluctuation in the value of their investments without feeling an immediate desire to sell

Question 48

Capacity for loss

Answer 48

The clients ability to absorb any financial losses that might arises from a particular investment

Question 49

Example of objective factors

Answer 49

Timescale - over which a client may be able to invest will determine what products are suitable and what risk should be adopted
Commitments - family commitments are likely to have a significant impact on clients risk profile
Wealth - a client with few assets can little afford to lose them, while those with immediate financial priorities are covered may be able to accept greater risk
Life cycle and age - 30/40 year olds will aim for long term growth. As retirement approaches this will change as the client will be looking for a secure income to live on

Question 50

Examples of objective factors

Answer 50

Clients level of financial knowledge- generally, investors who are more knowledgeable about financial matters are more willing to accept risk

A clients discomfort with a level of risk - some individuals have a psychological make up that enables them to take risk more freely than others and to see such risks as opportunities

A clients preferred investment choice - risk attitude can also be gauged by assessing a clients normal preferences for different types of investments such as the relative safety of a bank versus the potential risks of stocks and shares

A client approach to bad decisions- some can take view that they assessed the opportunity fully and any loss is just the cost of investing. Others regret and avoid similar scenarios

Question 51

Suitability and affordability. In accessing the clients knowledge and experience the firm should gather information on

Answer 51

Types of services and transactions
Nature, volume and frequency and time that the client has been involved in such services
The clients level of education, profession or relevant former profession

Question 52

Information given to clients

Answer 52

The purpose of this duty is to disclose material information to ensure the client had all information to make a full and informed decision about the suitability of the recommendation being made

Eg suitability reports etc

Question 53

Cooling off period

Answer 53

In certain circumstances, clients who are buying investment products or services are entitled to a period of reflection, cooling off period, where they decide not to proceed with their purchase

If the right to cancel is provided, the firm must give clear and prominent notice in writing either before or if not immediately after the sale. They must inform the client of
- existence of the right to cancel
- it’s duration
- the conditions for exercising it, including any amount they may have to pay
- what happens if they don’t exercise the right
- any other practical details