Chapter 8 (5 marks, all multi response) – Aims Of Retirement Planning

Question 1

The fact-find contains several different sections, covering a variety of areas, including: HAVE A LOOK AT A SALTUS FACTFIND

personal and family details
Essential information when deciding the types of death benefits an individual requires, both pre and in retirement. Remember, the more add-ons an individual requires, the larger the pension fund needed to meet these requirements.
employment information
This type of information will be essential for a couple of main reasons…

1) It will show if the individual has access to any employer-sponsored or workplace pension schemes. Such schemes will require a minimum employer contribution as well as the individual contributing, which will boost funding levels. Any charges will usually be met by a sponsoring-employer, leaving more funds available to meet the client’s retirement planning needs and objectives.

2) It shows the earnings of the individual. Remember, tax relief on individual pension contributions are capped at the greater of 100% of gross earnings and £3,600 gross with no reference to earnings. Contributions may be better off being spread, if this attracts the highest level of tax relief for the client and avoids an annual allowance charge (if the relevant allowance is breached).
income and expenditure
This section is essential for establishing the disposable income the individual has, to put towards their retirement planning needs and any solutions proposed. Any solution recommended by an adviser requiring regular premiums must be shown to be affordable for the client on an ongoing basis, and not just at the point of advice.

Regular pension contributions should increase each year, affordability permitting. For most clients, the amount of income required, and the resulting pension fund needed to achieve this aim, will be initially unaffordable in terms of contribution levels. Increasing pension contributions annually in line with earnings is an effective way to try and combat this, and achieve the client’s retirement objectives.
assets and liabilities
Does the client have assets that are not as tax-efficient as they could be? Could money on deposit be redirected into single-premium pension contributions? Such contributions would boost pension planning for the client, and benefit from HMRC tax-relief at the individual’s highest marginal rate.
risk profiler
This is a key area that will affect the advice given, type of scheme selected, and the types of funds invested into. A client’s attitude to risk (ATR) will vary according to their personal circumstances and experiences. The client’s ATR will colour all aspects of the retirement planning advice given.
objectives summary
This section of a fact-find is key in allowing the adviser to agree with the client what their key objectives are, and how they rate these in terms of a priority order.

Answer 1

LOOK AT 8.1 FOR SOME KEY QUESTIONS TO ASK A CLIENT

FOR CONTEXT:
However effective and thorough this fact-finding process is, it cannot be 100% accurate.

The younger the client is, and the further they are away from retirement, the more difficult it is to accurately predict income requirements. One idea that can be used is to link retirement income needs to a percentage of current earnings.

We will now look at some of the key factors that the questions above are trying to establish with the client in relation to their retirement planning, and why these factors are so important in relation to ‘giving best pensions advice’.

Question 2

There are a number of key factors that can affect an individual’s retirement planning. Give some examples of where each factor is important to consider. The following important factors are: (OBVS THERE IS MORE TOO)

-Capital needs
-Income needs
-Inflation
-Contribution levels
-Attitude To Risk (ATR) and capacity for loss
-Timescales to retirement
-Overall wealth
-Attitude to other financial planning areas
-Past experience
-ATR profiles
-Ethical/Socially responsible investing/ESG considerations

Question 3

The following areas also need consideration by a financial adviser when deciding what retirement strategy best suits a client. These include:

Answer 3

Cash flow modelling
Stress testing
Volatility and pound cost averaging
Safe withdrawal rate

Question 4

What is Cash flow modelling?

Answer 4

In its simplest form, this is the process of assessing a client’s current and forecasted wealth, along with inflows (income) and outflows (expenditure), to enable a picture to be created of their finances, both now and in the future. It allows a financial adviser to better recommend the most suitable retirement strategy for a client, coupled with the right asset allocation.

Stress Testing is used with cash flow modelling.

Question 5

Volatility and pound cost averaging

The effects of volatility must be considered on a client’s retirement income and strategy.

Regular contributions purchase units at different prices. This can mean more units are purchased, known as pound cost averaging. If taking withdrawals in a falling market the reverse is true, as more units need to be sold to generate required amounts. This is known as reverse pound cost averaging and can exaggerate the volatility of the fund. This is often called sequencing or sequencing of returns risk.

Question 6

What is the Safe withdrawal rate

Answer 6

This is the rate that a client can sensibly withdraw from their pension fund whilst ensuring it lasts for their lifetime. This rate must use a variety of assumptions and one of these is an expected 30 years in retirement. As you can imagine, this is another key area to discuss with clients when considering their retirement planning strategy.

Question 7

How can property as an asset class be used in a pension?

Answer 7

Property has a variety of uses in a pension scheme:

reducing risk due to negative correlation with equities. (property and equities tend to be negatively correlated)

helping a pension portfolio achieve a real rate of return.

allowing business owners to invest in commercial property for the benefit of the business.

Question 8

Every company issue shares, but for shares to be offered to the general public the company must usually gain a listing on a stock exchange, and offer a minimum of 25% of their ordinary share capital for sale.

Ie the rules to become a PLC. There are also other rules in terms of minimum number of directors etc

Question 9

Equities have a variety of uses in a pension scheme:

helping a pension portfolio achieve a real rate of return.
allowing an individual in drawdown to positively outweigh mortality drag through the positive investment returns that equities can achieve.
helping an individual’s pension fund absorb the higher charges associated with drawdown.

Question 10

8.2: Self-investment options

RPSs can, and do, use a wide range of asset classes and both direct and indirect investments.

Question 11

Direct investments are most common with pension schemes such as an SSAS or SIPP. These are where assets are held by the scheme itself, rather than through a third-party investment.

The most common examples include shares and commercial property that the pension scheme itself owns.

Indirect investments are accessed through a third party, such as a collective investment scheme. There are a wide range of collective investments that can be used by a pension fund. These include: Unit trusts/OICEs, hedge funds, with profit funds, REITs, ETFs etc

Question 12

With-profit funds

A with-profit fund invests into all four types of asset class. Companies such as the Prudential and Standard Life offer with-profit funds that have been running for decades.

With-profit funds give investment growth through the addition of bonuses. These can be annual and/or terminal bonuses.

Annual bonuses are added based on investment profits year on year. In good years, an insurance company will hold back some profits so that it can continue to award annual bonuses in years where profits are not quite as good. This concept is known as smoothing.

Bonuses, once added to an individual’s plan, cannot be taken away if the plan is held to its set term.

If the individual cashes their plan in early, a discretionary charge, known as a Market Value Adjuster (MVA), can be levied. This claws back some of the bonuses awarded and protects the other with-profit policyholders.

A terminal bonus looks at investment profits for the whole term the investment has been held.

It can be added at retirement or death, but is far from guaranteed

Question 13

Investment trusts are traded as Public Limited Companies (PLCs).

Answer 13

They have a fixed number of shares, which are traded on the London Stock Exchange like other companies.

Their share price moves in relation to market forces, and the fund is not bound to mirror its NAV in value. If investors see a value in the company over and above the total value of its assets, then the capitalised share value will exceed the NAV.

This is a key difference between an investment trust and unit trusts and OEICS, which trade at their NAV.

Question 14

A registered pension scheme can utilise different types of indirect investment funds, but it can also offer different specialist fund types, so we will consider these next.

Question 15

Pensions can have specialised fund types called 8.2.2: Different fund types

Lifestyle funds and Target date funds.

This flash card is about lifestyle funds

Answer 15

Lifestyle funds

With regard to asset allocation and risk taken, the longer the term to retirement, the greater levels of risk some investors are prepared to take with their pension investments.

As an individual gets closer to their selected retirement date, they are more susceptible to the effects of fluctuations in their pension fund value. Remember, the lower the pension fund value, the less income available through whatever income option is selected.

To counter this issue, some pension providers offer a lifestyle fund.

Lifestyle funds are more usually associated with stakeholder pension plans, but can be available in other scheme types.

These funds have unique characteristics which include:

a pre-programmed, phased switch, five to ten years before retirement
from higher risk to lower risk asset allocation
gradually de-risking the pension fund asset allocation
to a balance of around 75% invested in gilts and 25% in cash by retirement
A lifestyle fund locks in gains that have been made during the policy term, and reduces the risk of fund value fluctuations leading up to retirement.

This approach has both benefits and drawbacks for the client such as: WHAT

If an individual’s retirement date has changed this can cause specific issues with life styling.

An earlier retirement date can mean the fund still has a higher equity asset allocation, so can fluctuate in value at this crucial time leading up to income requirements.
If a later retirement date is used, the client could lose out on greater growth opportunities, as funds will have been switched into cash and gilts too early.

Question 16

Pensions can have specialised fund types called 8.2.2: Different fund types

Lifestyle funds and Target date funds.

This flash card is about target date funds

Retirement date funds in NEST are also covered earlier in this study guide in Chapter 3. Please return to this section if you feel you need a refresher.

Answer 16

Target date funds

BASED ON THE INDIVIDUALS YEAR OF RETIREMENT
These are most commonly used by the workplace pension scheme providers that have entered the pension market from 2012, such as the National Employment Savings Trust (NEST). They are called Retirement Date Funds in the NEST.

An individual saving through this type of scheme selects a fund type that is aligned with their desired retirement age. The fund will initially have a higher risk asset allocation, so utilising asset classes such as equities and property. As the individual approaches their selected retirement date, this asset allocation gradually switches to cash and fixed-interest securities.

This sounds like a lifestyle fund, but is available through workplace pension scheme providers such as NEST.

Question 17

8.2.3: Self-invested pension schemes

Answer 17

Self-investment essentially means a pension scheme where the individual can make their own investment decisions from the full range of investments approved by HMRC.

There are two main types of schemes that allow the member this control: SIPPs & SSAS’s

Question 18

8.2.3: Self-invested pension schemes

Self-investment essentially means a pension scheme where the individual can make their own investment decisions from the full range of investments approved by HMRC.

There are two main types of schemes that allow the member this control:

Question 19

Self investment schemes such as SIPPs or SSAS’s

Answer 19

Such schemes tend to be utilised by a more sophisticated individual and, as a result, there are a number of HMRC restrictions imposed to ensure schemes do not take advantage of investment rules.

Schemes such as an SIPP or an SSAS have some specialised options available to them in terms of their pension fund monies.

These can include: Scheme Loans

Question 20

An SSAS can lend, whereas an SIPP cannot.

The maximum SSAS loan is 50% of net scheme assets which is calculated in a prescribed way: HOW? LOOK AT EXAMPLE 8.4 OR CHAPTER 3

There are some criteria for an SSAS loan, including: what is this? (If any of these criteria are not met (8 in total), the loan will be classed as an unauthorised payment, with taxation and scheme deregistration implications.)

Question 21

An SSAS can lend, whereas an SIPP cannot.

Both an SSAS and an SIPP can borrow for a commercial purpose. This borrowing is also limited to 50% of net scheme assets.

Question 22

SSAS’s can lend and borrow (for commerical purposes)

SIPPs can only borrow

Question 23

Investments in a sponsoring employer

An SSAS is restricted to investing no more than 5% of its fund value (up to 20% where there is more than one sponsoring employer) in the shares of a sponsoring employer. There is no such limit in relation to an SIPP.

An SIPP could therefore, in theory, invest 100% of its assets in the shares of the member’s company.

Answer 23

There is a limit where an SSAS is purchasing shares in the sponsoring employer.

An SSAS can invest up to 5% of the fund value in shares of one sponsoring employer. There is no restriction on the number of shares though, so potentially 100% of the shares could be owned by the scheme, as long as that was only 5% of its overall assets. If there are associated employers, then then the maximum is 20%.

Question 24

Investments in taxable property

When pension simplification was introduced by the Finance Act 2004, there were few restrictions on the assets a pension scheme could invest into.

This led to many schemes on offer that invested members’ monies into all sorts of areas including residential property, works of art, fine wines, and antiques.

Because of all this speculation, HMRC introduced taxable property rules which meant that any asset falling under this classification, if held in an RPS, would attract unauthorised payment taxation. We have covered the unauthorised payment taxation back in chapter 2 section 2.6.3. Please return to this section if you feel your knowledge needs a refresh.

Question 25

Do activity 8.2

Question 26

Disadvantage of RPS’s For certain individuals on low incomes, pensions could replace income that is claimable via DWP benefits, which would represent poor value for money for the member.

Answer 26

All of this means that individuals use a range of alternatives to save for their retirement.

Considering using an RPS should be a client’s first port of call, due to the tax advantages available through them, but we will now move on to our third section of this chapter, where we consider alternative options that can be used to save towards retirement. Before we do so, have a look at two exam style questions.

Question 27

8.3: Alternative options for retirement planning

This includes:
8.3.1: ISAs

Question 28

8.3.1: ISAs

Often used as an alterative to pensions

ISAs come in a variety of forms from self-select, collective investment scheme ISAs, managed stockbroker ISAs, cash ISAs, to name a few. From 6th April 2016, we had the Innovative Finance ISA introduced and from 6th April 2017 the Lifetime ISA (LISA) was introduced.

Answer 28

Self-select

This is where the investor selects the individual company shares or collective investments that they wish their ISA monies to be invested into, and an account manager duly carries out the investing.
This ISA type usually appeals to the more sophisticated investor.
Collective investment scheme

The ISA subscription is invested into collective investment schemes such as a unit trust, OEIC or investment trust with all the characteristics of such schemes, but with ISA tax advantages.
Managed stockbroker

This contains a portfolio of equities that are actively traded by a stockbroker to maximise returns.
Cash

Investments are made into a variety of cash options such as bank or building society deposits.
Cash ISAs must guarantee to return at least 95% of investors’ monies within a five-year time scale.

Question 29

Lifetime ISA (LISA) - one of the favourites of the R04 examiner!

This ISA type can be taken out by individuals under 40, either to purchase a first home or towards retirement planning.
There is a £4,000 annual investment limit with a government bonus (up to age 50) of 25%, so an annual maximum of £1,000.
An individual can now invest £20,000 annually into an ISA and this can split between the different types we have just covered. If monies are withdrawn, they can be ‘re-topped up’ as long as this occurs in the same tax year.

Question 30

Innovative Finance ISA (IFISA)

This allows investors to lend their ISA allowance through the Peer to Peer lending market.
This is also known as crowdfunding.
Interest rates are much higher than on a cash ISA, but risks are also significantly higher.

Question 31

On death, historically, an ISA automatically terminated, and the underlying assets reverted to forming part of the deceased’s estate and being subject to inheritance tax (IHT). This changed from April 2015 with the ability for a spouse or RCP to claim an additional ‘allowance’, at the level of the deceased’s ISA investments. This is known as an additional permitted subscription (APS). They do not have to inherit the actual funds to benefit from the APS.

There is a three-year timescale from the ISA holder’s death for this to be claimed, which is in addition to the claimant’s own ISA allowances.

Answer 31

An ISA cannot be placed in trust, so cannot be part of a ‘spousal bypass trust’ to bypass the estate on death.

Question 32

8.3.2: Investments into unlisted shares

This is EIS, SEIS & VCTs

Question 33

Risks associated with property investment

The risks associated with property investment include:

Liquidity Risk: The ability to sell at a given time.
Management Risk: Skills and funds required to run the business.
Void Risk: The risk that the property will be vacant with no tenant paying rent.

Question 34

The risks associated with equity release include:

high potential costs
The usual costs associated with selling a property such as valuation, conveyancing, mortgage, and solicitor fees.
reduction in the individual’s estate
There is less to be passed down to loved ones.
affecting entitlement to DWP benefits

Generating this capital sum will affect any DWP benefit that is means tested such as Pension Credit. It can also affect the individual’s tax position. (Remember how pension credit is capital and means tested)

Answer 34

8.3.4: Using a business sale

A very common phrase used by business owners is ‘my business is my pension’. Many reinvest all profits into their business to increase its value.

Using your business as your pension has some advantages and these include:

Profits subject to corporation tax: This is levied at a lower rate than income tax.
Business Relief: Business assets will often qualify for 100% BPR if they have been owned by the individual for a minimum two years prior to death.
Business Asset Disposal Relief: Any CGT levied on profits made from a qualifying business sale will be reduced to a 10% rate on a lifetime gains limit of £1,000,000 (current tax year).
Also, many individuals feel more confident about backing themselves as their investment via their business, rather than considering areas that they are less familiar with.

The risks associated with a business sale include:

poor diversification
Both the individual’s current and retirement incomes are reliant on the same source.
illiquidity
A business can only be sold if there is a willing buyer. A buyer may be difficult to find, plus they may not pay you what you think the business is worth.
time of sale
There is no guarantee that the timescales for retirement will coincide with a buoyant economy and a good time to realise the business value.

Question 35

Life assurance based investments

Single premium plans

A single premium product is technically known as a whole of life plan. This means it has no maturity date. The investor can encash all or part of the bond at any time. A bond can be set up on a single or joint-life basis. Joint-life plans usually use a ‘second death’ basis. This means that, on the first death the bond just passes into the sole survivor’s name.

Single premium plans or bonds are non-qualifying, so proceeds are potentially subject to further tax, subject to certain conditions and features:

a chargeable event must have occurred
These include death, assignment, maturity, part surrenders and surrenders.
5% annual withdrawals are permitted tax deferred
Up to 5% of the original investment (not the current value) can be withdrawn tax deferred. This is cumulative so can be rolled over. Taxation is deferred until final encashment or 100% of the original investment has been withdrawn. Individuals that are currently higher or additional rate taxpayers can defer assessment of the income until a later date. At this point they may be a non-UK resident, or a basic rate taxpayer so have no further liability.
top slicing can be utilised
HMRC allows any gain made to be divided by the number of years it has been made over. Remember, basic rate tax is satisfied internally so additional tax will only be paid if this ‘top slice’ pushes an individual into higher or additional rate tax (new rules are a bit more complex).
assignment can be used
An individual can assign an investment bond to an individual who is a basic or non-taxpayer, to reduce the tax liability on encashment. If this individual is their spouse or civil partner there are no issues on this legal transfer either.

Answer 35

Regular premium plans

A regular premium plan is more likely to be a qualifying policy. If the plan satisfies the qualifying rules, and the owner is the original owner, proceeds will be paid free of further taxation. You cannot call this a tax-free plan due to the non-reclaimable tax that has been paid, internally. Qualifying rules include the following.

Such a policy can start out as qualifying and become non-qualifying if any of the above rules are broken.

A plan can never start off as non-qualifying and become qualifying.

Question 36

DO activity 8.3

IT HAS ALL ALTERNATIVE INVESTMENT TYPES

Question 37

8.4: Regular reviews

Regular reviews are needed, both in the pension accumulation and decumulation phase of an individual’s retirement planning. The factors that need to be considered will vary according to which stage the individual is in whilst reviews are carried out.

Reviews should be carried out at least on an annual basis, but if the client’s circumstances change, reviews should be carried out more frequently.

Answer 37

8.4.1: Accumulation reviews

As an adviser, as part of the fact-finding and ‘know your client’ process you will have agreed the following:

income requirements.
capital requirements.
attitude to risk.
the retirement planning shortfall.
affordability.

There are a variety of actions that can be recommended by an adviser if the retirement planning shortfall is difficult to bridge. WHAT?

8.4.2: Decumulation reviews

Reviews during the decumulation stage of a client’s retirement are just as important. With individuals retiring earlier and living longer in retirement this can lead to a period of 30 years+ during which income payments need to be made.

There are a variety of factors that could affect a client’s review and retirement income, including:

There are also some retirement income products that require regular reviews.

The option requiring the most frequent reviews is capped drawdown.

Capped drawdown clients and plans require:

provider reviews every three years up to age 75.
annual reviews thereafter.
adviser annual reviews.

We will now look at a couple of areas relating to reviews during pension decumulation: level fixed income and variable income.

Question 38

What the respective option in declumlation phase,
what can be discussed?

Answer 38

Level fixed retirement income

Income that is paid from a scheme pension or non-investment based, non-flexible lifetime annuity will be difficult to vary. Escalation can be built in, but this is a set annual increase, not the ability to vary income levels. There is no flexibility to vary income levels such as decreasing, stopping, or restarting income. These pension income options do not provide this level of flexibility.

The above schemes can be transferred in payment, but the new provider must mirror the original scheme rules, so, even if the client transfers, this will not give them any more flexibility income-wise. Such a transfer will also incur charges, which could in practice reduce fixed income levels still further.

Variable income

Variable income usually comes from three main sources:

The ability to vary income will depend upon the terms of the provider’s product.

A review of the client’s needs and circumstances will be required if such a change is to be actioned. The performance of any underlying investments must also be taken into account.

Just as with pension accumulation, additional reviews will be required if there is a change in a client’s personal circumstances. Member-instigated drawdown review rights were introduced by the Finance Act 2007. These can only be requested on a plan anniversary. This is only required for an existing capped drawdown; no provider review is required for FAD. Adviser reviews for both should be annual.

In relation to investment-linked annuities, there are some additional options open to the individual, if they need to vary income levels in retirement. These include:

changes to underlying bonus or unit growth levels selected
This can lead to higher income levels going forward if bonus or unit growth rates are increased. The converse is also true if they are decreased.
switching to a traditional non-investment-linked annuity
This will allow the client to take a guaranteed income for life. Annuity rates may have improved, the client’s circumstances may be clearer, or the implications of mortality drag are becoming too onerous.

Question 39

Gradual retirement

As mentioned, this is also known as phased retirement. This is where an individual gradually crystallises their pension benefits rather than all in one go. Reviews should be used to look at income needs to decide how much needs to be crystallised going forward. This exercise is split into three stages: WHAT IS THIS

Question 40

Changes in income needs can be permanent or temporary.

One example is bridging to state pension age (SPA) that is sometimes offered through DB occupational schemes.

This pays a higher income, usually from age 60 through to SPA when the state pension starts to be paid, which reduces at SPA (also known as an integrated pension).

This could be covered through individual schemes as well, so a higher amount crystallised to start with, probably utilising PCLS for this higher temporary income.

If the need is permanent, then income sources such as an annuity should be considered by the client. The higher the increase in income required, the more likely it is that the secured income options (annuity or scheme pension) will be the best solution.

Question 41

Recycling excess income

If income needs fall and an individual has ‘excess’ income, recycling this income as pension contributions can be considered. There may however be issues with the MPAA as a result.

It has two main benefits:
Increases a lump sum death benefit
Creates a further source of PCLS

Answer 41

Excess pension income could ALSO be recycled into alternative forms of retirement planning, such as ISAs or collective investment schemes.

Question 42

In retirement, people are obviously ageing, as are their dependants. Therefore, many ‘postpone’ making decisions with regard to dependant benefits, by using retirement income options such as drawdown pension.

No-one wants to build in expensive dependant benefits if they are not going to be used because the dependant has either died or reached an age where HMRC no longer consider them a dependant.

Remember from Chapter 6 in this study guide, that the inclusion of any features such as dependants’ pensions will decrease the amount of upfront income the client can receive, if using a secured form of income such as a lifetime annuity, so, from a review perspective, this area should be closely monitored.

Answer 42

Estate planning needs

As individuals age, the problem of estate planning generally becomes of greater importance. Even if a family becomes wealthier in their own right, a parent will generally wish to leave their children as much as they can, as tax-efficiently as possible.

If this area is a concern, then drawdown is potentially a better option than secured annuity purchase. Under drawdown, a lump sum can be left without any fall in income levels. With an annuity, if capital protection is built in (on death this pays a lump sum) this will reduce up-front annuity income levels.

Question 43

Subsequent annuity purchase

Individuals who are utilising drawdown or phased retirement, may reach a stage when they wish to simplify their affairs and purchase an annuity. There is now no requirement to do this by a certain age (it USED to be age 75).

Age 70 onwards does bring increased challenges, as the effects of mortality drag increase dramatically from this point onwards, so it may be an idea for the individual to buy an annuity income before the effects of this become too pronounced. As a client ages and/or the level of income they require rises, they may be better suited to a secured annuity income anyway.

Answer 43

Changes in investment conditions

Changes occurring in the equity, property, and bond markets will affect an investment-linked retirement plan.

Rises and falls can affect an investment-linked retirement plan in a variety of ways including:

the need to rebalance pension fund investments
If equities are performing strongly, a client’s asset allocation may be ‘out of balance’ with their agreed risk parameters, and therefore need adjusting. This is known as ‘rebalancing’.
changes in the client’s ATR
ATR is likely to become more cautious as a client ages, however a certain degree of risk may be necessary to counter-balance issues such as mortality drag. This may lead to a decision to switch from drawdown to annuity purchase.
changes in a client’s other investments
A financial adviser needs to take a holistic view of the client’s investments, and not just focus on those within their pension plans.
the need to create a new cash / fixed-interest securities reserve
Earlier in this chapter we mentioned asset allocation, and said that different asset classes have different uses within a pension plan. Cash and fixed-interest securities are commonly used to pay plan charges, and also used to provide income in the early years of withdrawals. This reserve may have been run down and need replenishing.
new investment opportunities
There could be new fund and investment areas developed, that may suit a client. These would need to match a client’s ATR. Some of the new developments coming through include exposure to derivatives, which may be outside your average client’s comfort zone, from a risk perspective.

Question 44

Legislation changes

As we have seen, legislation changes alter the pension landscape. This can have the effect of either increasing or decreasing the options open to a client. Consider the pension flexibility changes and the opportunities they now give an individual in retirement such as FAD and UFPLS.

Product development

Many new products have been developed, such as impaired and enhanced life annuities and investment-linked annuities. When a client’s circumstances are reviewed, any new options must be considered.

Answer 44

Changes in the economy

Economic changes can have a significant impact on pension planning and income.

If the economy becomes too buoyant, then interest rates are likely to rise like we saw in 2022/23. This can lead to increased interest rates and then gilt yields. Long-term gilt yields underpin both annuity and GAD rates, so this could mean a client is better off.
Alternatively, rises in the rate of inflation may erode the income that an individual has in retirement, especially if that income is fixed and does not escalate each year. Look at the rate of inflation we have all experienced in the last couple of years – as high as 11.1%!!
New markets often develop due to economic change. Look at China and Japan. They have grown, as investment areas, over the last decade.
We are starting to see and understand some of the economic impacts of the Brexit vote to leave the EU by the UK. Much was said in the lead up, usually via what was termed as ‘Project Fear’, with regard to losses and reductions in individual’s pensions if the UK voted to leave. Thankfully, the number of direct implications of Brexit on the pension world is relatively low.

Question 45

1: Retirement planning objectives

The retirement planning process is based on the principle of ‘know your client’ and is satisfied by the completion of a fact-find.
A fact-find contains a variety of sections, including personal and family details, employment information, income and expenditure (where affordability is determined), assets and liabilities, a risk profiler, and a section listing and rating the client’s objectives.
Several key factors affect a client’s retirement planning.
These include capital and income needs, inflation, contribution levels, ATR, and asset allocation.
There are five different types of ATR: no, low, medium, medium to high, and high risk.
Some clients also wish to take an ethical approach to investing. This could reduce diversification and therefore increase unsystematic risk.
The four asset classes available in a pension are: cash, fixed-interest securities, property, and equities.
Cash as a pension asset class can be used to provide PCLS, provide income in the early years of income withdrawals, or cover charges.
Fixed-interest securities can be used to provide a ‘safe haven’ in times of stock market uncertainty.
Property and equities will provide a real return, and a hedge against inflation.
This starts to cover syllabus learning point:

8.1: Evaluate the aims and objectives of retirement planning in relation to:

An individual’s aims and objectives.
Investments available to meet these objectives.
Alternative sources of retirement income.
Regular reviews and the factors affecting them.
Asset allocation factors.
The main characteristics of self-investment.
2: Self-investment options

An RPS has a wide choice of direct and indirect investments.
Indirect investments available include with-profit and insurance company funds, unit trusts, OEICS and investment trusts.
With-profit funds increase in value through the addition of bonuses: annual and terminal. This leads to a steady increase in value, known as smoothing.
Insurance company funds tend to be unit-linked where the investor buys units in a fund. Unit prices will be more volatile than a with-profit investment fund, as there is no smoothing.
A lifestyle fund offers a pre-programmed switch, usually five to ten years pre-retirement. Asset allocation is switched to cash and fixed-interest securities to avoid last minute fund value falls.
A target date fund is similar to a lifestyle fund, but is based on the year the individual wishes to retire. If this changes, the individual can simply select a different fund.
There are two main pensions schemes that allow self-investment: an SIPP and an SSAS.
An SSAS can lend monies to its sponsoring employer, an SIPP cannot. The loan is subject to many rules and cannot exceed 50% of the net SSAS value.
Both an SIPP and an SSAS can borrow for a commercial purpose. Again, levels are restricted to 50% of net scheme assets.
An SSAS can invest in the shares of its sponsoring employer, but this is restricted to 5% of the total fund value (up to 20% if more than one employer). An SIPP has no such restrictions and therefore could invest up to 100% of its assets in such shares.
Scheme investments into taxable property could lead to both unauthorised payment taxation, plus a scheme losing its RPS status.
This continues to cover the syllabus learning point:

8.1: Evaluate the aims and objectives of retirement planning in relation to:

An individual’s aims and objectives.
Investments available to meet these objectives.
Alternative sources of retirement income.
Regular reviews and the factors affecting them.
Asset allocation factors.
The main characteristics of self-investment.
3: Alternative options for retirement planning

Using an RPS for retirement planning has many advantages but also has some drawbacks such as: not being able to access monies until age 55, maximum PCLS / tax-free cash of 25% and restrictions on the types of investments that can be used.
Individuals can therefore use other investment alternatives that include ISAs, investments into unlisted company shares, residential property, their own business, and life assurance based investments.
ISAs have many advantages the main ones being no restriction on when monies are taken, nor what they can be used for.
The Lifetime ISA is an alternative to using an RPS for retirement planning.
Investments into unlisted shares are usually through an EIS, SEED EIS, or VCT. These are high-risk investments, as there is a heightened incidence of companies going bust.
Residential property is a very popular investment in the UK. It is, however, a very illiquid asset class, with high upfront costs and poor diversification.
Using a business sale to generate monies for retirement can be difficult. The market may be depressed at the point of sale, and the individual may not get what they expect as a sale price.
Life assurance based investments are split into two groups: single and regular premium plans.
Single premium plans are called investments bonds. They have some advantages, including the ability to take 5% of the original investment tax-deferred, to roll up this option, and to use top-slicing to reduce the chance of paying further income tax on a gain.
Regular premium plans are likely to be qualifying. This means that the plans must satisfy certain rules, which mean that any proceeds will be paid tax-free.
This continues to cover the syllabus learning point:

8.1: Evaluate the aims and objectives of retirement planning in relation to:

An individual’s aims and objectives.
Investments available to meet these objectives.
Alternative sources of retirement income.
Regular reviews and the factors affecting them.
Asset allocation factors.
The main characteristics of self-investment.
4: Regular reviews

Regular reviews are required, both in the accumulation and decumulation stages of retirement planning.
Life changes can also give rise to the need for a pension review, such as: getting married, having children, moving to a new house, changing jobs, or the death of a spouse / civil partner.
Decumulation reviews can be affected by a variety of factors such as legislation changes, changes in circumstances, changes in aims and objectives, and new investment opportunities.
If an individual has a level retirement income, it is difficult to vary. Variable income, however, could be altered, and could come from: investment backed annuities, phased retirement, or drawdown.
If a client is looking to gradually retire (phase retirement) there are three review stages: agree net requirements, deduct income in payment, giving an income need for the next year.
Other factors that could affect reviews in the decumulation stage of retirement include changes in investment conditions, legislation changes, development of new products and economic changes.
This completes the coverage of syllabus learning point:

8.1: Evaluate the aims and objectives of retirement planning in relation to:

An individual’s aims and objectives.
Investments available to meet these objectives.
Alternative sources of retirement income.
Regular reviews, and the factors affecting them.
Asset allocation factors.
The main characteristics of self-investment.

Question 46

John has put monies into an onshore investment bond, as an alternative to a registered pension scheme. When he retires, he plans to live and work in Italy for at least five years for a well-known children’s charity. In relation to his investment bond, John…

will be able to withdraw 5% of its current value each year, tax-efficiently.

could encash the bond whilst he is a non-UK resident, to save tax.

could assign the bond to his wife, Susie, a non-taxpayer.

will benefit from tax-free growth internally.

can invest as much as he can afford.

Answer 46

b, c & e

John’s tax-deferred withdrawals are restricted to 5% of the original investment, not current value.

He can encash this bond whilst a non-UK resident, and avoid UK tax, or assign it to his wife Susie.

An investment bond suffers internal tax so is not tax-free.

The only issue that restricts John’s investment is affordability.

Question 47

Penny is a non-taxpayer and has the following investments:

Investment bond £100,000

Treasury 2038 5% £20,000

Investment trust £55,000

Unit trust £35,000

Which of the following statements are correct?

All income and growth will be tax-free.

Treasury interest will be paid gross.

The investment trust is likely to be the riskiest.

The unit trust carries the least risk.

The investment bond is the most diversified.

Answer 47

b & c

Investment bond, unit and investment trust funds all suffer tax internally. Not all of these can be reclaimed by a non-taxpayer.

The coupon income on a gilt is gross, but taxable.

An investment trust can gear (borrow) with no restrictions, and, as such, will be a riskier investment.

Gilts are issued by the UK government, and are ‘virtually’ risk free.

The investment bond, unit and investment trusts will all be diversified.

Question 48

Peter has invested into both an Enterprise Investment Scheme (EIS) and Venture Capital Trust (VCT). He is a higher rate taxpayer. In relation to these types of investment…

both will only be free of capital gains tax after three years.

the VCT will be more income tax efficient for Peter.

the VCT will not be subject to inheritance tax.

both the EIS and VCT qualify for 30% tax relief on contributions.

both will be income tax-free, after five years.

Answer 48

B & D

A VCT is CGT-free immediately, whereas EIS shares must be held for a minimum three years.

VCT dividends do not suffer further tax. Peter would have a 32.5% income tax liability on EIS shares.

A VCT does not qualify for business relief, so would not be IHT-free.

Both an EIS and VCT benefit from 30% income tax relief on contributions, up to a capped limit. Only dividends received from VCT shares are exempt from income tax.

Question 49

Howard is a director of his own company. He is saving for retirement into a Small Self-Administered Scheme (SSAS). He has three other directors who run the business alongside him, plus 100 employees. In relation to the SSAS…

all directors and employees could be members.

all investment decisions must be agreed by all scheme trustees.

the scheme administrator must be approved by the FCA.

the scheme will be regulated by The Pensions Regulator.

the scheme will come under the FCA in terms of conduct regulation.

Answer 49

A, B & D

An SSAS has no limit on its members so all the directors plus employees could be members. All members must be SSAS trustees, and any decision must be agreed by all these trustees.

Neither the scheme administrator nor the SSAS itself comes under the FCA, in terms of regulation.

An SSAS is an RPS, provided by an employer for an employee, and will come under the remit of TPR.

Question 50

John is aged 76, and in retirement. He is funding his retirement using income withdrawals. Which of the following factors should a financial adviser consider when carrying out an annual review with John?

John’s net annual income requirement.

John’s attitude to investment risk.

Any legislation changes.

Any new financial exams the adviser has passed.

Any changes in John’s personal circumstances.

Answer 50

ALL EXCEPT D

All the above factors are relevant in relation to carrying out a pension review for John except for his new financial exam passes.

All the other factors should be considered when carrying out a review with John.