Objective 6 - Savings Flashcards
Alex is considering putting some of the funds he is due to receive from Tanya’s DIS payment into a suitable trust arrangement to provide for the children’s future needs. State the additional information you would require in order to advise Alex on this objective.
What age will children get the funds
How much?
What is the money to be used for?
Likely costs of what he wants to provide for
How much of the £260k to allocate - lump sum - monthly
Any other family members who want to contribute
Who would look after the investment fund on his death
Investment assumptions such as growth, inflation rates he wants to use
Investment constraints such as timelines, risk, ethical
Views on control? Whole inv or some control
CTF and JISA maximised?
Views on releasing the control of assets by making lifetime transfers
Willingness to use trusts now or post death
Details of any previous lifetime transfers made
Desire to leave funds to charity - support charity with Tanya’s illness and suddenly death
Future income and capital requirements
Apply some of the funds from the DIS to other aims/objectives
Investment experience
Willingness to make gifts/transfer immediately
Alex is keen to set aside money for Thea and Cameron’s future needs in the event that they want to go to university. He is considering NS&I Premium Bonds, Junior ISAs / Child Trust Funds and Friendly Society Plans.
(a) Explain for each of the investments how these work, including the income and capital gains tax consequences.
NS&I
Provide income tax free - winnings are exempt from CGt
The plans can be held in the children’s names
Any winnings up to a certain limit can be reinvested
Max holding is £50k can be allocated from DIS
JISA/CTF
Provide tax free capital gains and income
Held in children’s names
Limited to £9k per tax year JISA
Limited to £9k per tax year CTF per birth year
Children can manage from 16 and full access at 18
CTF Thea qualified but new ones been stopped since 2011
If Thea doesn’t have one the have to open a JISA
Cameron only option is JISA
Friendly society plans
Grow free of income and capital gains tax
Plans can be held in children’s name
Contributions limited to £270 annually or £300 pay if paid in instalments
Plan proceed are tax free on maturity
Alex is keen to set aside money for Thea and Cameron’s future needs in the event that they want to go to university. He is considering NS&I Premium Bonds, Junior ISAs / Child Trust Funds and Friendly Society Plans.
(b) State why these options may not meet Alex’s objectives.
These options are in children’s name - he can manage initially
All capital available to kids at 18
Loss of control of fund use - may be used for something else
JISA/CTF not accessible before 18
Can’t control when funds are distributed to the kids
Limitations to what can been invested into the schemes
Other than premium bond can only put a small amount
Premium bonds have a unknown return - may win might not - inflation could be a issue
Alex is considering putting some of the DIS payout into a discretionary trust for the benefit of Thea and Cameron. Outline to Alex the key factors he should take into account when considering the suitability of such a trust.
Offers flexibility if he has more children
Current beneficiaries can be changed
Additional funds can be added
Will be classed as a CLT for IHT purposes
If no other gifts and less than the nil rate band not subject to lifetime IHT
Periodic and exit charges may be applicable in the future
Income generated in the trust will be charged at basic rate for £1k then additional rates for any other income
Capital gains can be offset against the trust allowance £3k
As he already has a trust only £1.5k would be available
Gains above this will be taxed at 20%
He already has a trust setup, he could utilise the same one
Beneficiaries could claim back any income tax paid relevant to their own tax status
Alex can be a trustee and retain control/ should appoint more trustees just in case he dies
Legislation / tax changes/ market changes
Cost of childcare being able to be met from disposable income - not needing DIS
Impact of accepting reduced work hours on his disposable income
The need for capital in the next few years to provide for the children’s more immediate needs
Alex may choose to use a bare trust to hold funds for Thea and Cameron. Explain the factors he should take into account when considering the suitability of such an action.
No changes to beneficiaries allowed
Additional funds can be added
Once set up, difficult to revoke
for IHT purposes classed as PET, for CGT they would be a disposal
Any gifts after 7 years will not affect his nil rate band
He can be a trustee and nominate others
Tax efficient as taxes are at the children’s rates and can use their full allowances
0% starter rate, PSA, DA, CGT
However as gift is from parent, income over £100 pay is taxed as Alex’s at 40%
Trust could be closed when all beneficiaries are over 18 and agreement, he would lose control.
Alex is considering gifting lump sums to the children, using the discretionary trust he has set up for his life policy. Distributions from the trust could then be made as required.
Explain the potential benefits and drawbacks of this strategy.
If transfers into the trust do not exceed £325k over 7 years no lifetime IHT due and periodic and exit charges avoided
Alex can be a trust to retain some control
Can appoint additional trustees
Currently set up to Tanya, this will need to be changed to the children
Trustees can allocate the assets when appropriate
Can inc children and future grandchildren
Wide powers available, can support children in ways not anticipated when set up
Children wont gain access at 18 and use how they want
Holding assets for beneficiaries can avoid the need for deputies if they cannot manage their own affairs
A discretionary trust can protect a vulnerable individual from exploitation
It can also protect assets from creditors in the event of bankruptcy or liquidation
Drawbacks
Assets that go over £325k will be taxed
At creation 20%
Every 10 years max 6%
When capital payments are made to beneficiaries
If trustees decide not to appoint assets to a particular beneficiary could cause jealousy or disputes
Caught by parental settlement rules so if over £100 generated will be taxable on Alex
Trustees get wide powers, who would be he be able to rely on
Family or friends might not have the required skill or time to carry out their duties
Appointing professional trustees usually has a cost
Alex is looking at setting up a new discretionary trust for the children, with some of the funds he receives from Tanya’s DIS payment.
(a) Explain the process and considerations for setting up a discretionary trust.
Alex as the settlor to select trustees
At least 2 in case a trustee dies (no more than 4)
Alex could be trustee to retain some control while alive
Can appoint a professional trustee but will insure costs
Need to choose the beneficiaries (children)
Could include classes of beneficiaries to allow - yet unborn children or grandchildren to benefit
Should avoid himself as a potential beneficiary to mitigate IHT
Settlor decide how the assets in trust should be used via trust deed
Create a letter of wishes, setting out how he wishes the trustees to deal with the trust assets
The trust is registered with HMRC
As 2nd trust to be created only half the cgt exemption is available and split between the 2 trusts
Alex is looking at setting up a new discretionary trust for the children, with some of the funds he receives from Tanya’s DIS payment.
(b) Explain why holding an investment bond within the trust would help with Alex’s financial objectives.
Inv bond will allow to invest in a diversified way with growth potential
Inv bonds don’t produce income, no income tax charge unless chargeable event occurs
This helps to mitigate the parental settlement rule
5% withdrawals can be used to meet increased childcare costs - this will not be a chargeable event
Funds not used are left to grow/ inv growth protential
Growth from the bond is immediately out of estate for IHT
Will have IHT liability if DIS funds kept within the estate
Putting funds in trust will mitigate this and out of his estate after 7 years
The withdrawals can be made ad-hoc or cumulatively without a immediate tax charge
Funds will be available for future needs/ education etc
The trust doesn’t end at 18 so further distributions can be made after 18 to help with life events
Explain, in detail, what a Junior ISA is and how Alex could utilise these to build up a lump sum for each of his children.
Each child can have a JISA in their name as they are under 18 and a UK resident
Thea can only have one if she doesn’t already have a CTF - this can be transferred into a JISA if Alex wants to
Can be invested in both cash and stocks and shares
The returns are free of income and capital gains tax
JISA are not subject to the £100 parental settlement rule so not high rate tax needed to be paid
Contributions of up to £9k can be made each year
Alex will need to open the account however anyone can pay in as long as contribution limits are not exceeded
At 16 he children would be able to manage their own account and decide on fund selection
Access to funds not allowed until they reach 18, would be suitable for many uses - education, property etc
At 18 will auto transfer to a adult ISA and funds fully accessible
Once the children reach 16 they could hold an adult cash isa in addition to their junior ISA so potentially £29k wrapped each yr
Describe how Alex’s maximum tax-relievable pension contribution for the current tax year would be established (no detailed calculations are required).
Start with current AA £60k and current tax year
Not subject to tapering looking at current income levels
Calculate the pension input about for current year
Alex + employer contributions as part of DC pension
Made in the relevant pension input period (tax year)
Combined contributions are 10% of £90k so £9k
Deduct the pension input amount from the AA
To give you the remaining allowance for the current year
Calculate carry forward allowance from the previous 3 years
Using the same process but against previous years AA £40k
Make pension contributions using current years allowance first
Only then can carry forward be used from the last 3 years
Carry forward can not exceed Alex earned income of £90k
If he accepts reduced hours his and his employers contributions are likely to be based on the new salary so lower amount going in
Equally his max tax relievable amount will reduce to his new earned income figure
Due to Tanya’s death, Alex has inherited her DIS lump sum, ISA portfolio and unit trust. The couple’s mortgage has also been fully repaid. As a result Alex has scope to make increased contributions toward his eventual retirement.
In respect of Alex’s workplace pension plan, identify the benefits of making increased pension contributions.
Quite young has 28 years until SPA and 25 year to NPA
He has modest savings currently
Appears to have matched contributions from employer - might be able to get more matched
Gets 40% income tax relief on his contributions, 20% via relief at source and 20% via self assessment having his basic rate band extended
Grows free of income tax and capital Gian tax so tax efficient
Free of IHT
Once DIS paid his estate will be subject to IHT
Allowed up to 100% tax relief of earning - even with lower salary has scope to increase
Likely to have availability of carry forward to make use of
Larger pension fund will lead to higher PCLS and income in retirement
Regular contributions could benefit from pound cost averaging
Additional contributions can be organised by him by his employer so he would have to do very little administration himself
In respect of Alex’s eventual retirement plans, explain to him the benefits of increasing his monthly contributions to his workplace pension scheme rather than making lump sum contributions..
Benefit from pound cost averaging potentially increasing his returns
Could mean increased benefits when retiring
Built in flexibility to stop and start contributions
Newly bereaved - does not know increased expenditure and potential lower salary
Avoid market timing risk/ reduce chance of a capital loss
Will have the discipline of regular saving /important when he has so many other things on his plate right now
Simple admin as these increased payments will be deducted from his salary by employer
Employer more likely to match increased regular payments than ad hoc lump sums
Employer fore likely to pass on any NICS savings to Alex on regular payments than ad hoc sums
Alex has never checked his Single Tier State Pension entitlement.
Explain what State Pension he may be entitled to, and what could affect this entitlement.
Obtain State pension forecast online, by completing BR19 form contacting the future pensions service
He will reach state pension age after April 2016 so will be entitled to the single tier state pension
Need 35 year record to get full benefits
He has been working for current employer for 15 years and has a further 28 years before SPA 68
For any benefits need min 10 years - he should be ok
He has potential of reaching the 35 years for full benefits
Entitled at age 68, we don’t know his intended retirement age and or if future legislation will push this age back further
The State pension is guaranteed and index linked income, it will ensure he has sufficient retirement income
He will be able to defer his state pension benefit if he doesn’t need it, this will give him a 1% increase for every 9 weeks of deferral which is equivalent to an annual increase of 5.8%
He will not inherit anything from Tanya’s state pension
Issues
Need sufficient years NIC
Delays return to work
Current earning above high income child benefit charge
However should still claim benefit even if it is not paid
This will ensure he remains eligible for CB, until Cameron is 12
His state pension benefits may have been reduced if he was contracted out any time in the past
The impact of this would have been calculated when the state pension benefits changed in 2016
