Financial protection Flashcards
Comment briefly on the couple’s present position and identify any weaknesses relating to financial protection.
If either Dan or Tara were to die:
They have no life cover at present
They have no wills in place
Their relationship has no legal basis in law
As the main residence is held as joint tenants, the survivor would inherit
by the right of survivorship even though there is no will
The survivor would also inherit their joint contents/car, NS&I Income Bonds and the Unit Trust
The survivor would continue to receive the income from the NS&I Income Bond
The full amount would now be taxed on them rather than 50% on each of them
The same can be said of the dividends from the unit trust
There will be IHT payable on a proportion of these assets on first death as the couple are not married, reducing the amount that goes to the survivor if a SL WOL policy is not put in place
As neither has made a will, their free estate will pass according to the rules of intestacy
This means their sole assets would go to the twins (under trust if under 18 and not married / in a civil partnership at time of death) meaning the
survivor will no longer have access to this capital and the income from it
The deceased’s share of the business would also go to twins unless an arrangement to the contrary has been made
The survivor’s total income would therefore halve
As they have nominated each other for the PP benefits, they would receive the value of the PP tax-free (although if they take it out of the pension fund it will form part of the survivor’s estate on subsequent
death)
Each has a significant IHT liability and no provision has been made for this
Bereavement support payment not currently available to unmarried couples so neither would receive this
Comment briefly on the couple’s present position and identify any weaknesses relating to financial protection.
If either Dan or Tara were unable to work through ill-health:
Neither Dan nor Tara has income protection cover
If Dan or Tara did not take a salary from the company the couple’s standard of living would be severely impacted as would their ability to fund for retirement
It does not appear to be the type of company where the money would keep coming in regardless of whether Dan or Tara were working
Neither has CIC
Neither has PMI, meaning they’d be reliant on the NHS for any treatment
Entitled to statutory sick pay, but that’s less than £100 a week and only pays out for 28 weeks
Child benefit would continue (assuming they are claiming it (if they are not, they should!))
State the factors a financial adviser should take into account when constructing a financial plan for Dan and Tara’s financial protection needs.
No life cover for Dan or Tara
Return of pension fund of £82,000 for Dan (goes to Tara)
Return of pension fund of £65,000 for Tara (goes to Dan)
Death benefit nominations each other
Neither has CIC
A combined life / CIC policy may be more cost effective
Although standalone and separate life provides wider cover
Neither has income protection
Neither has PMI
Neither has unemployment cover
The income required on death / illness of either Dan or Tara
Their current good health
Their budget
The term required
Existing savings
Entitlement to state benefits
They are unmarried with two young children
They have no wills
They appear to be ‘key persons’ in their firm
The firm has no protection in place for them
The business could also provide them with protection policies
Explain to Dan and Tara the differences between income protection insurance and critical illness cover.
IP pays regular income after deferred period until recover
CIC pays a lump sum after survival period
IP designed to cover regular, monthly expenditure
CIC designed to pay off debts, make adaptations to home or car
IP must be unable to work to claim benefit
CIC only need a diagnosis, could still be in work
IP covers more illnesses, including back pain and mental health conditions
CIC restricted list of tightly defined conditions
IP only available as single life policy
CIC joint or single life
IP benefit salary-related, maximum 50 – 60% for individual cover, 75% for group
CIC no restrictions to sum assured (unless provider imposes one)
A relevant life policy (RLP) could help the couple’s goal of increasing financial protection and mitigating any potential inheritance tax liability on their estate,
whilst maximising their estate for the benefit of the twins. Explain what an RLP is and how it should be set up.
Term assurance bought by employer (their company) to provide death
in service benefits
Does not form part of annual/lifetime allowance for pension purposes
The policy must meet certain conditions to qualify:
o Pay out a lump sum on death before 75 (terminal illness can be
included)
o No surrender value
o No other benefits – although can provide ill-health, disablement, death by accident benefit for employees during service
o Benefits are payable to the individual / charity entitled to them or
to a trustee acting on their behalf
o Main purpose of policy must not be tax avoidance
No income tax liability on Dan or Tara if company pays premiums
No NI liability for Dan, Tara or the company if company pays premiums
Set up under discretionary trust to ensure outside Dan and Tara’s estate on death
Each other and the twins as beneficiaries
Both should complete a nomination form
After 1st death, survivor can ask trustees to provide them with an income / capital / loan from the trust during their lifetime
Providing they spend any funds taken out, the DIS will not impact their estate on 2nd death
No IHT on creation of trust
No IHT when death / terminal illness benefit paid to trust
Subject to periodic (10 year) and exit charges
Explain to Dan and Tara what will happen to their respective shares of the business on their deaths.
Assuming no other arrangements are in place and a will has not been made
The shares would pass to their administrator
IHT should not be payable as 100% business relief should apply
Assuming they live for 2 years after setting it up
The shares would then pass to the twins according to the rules of intestacy
Explain why group financial protection cover might be beneficial to Dan, Tara and any employees they might have, together with any downsides when compared to individual cover.
Group cover may offer ‘free cover’ for employees up to a particular sum
assured
This can mean no underwriting, meaning those with a history or poor
health / dangerous hobbies etc. can obtain cover
Group cover can be cheaper due to lower processing costs and the
employer’s bargaining power
Depending on the type of cover, if employer pays premiums, this may
be taxable as a benefit in kind
Employee would therefore pay income tax on value of the premiums
Premiums should be tax deductible for the company
Cover usually ends when employment does
Group CIC – benefit paid tax free
Group income protection – benefit taxable
State the benefits and drawbacks for Dan, Tara and any other employees of the business providing them with access to a group private medical insurance scheme.
May provide cover for family members too Minimal underwriting Covers pre-existing conditions Subsidised cost Speedier treatment May be portable on retirement Taxable as benefit in kind Inflexible if cannot continue on retirement May not be affordable Provides no emergency cover
State the benefits and drawbacks for Dan, Tara and any other employees of the business providing them with
death in service cover.
Benefits
No personal cost to Dan and Tara / employee
Not classed as taxable benefit (benefit in kind)
Cover increases over time as pay rises
Benefits payable outside estate assuming written under trust
No medical underwriting
Benefits tax-free
Provides valuable cover where the couple have none
Drawbacks
No control over the amount of cover
Cover most likely lost if leave business
Business could withdraw cover at any time
Proceeds of 1st to die most likely to be in estate of 2nd to die if they are not spent / placed under trust beforehand
Comment briefly on the need for key person insurance for Dan and Tara’s business.
The success of the business appears to depend on the availability of Dan and Tara
If either of them were to die, suffer a critical illness or long-term illness this would affect the profitability of the firm
If the firm does not make a profit their main source of income would stop
This would affect their standard of living today, their ability to save for school fees and their retirement plans
Explain the two methods commonly used to calculate key person cover together with their respective drawbacks.
Multiple of salary
Select a multiple of key person’s salary of between 5 (usual) and 10
Most commonly quoted and used method
But – salary may not reflect total earnings (so could use this instead)
But – salary may not reflect key person’s value to business
But – multiple chosen has no basis in fact
But – does not allow for time factor, i.e. that an older employee may be
worth less than a younger one due to time to retirement
But – does not allow for where a firm simply replaces key person
Proportion of profits
Takes into account how long it would take to replace profit generated by key person
Formula is key person’s salary x last year’s profit x years to replace key
person over the firm’s salary bill
Profit can be before or after tax
o Net better reflects business performance but may be artificially low for tax purposes and doesn’t allow for fixed expenditure
o Gross better reflects business profits lost and proceeds will be taxable
But – salary may not reflect total earnings (so could use this instead)
But – salary may not reflect key person’s value to business
But – time factor is difficult to assess
But – if firm is making a loss cannot use formula
Explain to Dan and Tara how a key protection policy could be set up to protect the company in the event of their serious illness or death. (NB This could also
be a R&J question)
Life cover and CIC
Identify an appropriate sum assured using loss of profits or multiple of
salary
Term to planned retirement or short-term / renewable depending on
budget
Indexation to keep pace with inflation / guaranteed premiums if budget
demands it
Key people are underwritten
Company is policyholder and pays premiums
Key person is life assured
Premiums will not be an allowable business expense as Dan and Tara
are directors of the company
Policy proceeds paid to company
Treated as trading receipt and subject to corporation tax
Identify 4 drawbacks for Dan and Tara of the company setting up the key person policy.
Cost of premiums
Lump sum subject to corporation tax
Lump sum may not be sufficient
No surrender value so if don’t claim premiums are wasted
