R06 Flashcards
What are the six steps of the financial planning process as described by ISO 22222?
1 - Establish and define the client and personal financial planner relationship.
2 - Gather client data and determine goals and expectations.
3 - Analyse and evaluate the client’s financial status.
4 - Develop and present the financial plan.
5 - Implement the financial planning recommendations.
6 - Monitor the financial plan and the financial planning relationship.
Who would typically be considered a vulnerable customer?
HINT: 3 categories.
On account of:
- age,
- state of health or mind,
- recently bereaved.
How long should records of life and pension policies be held for?
Life assurance and pensions - keep records for 5 years.
Client’s objectives should follow the acronym SMART; what does SMART stand for?
- Specific
- Measurable
- Action-related
- Realistic
- Time-related
Name 3 benefits of using a financial planner?
- Identifying problems and goals.
- Identifying financial strategies.
- Setting priorities.
- Researching the market for the best products.
- Getting the planning done.
- Making and/or preserving wealth.
- Avoiding common financial mistakes.
What is a ‘risk premium’?
The difference in the rate of return between an investment involving risk and a risk-free investment.
What is ‘risk capacity’?
The amount someone can afford to lose without endangering their financial objectives.
What does ‘capacity for loss’ mean?
The client’s ability to absorb any negative financial outcome that may arise from an investment.
What is the ‘critical yield’?
The rate of return needed to meet the objective based on a given level of investment.
What is the aim of ‘psychometric risk profiling’?
Assesses psychological risk tolerance instead of objective financial capacity to take risks.
What is fact-finding?
Skilled process of gathering client data, it is essential to gather sufficient information to ensure recommendations are suitable and relevant.
Name 3 things you would need to understand about being a member of an occupational DC scheme?
- Type of scheme.
- Level of contributions.
- Death in service benefits - in trust or expression of wish.
- Value of fund.
- Previous protection in place.
- Auto-enrolment/3% employer contribution since 2019.
- Whether flexi-access/UFPLS is available from current provider/desired by client.
Who are the legal owners of trust property?
The Trustees.
What are 2 issues with centralised investment propositions?
- Shoehorning.
- Charges.
- Conflicts of interest.
- Blurring of responsibilities.
What does the ‘real rate of return’ take into account?
Inflation.
What should a summary of earned income set out?
HINT: 8 things.
- Level of income.
- Source of earnings.
- Employment status.
- Volatility of earnings.
- Job security.
- Employee benefits.
- Pension position.
- Tax position.
What is a current cash flow statement?
The total income less total expenditure for the current period.
Name 3 risks with potentially major financial implications?
- Death of family member.
- Unemployment/business failure.
- Illness/accident.
- Divorce/separation.
- Devaluation of business/property.
- Investment risk.
- Longevity - outliving resources.
What is a lifetime cash flow projection used for?
To forecast clients’ income and expenditure profiles over the longer term.
What does a benchmark/standard priority list normally look like?
HINT: 7 things.
- Cover day to day living expenses.
- Protection against the unexpected.
- Buying a home and raising a mortgage.
- Paying for children’s education.
- Saving for retirement.
- Saving and investing.
- Estate planning.
What is prospect theory?
Losses have greater emotional impact than the equivalent amount of gains.
What is the general strategy for dealing with debt?
HINT: 5 things.
- Clear high-cost debt as quickly as possible.
- Set up short-term savings to avoid debt in the future.
- Consider flexible mortgage for self-employed or those with variable income.
- Choose loan repayment that fits with client’s risk profile.
- Protect loans with insurance.
Name 2 elements of taxation that the Government has introduced for buy-to-let landlords in an attempt to help the first-time buyer market?
- Extra 3% on Stamp Duty Land Tax for second properties/buy-to-let properties over £40,000.
- CGT surcharge of 8%.
What is the usual waiting period for ‘Support for Mortgage Interest’?
39 weeks (unless claiming State Pension Credit in which case no waiting period).
State 3 disadvantages of redundancy cover?
- Policy may never pay out.
- Policies are expensive.
- Benefit paid for set period.
Why must care be taken when choosing a P2P lender?
They are not covered by the Financial Services Compensation Scheme (FSCS).
Describe phased drawdown?
The use of flexi-access drawdown/UFPLS to delay annuity purchase but provide the required retirement funds in the meantime.
State 2 advantages of the ‘two pools’ approach to asset allocation for retirement income?
- Provides strong defence against market downturns.
- Spendable income for chosen period is secure.
- Allows focus on growth for adventurous pool.
- Able to ride out a major stock market fall.
What are 3 important criteria when choosing a protection product?
- Cost.
- Financial strength or provider.
- Underwriting.
When explaining and justifying recommendations, how should a report be structured?
- There should be a logical structure.
- Introduction.
- Current situation.
- Aims and objectives.
- Recommendations.
- Review procedures and further work.
- Revisions, review, and monitoring.
- Economy of length.
- Accessible language.
- Attractive layout.
What are the 3 main types of platform?
- Advised.
- Direct.
- Workplace.
What is the purpose of a review?
To compare actual performance and client circumstances against the original plan.
State 2 advantages of ‘time-based charging’?
- Same method used by other professionals.
- Basis seems fair.
- Charges not linked to fluctuations in the value of the portfolio.
State 2 advantages of fixed fees?
- Certainty - client knows how much it will costs.
- Fixed - not linked to fluctuations in the stock market.
- Fair and transparent.
Name 2 changes to a contract which would not result in legacy trail being switched off?
- Automatic increase in premium due to indexation set up before 1st January 2013.
- Automated fund switches.
- Automatic rebalancing of a portfolio at set intervals.
- Non-advised reinvestment of dividends/distributions into existing investments.
Establishing Client Objectives, Needs, and Priorities.
HINT: 4 Points.
- Building adviser/client relationships takes time.
- Need to establish trust.
- Successful relationships are close and interactive.
- Knowledge and understanding of the client is more important than knowledge of products.
ISO 22222 - Step 1?
HINT: E and D R
Step 1 - Establish and Define Relationship with client.
ISO 22222 - Step 2?
HINT: G D
Step 2 - Gather Data and determine their goals and expectations.
ISO 22222 - Step 3?
HINT: A and E
Step 3 - Analyse and Evaluate the client’s financial status.
ISO 22222 - Step 4?
HINT: D and P FP
Step 4 - Develop and Present the Financial Plan.
ISO 22222 - Step 5?
HINT: I R
Step 5 - Implement Recommendations.
ISO 22222 - Step 6?
HINT: M P and R
Step 6 - Monitor Plan and Relationship.
ISO 22222 Step 1 - Establish and define the client/financial planner relationship.
Key points?
- Provide information in writing about the services being offered including: scope of services, financial planners qualifications and expertise, details of conformity to International Standard (ISO).
- Use a variety of methods to gather information from client regarding personal details, employment status, relationships, financial position, state, employer and private benefits, insurances and entitlements, immediate needs and short and long-term goals.
- Provide written documentation regarding terms of engagement (Client Agreement) setting out:
— Regulatory status of the firm and type of the firm and type of service it offers.
— Scope of services the financial planner provides.
— How they will communicate.
— Client classification.
— Record keeping.
— Anti-money laundering procedures.
— The advice process.
— Any known conflicts of interest.
— Adviser fees for initial and ongoing advice.
— Duration of agreement.
— Frequency of contact.
— Confidentiality provisions.
- Written agreement ensures client has clear understanding of services provided and cost of advice.
ISO 22222 Step 2 - Gather client data and determine their goals and expectations.
Key points?
- Additional information, e.g. assets/liabilities, needs, goals and objectives with timeframes, risk profile/tolerance/capacity, ESG (Environmental, Social and Governance) impacts, ethical and religious factors.
ISO 22222 Step 3 - Analyse and evaluate the client’s financial status.
Key points?
- Assess information gathered in relation to client’s current and future goals.
ISO 22222 Step 4 - Develop and present the financial plan.
Key points?
- Review, discuss and resolve any issues the client may have.
- A plan should be produced with suitable and usable recommendations.
ISO 22222 Step 5 - Implement the financial planning recommendations.
Key points?
- Implement in line with terms of engagement.
- Produce documentation to record extent to which recommendations are accepted.
ISO 22222 Step 6 - Monitor the financial plan and the financial planning relationship.
Key points?
- Continue to use plan and update when required.
British Standards for Financial Planning Firms
HINT: 9 overarching principles:
- T
- D
- I
- D C and D
- A
- C
- P
- C of I
- C
- Transparency
- Disclosure
- Integrity
- Due care and diligence
- Accessibility
- Confidentiality
- Professionalism
- Conflicts of interest
- Competence
Financial Planner Responsibilities?
HINT: 3 Points.
- Status of planner (make it clear before providing services whether you are independent, focused independent or restricted)
- Advice tools and investment strategies (panels used, platforms used, model portfolios used, DFMs used)
- Limits of authorisation (client must understand scope of advice and planners must realise what they are competent/authorised to do and what they are not)
Suitability
2 Key Points?
- Planner must have sufficient information to ensure recommendation is suitable and justify affordability, risk and fulfilment of objective.
- Vulnerable customers owed an additional duty of care (typically on account of age, health/mind, recently bereaved). Stricter procedures around how advice is given, amount of risk they can be exposed to.
Client Information
2 Key Points?
- Should provide a clear picture of client’s personal and financial circumstances.
- Information should be readily accessible.
Execution-only and Execution-only platforms
2 Key Points?
- Essential to give no advice at all.
- Record position with client’s handwritten confirmation.
Limited Advice
2 Key Points?
- Client should be aware of limited nature.
- Planner should record it in Suitability Report.
Professional Clients
1 Advantage?
- Save time and cost as no requirement to provide investment risk warnings or document them.
Professional Clients
1 Disadvantage?
- Lose protection given to private clients.
Collective Investment Schemes and NMPI
2 Key Points?
- Regulated collective investment schemes (CIS) are UK-based and authorised by the FCA.
- Unauthorised collective investment schemes (UCIS) and close substitutes, together known as Non-Mainstream Pooled Investments (NMPI), are not subject to the same restrictions and considered high risk. They cannot be promoted to retail clients - only professional and high net worth clients. May not be covered by FOS and FSCS. In June 2013, the FCA published its final rules banning the promotion of NMPIs to the majority of UK retail investors.
Insistent Clients
2 Key Points?
- Clients that want to make decisions not appropriate for them.
- Planners should express in writing that they wouldn’t recommend this and carry out transaction or not act for the client at all.
Who authorises Regulated Collective Investment Schemes (CIS)?
FCA.
Record Keeping
4 Key Points?
- Pension transfers, pension opt-outs and FSAVCs - no time limit.
- Life assurance and pensions - keep records for 5 years (financial promotions 6 years).
- Other policies - keep for 3 years.
- Should abide by UK General Data Protection Regulation and Data Protection Act 2018.
Fair Treatment of Customers
2 Key Points?
- Firms must strive to deliver positive customer outcomes - initially and on an ongoing basis.
- Monitor persistency, complaints and range of products/providers used.
Adviser Charging
3 Key Points?
- Commission payments from retail investment products is BANNED.
- Now advisers charge fees for advice based on the service provided.
- Fees must be disclosed in £’s, even if fee equates to a %.
Establishing Client’s Aims and Objectives
3 Key Points?
- Aims and objectives may get re-defined as a result of the fact-finding process.
- Aims may change and develop over time.
- Couples may not share the same approach to life and money.
Regulatory Position
- Financial Planner must ensure clients:
HINT: 3 Points.
- Can afford the recommended investment/financial product.
- Understand the risk involved.
- Understand how the recommendation(s) meet their needs or aims.
What are the potential benefits of receiving and acting upon advice from a qualified financial adviser?
Financial problems, goals and priorities will be identified.
Benefit from adviser’s research.
Help with budgeting/cash flow.
Assessment of suitability of existing arrangements.
Tax planning, use of tax wrappers or tax efficiency.
Assessment of attitude to risk (ATR) and capacity for loss.
Receive recommendations/create a financial plan.
Dealing with professional/ knowledge/clarity of explanation.
Ongoing service/reviews.
Consumer protection/regulated advice.
List 4 benefits of paying adviser fees for initial/ongoing service:
(a) On an hourly cost basis?
Familiar or same as other professions
Easy to understand and compare
Based on actual work undertaken,
amount invested is irrelevant –
cheaper for larger sums
Fee cap can apply
List 4 drawbacks of paying adviser fees for initial/ongoing service:
(a) On an hourly cost basis?
Can be seen as inefficient – or adviser ‘running up the clock’
May put clients off making contact or asking for advice
Paid from personal funds
Unknown total cost
List 4 benefits of paying adviser fees for initial/ongoing service:
(b) As a fund-based fee?
Can negotiate lower fees for larger investments
Payment via provider if not from personal funds
Incentive to grow funds
Attractive for lower amounts /lower
fees for lower amounts
List 4 drawbacks of paying adviser fees for initial/ongoing service:
(b) As a fund-based fee?
Difficult to predict each year
May not be in line with service
provided, not reflecting time spent or larger portfolios not generally harder to administer.
Extra charges may apply for other services.
Reduces potential investment growth
List 4 benefits of paying adviser fees for initial/ongoing service:
(c) On a fixed fee basis?
Familiar or same as other professions
Known cost
Easy to understand and compare
Amount invested is irrelevant –
cheaper for large sums
List 4 drawbacks of paying adviser fees for initial/ongoing service:
(c) On a fixed fee basis?
Is fee justifiable?
Paid from personal funds
May put clients off making contact or
asking for advice
Exactly what is included?
Explain how lifetime cash flow modelling is used?
Lifetime cash flow projections are used to forecast clients’ income and expenditure profiles over the long term
They provide a year-by-year summary of cash paid to and paid out by the client, showing the years where there will be a surplus or a deficit.
The main variables are:
o The level of income and capital inputs
o The level of expenditure
o The assumptions made about future increases in income, capital values,
expenditure and inflation
o Projections can then be amended to include the effect of recommendations
Explain the benefits of a current cash flow statement when devising a financial plan?
Shows difference between expenditure and income
Highlights areas for cost reduction
Identifies opportunities to fill gaps in planning/establish planning budget
Can be used for analysing future cash flows/retirements cash flows and contingent
cash flows/loss of income on clients’ ill health/death
Enables the client to understand the long-term impact of large expenditure.
What is meant by the term ‘risk profile’?
It is the level of fluctuation/volatility that clients are prepared to accept in their investment/pension portfolio
Holding investments that are higher risk than their risk profile may result in unacceptable losses in poor market conditions
If investments are lower risk than they are prepared to accept they may miss out on higher returns
State the main factors that might influence a client’s attitude towards investment risk?
Timescale
Income/expenditure/disposable income/affordability
Assets/investments/level of wealth
Liabilities
Amount of investment available
Age of investor
Experience/understanding of market/investments
State of health
Objectives of investment/income or growth
Change in personal circumstances/marriage/death/job change
Outline the process that an adviser should follow to determine a client’s ATR by the use of a risk profiling tool?
Each client completes a risk profile questionnaire.
This focuses on timescales/priorities/responses to circumstances.
Generates a risk score
Score provides further discussion with client/used to produce asset allocation
Ascertain capacity for loss
Adviser and client agree suitable risk profile
Why should an adviser not rely solely on a computer-based risk profiling tool to confirm a client’s ATR?
Different results for each client would require further discussion
Different programmes produce different results
Client(s) may not be able to relate to content of questionnaire
Potential for client to misinterpret/misunderstand question
Will be unsuitable if they have a zero capacity for loss
Different risk may be in evidence for different objectives/timescales
State the reasons why a client’s ATR may have changed from high to medium risk?
Investment knowledge has increased/understands the risks of investments
They may have suffered losses/volatility with past choices
They might be near to retirement age/in retirement so want less risk/volatility
Client is looking for a secure income in retirement/their needs have changed
Identify and explain the key client-specific factors that you would take into consideration when assessing capacity for loss?
They have significant assets/wealth/adequate emergency fund
They can tolerate some loss/volatility
They have earned income
Level of income required
Guaranteed income from DB scheme/State pension
No potential inheritances
No liabilities
Short time frame to retirement
History of poor health in family/they are currently in good health
Why is diversification important?
Diversification can reduce risk in a portfolio
By holding a different range of assets
Each different investment can perform well in certain market conditions
The downside risk of one investment can be offset by the upside potential of another
investment
Diversification can reduce stock specific risk but not market risk
State the limitations of using an asset allocation model?
Doesn’t recommend an appropriate tax wrapper/take account of client’s tax position
Charges are not considered
Questions asked aren’t always relevant
Different models produce different results
Underlying assumptions subject to change/based on historic data
Needs to be reviewed
Understanding Client’s Aims and Objectives
Key Points?
- Recognising the client’s needs and objectives.
- Need to help clients understand general aims and specific objectives.
- Client’s objectives should be SMART (Specific, Measurable, Action-related, Realistic and Time-related).
- If objectives exceed financial capability, then prioritise.
- Family, personal relationships and dependencies are at the heart of financial planning.
- Use of open and closed questions to establish hard and soft facts.
- Another approach is listing possible aims and objectives (client chooses and ranks).
- Needs and objectives should be analysed to identify inconsistencies or conflicts.
- Distinguishing between immediate and future objectives (clients tend to emphasise short-term needs whereas planners emphasise the importance of long-term goals - compromise between the two).
- Timescale - the importance to establish and qualify long and short-term savings objectives.
- Quantifying and qualifying the objectives.
- Prioritisation - it’s not often possible to tackle all aims and objectives at the same time and priorities may change as a result of the financial planning process and over time as circumstances change.
- Needs analysis grid - technique for establishing and prioritising objectives.
Overview of ISO 22222 Stage 1?
- Establishing goals and objectives.
- Timescale.
- Income or growth.
- Capacity for loss and risk tolerance - impacted by age, health, income and wealth, experience and personality.
Overview of ISO 22222 Stage 2?
- Understanding client status, e.g. tax position and size of portfolio.
Overview of ISO 22222 Stage 3?
- Purpose.
- Objective.
- Risk statement.
Overview of ISO 22222 Stage 4?
- Asset allocation - cash, fixed interest, property and equities.
Overview of ISO 22222 Stage 5?
- Fund (stock) selection.
Overview of ISO 22222 Stage 6?
- Implementation.
- Buy funds, monitor and rebalance.
What are the benefits of using a Financial Planner?
- Identifying problems and goals.
- Identifying financial strategies.
- Setting priorities.
- Researching the market for the best products.
- Getting the planning done.
- Making and/or preserving wealth.
- Avoiding common financial mistakes.
Types of risk?
- Mortality and morbidity risk - might mean loss of earnings and higher expenditure.
- Unemployment risk - State benefits provide cushion but inadequate for most clients and so they need to build up a rainy day fund and/or take out unemployment cover.
- Relationship breakdown - pre-nuptial or agreement if not married.
- Litigation - consider legal expenses as part of household insurance.
- Loss of income - ensure adequate cover.
What is systematic risk?
Fall in returns due to a stock market fall.
What is non-systematic risk?
Fall in returns of individual investment due to an event that only impacts that particular investment.
What is inflation risk?
Value of returns and underlying capital eroded over time by rising prices.
What is interest rate risk?
Moving against the investor, e.g. down for those in variable accounts, up for those in fixed.
What is political/regulatory risk?
Governments and regulators change policy resulting in lower returns (e.g. a reduction in the dividend allowance - taxation risk)
Credit Risk
What is default risk and downgrade risk?
Credit rating agency states it thinks a fixed interest investment will default or downgrade it - its value will fall.
Credit Risk
What is counterpart risk?
The risk a party to a contract will default on their obligations.
Credit Risk
What is bail-in risk?
The risk an investor may be ask to provide financial help to the organisation they have invested in.
What is currency risk?
Moving against the investor, reducing returns once converted into GBP.
What is liquidity risk?
Being unable to sell an investment at an acceptable price within an acceptable timescale.
What is pound cost averaging?
Regular monthly payments buy more units when prices fall, reduces
volatility, preserves liquidity (rather than invest lump sum in one go).
What is the risk premium?
The amount investors require above the rate they can obtain in a safe investment in order to persuade them to invest in a riskier one.
Financial investment planning helps investors with medium to long-term goals by helping them?
o Think rationally about their investments o Understand their attitude to risk
o Construct long-term asset allocations
o Have realistic goals
o Monitor progress
Risk Profiling
• Should take account of client’s aims, resources and ability to tolerate loss
• Risk and return are generally positively correlated
• Need to understand:
o Client’s aims and resources available
o Client’s objectives and ability to tolerate loss
• Planner should recommend spread of asset classes, then funds and tax wrappers
Objective Factors
• Timescale, income and asset position
• Risk capacity - the amount someone can afford to lose without endangering their financial objectives
Subjective Factors
• Attitudes and aims
Investment Risk and Capacity for Loss
• The client’s ability to absorb any negative financial outcome that may arise from an investment
• Useful to establish a baseline/minimum amount that would be acceptable
Tolerance of Risk
• Client’s opinions towards risk may change through a greater understanding of investment and financial issues
• Consider:
o Prospect theory - people disproportionately dislike losses more than they like profits o Client’s over-reliance on certain types of investment
o Tolerance of risk is loosely correlated with education and age
Investment Risk and Volatility
• Stochastic modelling can define risk in a meaningful way
• Volatility is most frequently used measure of risk
• Standard deviation offers a convenient and practical method of explaining risk
• Sharpe ratio allows investors to see what extent investment returns have been achieved by the fund manager’s risk-taking
Limitations of Using Volatility
• Based on past performance
• Doesn’t measure trends
• Short-term volatility may be different to long-term volatility
Managing Risk
• Risk can be reduced through diversification but not eliminated
• Complexity of risk profiling
o Any measure of risk should describe the type of risk incurred - a simple statement doesn’t achieve this
• Shortfall risk - risk that a client will not meet their objectives
• Calculating the rate of return required and assessing the associated risks helps clients commit or reassess
• Critical yield - the rate of return needed to meet the objective based on a given level of investment
Risk Profiling Tools
• Most important part of process is discussion (not questionnaire)
• Wealthier clients likely to be in a better position to tolerate loss
• Psychometric risk profiling
o Assesses psychological risk tolerance instead of objective financial capacity to take risks • Preferred portfolio
o Client chooses preferred investment mix from set of portfolios • Downsides
o Couples may get different outcomes o Inconsistent results
o Lack of client understanding
o Time consuming
o No use if client has no capacity for loss
• Stochastic modelling
o Asset allocation based on economic model
o Aim to predict possible outcomes depending on range of assumptions
o Forecasts range of possible returns from different portfolios and probability of achieving them
o Helps client choose appropriate portfolio
• Projections are not guaranteed and are based on previous events
• Underlying assumptions should be:
o Conservative o Consistent
o Realistic
• Models based entirely on past events are rooted in fact, but the future won’t be the same, different periods vary greatly and projections based on past trends do not seem to comply with regulations
• Underlying assumptions need to be questioned and constantly reviewed
• Clients must understand assumptions are best guesses
Establishing and Explaining the Client’s Risk Profile
• Results of risk profiling should be recorded and kept in client’s report
• A statement in client-friendly terms of what levels of risk mean should be contained within the report
• All recommendations should be consistent with the client’s attitude to risk
Fact-Finding
• Skilled process of gathering client data, it is essential to gather sufficient information to ensure recommendations are suitable and relevant
• Outcome of fact-finding process is often a summary of the client’s financial position which facilitates setting objectives
• Often information will be required from product providers and third parties/ obtain via Letter of Authority
• Supplementary questions will be needed in addition to questions covered on fact-find
Basic Details
• Aim to draw up family tree
• Obtain identity information for Money Laundering purposes
• Age/state of health/medical history affects insurance
• Marital status - IHT/CGT issues and State benefits
• Financial dependence - now and in the future e.g., children and elderly parents/quantify degree and period of dependence
• Divorce/separation - terms of settlement and pension arrangements
• Domicile/residence - tax implications are significant. Non-UK domiciled spouse can elect to be treated as UK domiciled and enjoy the full spouse exemption but then IHT on worldwide assets, as well as the transferable residence and nil rate bands.
Minor Children
• Current ages and plans for more children
• Income/expenditure - cost of bringing up children is significant/more health/life insurance required but reduced savings?
• Sources of funds for education and maintenance of children
• Educational issues - intention for private or State school
• Higher education - likelihood of attending university and extent of parental help
• Trusts for children - determine type and provisions
• Wills - consider guardians and planning opportunities
• Children’s income, investment and tax- establish source and where tax liability due
o Establish eligibility for child element of Universal Tax Credit / Child Tax Credit
o Establish eligibility for Child Trust Fund and Junior ISA and if anyone is contributing o Maturing CTFs can be rolled over into adult ISAs without affecting £20,000 annual subscription limit
Income and Expenditure
• Criminal Finance Act 2017 – corporate criminal offence to fail to prevent an employee from facilitating tax evasion
• Income - distinguish between gross and net income
• Employment - length of service and benefits• Job security, benefits in kind (review tax efficiency of car) and share option schemes
• Shares/share option schemes and familiarity bias - reduces apparent risk, but beware in the event of the employer facing difficulty employee could lose employment and investments
Self-Employed and Controlling Directors
• Record ownership and date of establishment/accounting date
• Two/three years accounting information via balance sheet and profit and loss account
• Statement for business plans over short and long-term
• Self-employed pay Class 2/4 NICs
Expenditure
• Use bank statements/credit card statements to complete detailed analysis
• Determine needs in event of
o Unemployment
o Ill health/being unable to work o Death
o Retirement
o Death in retirement
• Fixed and discretionary expenditure - identify areas to reduce expenditure if other provisions are required
Assets
Establish:
• Ownership - joint or tenancy in common, is inter-spousal gifting an option?
• Use - personal, business or investment
• Dates acquired for CGT purposes
• Purpose e.g., to generate income or earmarked for future liability
• Expectation of future assets
• Income and tax position - type of income, security, and volatility
• CGT status of asset – base value, losses, exempt or qualifies for business asset disposal relief
• IHT status of asset - relief and exemptions available including business relief
• Existing investments provide insight into attitude and consider continued suitability
• Single premium investment bonds - record provider, fund links and number of segments
• With Profit Bonds - determine asset allocation, MVR position, underlying guarantees and read Principles and Practices of Financial Management (PPFM)
Liabilities and Guarantees
• Establish type of loan, interest rate, term, and security (asset or life insurance backed)
• Self-employed - determine income tax liabilities (deferred tax payments)
• Consider obtaining credit reports to establish any credit issues and if information held is correct
Protection Policies
• Record lives assured, sum assured, premium, start and end date
• Establish how policy held e.g., in trust or life of another
• If index-linked
• Guaranteed or renewable premiums
• Insurability options e.g., option to increase cover or extend term
• Relevant life policy – whether assignable after leaving service
• Critical illness - note conditions covered
• Income protection - note any policy restrictions
• Investment content - find out estimated surrender value and maturity value
• Terms - normal or loaded/any change in client circumstances
Pensions – Accumulating
• DB schemes
o Likely to have DB benefits in public sector but less likely in private sector
o Obtain scheme booklet/compare available benefits with client expectations o Position - fully open or being phased out
o Death benefits - ensure expression of wish completed
• DC schemes - understand:
o Type of scheme
o Level of contributions
o Death in service benefits - in trust or expression of wish
o Value of fund
o Previous protection in place
o Auto-enrolment/3% employer contribution since 2019
o Whether flexi-access/UFPLS available from current provider/desired by client
• Maximum contribution - lower of annual allowance and 100% of salary
• Carry forward is available
• Maximum annual allowance is £40,000 in 2021/22
o Tapered down to £4,000 for high earners
o Also reduced to £4,000 where DC benefits flexibly accessed in excess of PLCS and MPAA triggered
• Pension input periods now run alongside tax year
• Lifetime allowance is £1,073,100 in 2021/22, some people may have protections in place giving them a higher amount
• With-profit fund may have transfer value higher than fund due to terminal bonus, market value reduction (MVR) may apply
• Salary sacrifice – lower salary in exchange for greater pension contribution (or give up bonus)
o Advantages – save employee NIC, less earned income (regain personal allowance, avoid high- income child benefit charge), save employer NIC (either put money into pension or use for other purposes)
o Disadvantages – impacts ability to borrow, complex, reduces salary for all purposes (e.g., DIS, income protection, redundancy pay out), not binding on employer
Wills, Gifts and Trusts
• Wills - important for clients to understand effects of dying intestate
• On intestacy - children in family entitled to their share at age 18
• Ensure will is up to date and reflects client’s wishes
• Gifts and loans – lifetime gifts will either be exempt (no tax at all), potentially exempt – PET- no lifetime tax, taxed if die within 7 years and value over NRB, taper available after 3 years - or chargeable - CLT – lifetime tax at 20% if over NRB, then 40% (less 20% already paid) due on death within 7 years and value over NRB, taper available after 3 years, loans repayable on death
• Nil rate band is £325,000 2021/22 - transferable between spouses/civil partners
• Residence nil rate band where residential property left to direct descendants £175,000 2021/22 – this is also transferable if it is unused in full or in part of 1st death of spouse/civil partner, tapered if net value of estate over £2m by £1 for every £2 excess
• Both expected to remain the same until the end of 2025/26 tax year
• Trusts - note if client is settlor, trustee, or beneficiary of a trust
• Desirable to have copy of trust deed
• Types of trust: bare trust, interest in possession, discretionary, trusts for vulnerable beneficiaries
• Include details of any Power of Attorney, Enduring Power of Attorney or Lasting Power of Attorney
Ethical/Religious Issues
• Establish if client has views which might impact investment, borrowing or other aspect
• Socially responsible investment (SRI)
• Environmental, social and governance (ESG) factors
Ethical/Religious Issues - For?
- Often forward thinking and progressive companies
- Areas the companies operate in e.g. environment are promising
- Past performance can be higher than for non-SRI funds
Ethical/Religious Issues - Against?
- Restricts investment advice
- Many large companies excluded so funds confined to smaller companies
- Generally involves active management so higher cost
- Some companies are less transparent than others making it hard to screen effectively
Methods of Gathering Client Data
• Sources of fact-finding:
o Client meetings with and without partner/spouse
o Documents and records (Letter of authority may be required)
o Other advisers/relevant people e.g., accountant
Timing of Data Collection
• Some information may be requested upfront
• Most fact-finds are completed at the client meeting
• Some fact-finds are completed after the meeting
• Paraplanners may be used to complete sections of the fact-find
• Hard facts
o Objective often quantitative information e.g., employment status
• Soft facts
o Preferences, objectives, and aspirations e.g., attitude to risk
Questioning Techniques
• Advisable to use questionnaire or checklist to ensure all areas are covered
• Ask questions in logical order
• Typically computer-based software is now used
Phrasing Questions
• Obtaining information - open questions allow client to respond widely
• Client understanding - pose questions clearly and jargon free
• Thought provoking questions - encourage clients to think of areas not thought of and discuss
Recognising Client Errors/Inconsistencies
• All data should be qualified and verified - clients make mistakes or may not understand issues/products and information may be out of date
• Look for inconsistent attitude towards investment risk
• Obtaining accurate information is time-consuming so may be carried out by Paraplanner
The Regulator’s Findings of Good and Poor Practice Among Firms
• For example, exploring client’s objectives and goals
o Good practice - take account of future goals and aspirations
o Poor practice - non-existent or incomplete fact-find documents
Identify and Explain Conflicts of Interest
• Planners must give impartial advice
• If conflicts of interest arise must identify them and take action to deal with e.g. declaring conflict of interest to client and asking if client still wishes to proceed or ask another planner to act for
client
• Regulatory basis - conflicts of interest are within FCA’s fair treatment of customer principles
• For example, remuneration received from investment purchases/switches - must be in the client’s best interests
• Firms must prevent conflicts of interest where 3rd parties used for critical functions
• FCA to consult on inducement rules
• Advisers can only accept adviser charges and some minor non-monetary benefits
Main Types of Conflicts of Interest
Financial Planner and Client
- On personal basis or if impartiality is compromised
- May need to pass client to another planner
Main Types of Conflicts of Interest
Financial Planner’s Firm and Client
- Remuneration structure can lead to conflict
- Payment of commission on retail investment advice banned
- Fees should be fair and equitable and should provide value for money that the client understands and appreciates
Main Types of Conflicts of Interest
Conflicts Between Clients
- Families - e.g., acting for different members of a family or both parties in the event of marital breakdown
- Businesses - e.g., acting for employee and employer
Working with Other Advisers
• Planners must understand their areas of expertise and limitations and be prepared to work with others
• Understand when to refer to specialists e.g., legal advice or mortgages
• Planners may act as facilitator/co-ordinators of other professionals in providing client with holistic advice
• Ensure recommended professionals are competent and reliable and that each specialist considers the client’s whole position and doesn’t have tunnel vision in just their own are e.g., tax adviser viewing tax as over-riding objective
Accountants and Tax Planners
• Areas of expertise:
o Providing tax advice
o Drawing up accounts
o Divorce and separation
o Administering estates and trusts and managing assets
Lawyers
• Areas of expertise:
o Making/amending a will
o Administering estate of deceased person
o Setting up and administering a trust
o Buying and selling property
o Arranging divorce settlements
o Arranging a loan or mortgage
o Specialist tax advice
o Litigation
o Solicitors can now refer clients needing financial advice to any financial adviser that offers the best outcome for the client (not just independent anymore)
General Insurance Brokers
• House and contents and business insurance e.g., public and professional liability
Banks/Building Societies
• Accept deposits and make loans
Mortgage Advisers
• Advise and recommend most suitable mortgage to client
Stockbrokers/Fund Managers
• Direct investment in shares or fixed interest securities, discretionary or advisory basis or execution-only
Centralised Investment Propositions
• Portfolio advice services, discretionary investment management, distributor influenced funds.
• Issues - shoehorning, charges, conflicts of interest, blurring of responsibilities
Outsourced Investment Services
• Discretionary fund managers, multi-managers
Compound Interest and Time Value of Money
• Money received in future is worth less than the same amount received today
• Simple interest - interest earned is spent
• Compound interest - interest earned is re-invested
• Compounding - process of calculating growth with compound interest
• Discounting - calculating a future value in today’s terms
Compounding and Discounting Calculations
Key issues:
• Assumed rate of return (should be determined by asset type)
• How important is it to achieve the goal in the stated period?
• Cash:
o Interest rates have fluctuated considerably over recent years but long-term rate = 2%?
• Fixed interest
o More certain as rates fixed, long-term rate with reinvested interest = 3%? • Equities
o Most difficult to predict, but more stable over longer periods, long term rate = 8%? • May consider a range of returns as difficult to predict
Impact of Time
• A difference of just 1% changes outcomes significantly over longer periods
• Consider effect of charges, similarly, cutting management costs by 1% can achieve significant higher returns
• Postponing retirement by 5 years allows client to build up a much larger pension fund and also possible benefit from higher annuity rates
Inflation
• Nominal rate of return - stated interest rate ignoring inflation
• Real rate of return takes inflation into account
• Often makes sense to set target amount in ‘real terms’
Investment Uncertainty
• Means money is worth more now than in future as risk of failure to repay capital
• Annual savings - early years’ contributions are more important in terms of return as they have longer to compound
Borrowing
• Gearing/leverage - borrowing to invest increases investment returns but increases risk
• Rolling up interest - impact felt quickly over short period, but often feature on lifetime mortgages
• Decumulation - where withdrawals exceed investment returns the capital value will be eroded faster over time
Formulae for Compound Interest and Discounting
Percentage Change
Change in unit price of units x 100
Original price of units
Formulae for Compound Interest and Discounting
Simple Interest
I =P x R x N
100
I = Interest
P = Principal
R = rate per cent per payment frequency
N = number of years (frequency of payment)
The standard equation can be inverted to find:
P = 100 x 1
Rx N
R = 100 x 1
PxN
N = 100 x 1
PxR
Main aspects of the financial planning process
• Summarise client position - analyse and identify strengths and weaknesses and prioritise
• Summary - bring together all information in clear format and express concisely
• Analysis - identify strengths and weaknesses and quantify gaps, draw up plans to address shortfalls
• Prioritise - ordering importance of issues
Summary and Analysis
• Data collected needs to be converted into a useable format
• Current cash flow statement
o Excess expenditure - increase income and/or reduce expenditure
o Excess income - opportunities to fill other gaps
o Also use as a basis for calculating future and contingent cash flows
Earned Income
Summary of earned income should set out:
• Level of income
• Source of the earnings
• Employment status - employed/self-employed
• Volatility of earnings - consider suitability of flexible mortgages
• Job security - if insecure then may need additional savings
• Employee benefits - if limited/no sickness benefit then may need income protection
• Pension position
• Tax position
Analysis should consider security and stability of income, inflation protection, degree of dependence on single source and contingent income.
Investment Income
• Pensions in payment (taxed as earned income but in planning view as investment income)
o Total value
o Sources – State, employer, private
o Inflation cover?
o Variable or secure e.g., based on investment returns/security of DB scheme
o Survivor payments
o Summarise flexible withdrawals separately (flexi-access drawdown, capped drawdown) – include fund value, name and performance, reason for taking flexible income, intent to buy annuity in future (if any), charges
Income from Investments
• Detail which assets produce what income
• Detail if true income or element of capital e.g., withdrawals under bond
• Distinguish between static or increasing income
• Income should generally be shown gross (gross up if necessary) except withdrawals from life policies
State Benefits
• Affect need and desire to plan
• Might put people off (the State will provide mentality) or encourage (due to low levels of benefits / means-testing)
• NB – for R06, you should be familiar with the main State benefits – this is a good starting point:
https://www.gov.uk/browse/benefits
Analysing Income
Issues might include:
• Security
• Type of income - sole trader of Ltd Co
• Stability
• Inflation
• Diversification/dependence on one source of income
• Contingency
Tax Position
Consider:
• Pension contributions or charitable gifts if higher/additional rate taxpayer
• Transfer income producing assets to spouse if they pay tax at a lower rate
Cash Flow
• Current cash flow statement - total income less expenditure for current period
• Within summary detail:
o Earned income
o Investment income
o Tax position on income
• Within summary detail expenditure:
o Fixed expenditure
o Discretionary expenditure
• Allows you to highlight where savings can be made, any periods of high expenditure e.g., termly school fees or use of short-term borrowings instead of making savings
Net assets statement
• What the client owns and owes at a particular point in time
• Net worth
o Assets less liabilities
o Pensions - consider as investments - part of asset allocation, purpose to generate income/lump sums
o Private company shares - very illiquid so list separately
Main Home and Used Assets
• Home not really an asset - include within overall assets but list separately
Investments
Consider objectives for investments - key variables:
• Asset class
• Ownership
• Income yield
• Tax wrapper
• Base value, date of purchase
• Note any Socially Responsible Investment (SRI) issues
• Break down investments by tax wrapper and asset class when providing summary
Analysis of Investments
Consider:
• Any mismatch between client’s risk profile and existing investments
• Any excess of investments in one asset class, market or provider
• Charges
• Objectives
• Any With Profit issues
• Investment risk issues - identify:
o 3 to 5-year volatility on each investment
o Volatility for whole portfolio versus client’s attitude to risk
o Drawdown per investment i.e., maximum % loss over period of ownership
o Asset class, economic sector and market % breakdown
o Assessment of probability of client meeting investment targets
Liabilities
Summary should show:
• Categories of borrowing: type, security, term, capital outstanding, repayments, and APR
• Special features - e.g., interest only or fixed term
• Net wealth
• Percentage or ratio of debt to wealth
• Amount of equity in property
• Percentage of mortgage repayments to net income
• Percentage of short-term and credit card debt repayments to net income
Analysis of Liabilities
Consider:
• Cost of borrowings
• Amount of debt and costs
• Likelihood of debt repayment target being met
• Sole traders – impact of unlimited personal liability for debt of business
• Partnerships – impact of joint and several unlimited personal liability for debts of partnership (i.e., not just their own share)
• LLPs, Ltd companies – personal assets protected, providing owners do not give personal guarantees
Total Net Assets Summary
• Represents the value of client assets before taking into account liabilities
• Net worth is assets less liabilities
Risk Assessment and protection
Main risks with major financial implications:
• Death of family member
• Unemployment/redundancy/ business failure
• Illness/accident
• Divorce/separation
• Destruction/devaluation of business/property
• Investment risk
• Longevity - outliving resources
• Deal with risk = manage it or insure it
Financial Protection Summary
• List immediate and potential dependants covered
• For each plan list who is covered (immediate or potential dependants)
• Calculate financial loss expected on death/incapacity
• Calculate length of time support required
• Determine possible future dependant’s needs e.g., school funding or assistance with house purchase
• Existing liabilities e.g., mortgage should be covered by life and health insurance
• Compare existing cover to need identified
Health Cover
• Serious illness - fixed outgoings e.g., mortgage would remain but discretionary e.g., entertaining may reduce, but overall expenditure may not vary greatly
• Compare current position / cover with projected needs
• Income protection is tax free, but benefits limited (employer sponsored IP is taxable)
• Consider early retirement options and State benefit entitlement
Tax
• Calculate net income after tax
• Provide estimate of CGT if client considering selling any asset
Tax Position Analysis
• Highlight income and CGT issues
• How much income is subject to higher rate tax - pension opportunities?
• Tax planning:
o Use of marriage allowance
o Spread/transfer ownership
o Appropriateness of tax wrappers
o Potential CGT on switching
o Consider disposing in stages to use more than one CGT annual exempt amount
o Delay until a basic rate taxpayer in retirement
o Child benefit position
Retirement Review
Compare projections with client expectations (gap analysis) Establish cost of making good any shortfall:
o Increase level of saving
o Change asset allocation (take on more risk for higher returns)
o Change assumptions e.g., delay retirement
DC scheme – check value for money – is SIPP appropriate (charges?), is fund appropriate?
DB Scheme – confirm definitions of remuneration, service and accrual rate, funding issues and escalation rate
Lifetime Cash Flow Projections
• Used to forecast client’s income and expenditure over longer term
• Aim - to establish if the client can maintain lifestyle and meet financial goals
• Cash inputs e.g., inheritance or sale of business
• Assumptions: inflation, future increases in income
• Assumptions may be unrealistic, need to retest model over time
The Estate
Summary should include:
• Current position of wills, trusts, pension death benefits and lifetime transfers
• Domicile
• Any planned lifetime transfers
• Expected IHT position of client and partner
• LPA or EPA arrangements
Estate Analysis
• Compare objectives with current position
• Determine scope for changes to planning
IHT Planning and DC Schemes
Death before age 75
Lump sum and income paid tax free if within 2 years
IHT Planning and DC Schemes
Death after age 75
Lump sum and income taxed at recipient’s marginal rate
Prioritising
• Establish importance of objectives so planner can make best use of available resources
• Standard priority list (will vary according to client):
o Cover day to day living expenses
o Protection against unexpected
o Buying a home and getting a mortgage o Paying for children’s education
o Saving for retirement
o Saving and investing
o Estate planning
• Changing priorities
o Strong chance priorities will change as clients better understand their financial position o Need to revisit over time
Behavioural Finance
The study of how psychology can affect the decision-making process.
Anchoring attach thoughts to a reference point that has no logical reference to decision now
(e.g., wanting to wait for an investment to return to at least its initial price before selling)
Mental accounting separate money into difference accounts based on source and purpose
Confirmation bias first impressions hard to change, selectively filter / pay more attention to
information that supports opinions / ignore that which does not
Hindsight bias - belief past event was predictable / ignore that which does not
Herd behaviour mimic behaviour of larger group, whether rational or not
Prospect theory/losses have greater emotional impact that the equivalent amount of gains
Pre-Retirement Cash Flow
Current cash flow analysis should have identified if there is a surplus or deficit:
o If surplus, how is it best used?
o If deficit identify scope to increase earnings/identify discretionary expenditure and cut
back/revise aims
Clients who habitually borrow should be encouraged to reduce expenditure
Liquidity Planning and Short-Term Savings
All clients should have some easily accessible cash resources:
o To fund purchases e.g., car or holiday
o For emergencies
Longer-Term Savings
Clients may have to free up income for longer-term saving and protection
Affordability
Cash flow statement will illustrate client’s ability to maintain long and short-term financial commitments.
Certain commitments shouldn’t be taken on unless client can afford to continue e.g.
o Pension/savings with termination penalties
o Equity based/volatile investments
o Life/health insurance if unable to maintain premiums for reasonable proportion of term
o Pension scheme if the client will need to access funds in the short-term
Post Retirement Cash Flow
After retirement, there is greater need to keep income and expenditure in line as less scope to
boost earnings
o Could spend capital but danger of outliving resources
o Encourage careful budgeting
o Could borrow but not if rates on debt are higher than rates on investments (but consider
equity release)
Debt
Clear high-cost debt
Set up short-term savings to avoid debt in the future
Consider flexible/offset mortgages for self-employed or those with variable income
Choose loan repayment that fits with client’s risk profile
Protect loans
Mortgage Repayment
Repaying mortgage is risk-free, other investments aren’t
Pay off mortgage and use extra income to fund lifestyle or save
Keep Mortgage
Will need to invest in equities/property as need higher return than interest paid on debt
Avoid early repayment charges
Pay Off Mortgage
Return on paying off mortgage and not paying interest is tax-free
Buy-to-Let
Buy rental property with loan secured on it to generate income and long-term capital growth
Falling market as Government tries to improve situation for 1st time buyers - 3% SDLT surcharge,
8% CGT surcharge, reduced tax relief on mortgage interest payments since 2017
Buy-to-let
Benefits
Low interest rates = cheap borrowing
Use rent to meet mortgage payments
Other financial objectives achievable
Some tax relief on interest payments
Gearing can magnify returns
Diversification
Buy-to-Let
Drawbacks
Interest rates may rise
Void periods
Fees and costs reduce returns
Paperwork
Gearing risky
Illiquid investment
Debt Consolidation
Benefits
Lower rates
Increase disposable income
Single payment manageable
Other financial objectives achievable
Debt Consolidation
Drawbacks
Lose home if default
Longer term/higher amount paid back
Fee
Run up more debt/be declined
Equity Release
Raising capital on security of home to boost capital
Identify impact on means tested state benefits e.g., pension credit
Ensure other options have been considered e.g., downsizing
Lifetime mortgages (drawdown, interest only loan, fixed repayment life mortgages) and home
reversion schemes
Financial Protection Planning
Life assurance - base on need not standard calculations
Step 1: Identify need (spouse/children)
Step 2: Quantify level of cover (capital, long and short-term income)
Step 3: Determine period of cover (different for each need)
Step 4: Consider existing policies
Step 5: Recommend appropriate policy/s
Capital needs (in event of death)
o Funeral expenses
o Emergency fund
o Specific bequests
o Debts and mortgage
o IHT
o Aggregate to calculate total lump sum needed
Long-term income needs
o Annual personal living expenses of surviving spouse (deduct costs saved e.g., mortgage)
o Add: additional costs e.g., childcare, replacing employer benefits
o Deduct: continuing long-term net income - survivor’s income
o Deduct: long-term net income e.g., widow’s pension
o Calculate total long-term income needed
Short-term income needs
o Extra short-term income e.g., childcare
o Add: other short-term income
o Calculate total short-term income needed
Term Assurance and Whole of Life
Term fixed sum on death within term, level or decreasing
Whole of life fixed sum on death whenever it occurs, covers funeral expenses, legacies, IHT bill
Consider other factors e.g., inflation, additional benefits for family, flexibility, waiver of premium,
existing cover, timescales, State benefits
Income Multipliers
Once net income calculated, factors based on short-term annuity rates can be used to calculate cover
required
Assumptions:
- Capital is used up over period to provide spendable ‘income’
- Required annual income will increase by 3% per annum
- Tax is deducted at 20% from taxable element of withdrawals
Choosing Type and Level of Cover
Term linked to need, e.g., expected financial dependency of child (18 or end of university?)
Full recommendation often too costly - consider the following in order to reduce cost:
o Reduce required income - scale back or look for alternative sources of income
o Could period of cover be shortened?
o Are additional policy features e.g., future increase options really needed?
o Could additional cover be provided through employer under PP rules?
o Could cover be provided as part of a package?
Relevant life policies
o Stand-alone death in service plans
o To benefit from tax advantages must only provide lump sum death benefit payable before 75
to an individual, trust or charity and must not provide any other benefit, have a surrender
value, or be mainly used for tax avoidance
o If these conditions are met, policy does not form part of pension value for lifetime or annual
allowances nor is it taxable benefit in kind, benefits are also free from IHT if paid through
discretionary trust
Prioritising Life Cover
Capital needs are generally high priority - mortgage usually largest
Long-term income
o Consider if essential to maintain same standard of living
o Can surviving spouse work?
o Deduct State benefits
Incapacity and health
o How long could family cope with lack of income?
o How long do employer benefits last?
o Identify level of income provided
o Deduct saving and survivor income
Income Protection
Income while unable to work
Covers many illnesses
Based on ability (not inclination) to work
Benefit based on pre-disability earnings
N.B. There may be a case for IP and CIC although compromise (due to cost) may be required
Critical Illness Cover
Benefit not limited to earnings
Restricted list of illnesses
Benefit not dependent on earnings/ability to work
Provides capital lump sum
N.B. There may be a case for IP and CIC although compromise (due to cost) may be required
Pensions and Healthcare
If incapacitated and non-pensionable earnings, then restricted to £3,600
PMI
Gives clients ability to choose when and where they receive treatment
Employer provision - few tax advantages (premium is fully taxable and subject to Class 1A NICs)
Private provision - level and cost varies considerably, can add spouse and children
Redundancy Protection
State help with mortgage payments for those receiving income related benefits
Support for Mortgage Interest (SMI)
Interest up to £200,000 of mortgage/loan (£100,000 if receiving State pension credit)
Waiting period is 39 weeks after claiming benefits
No waiting time for those on State pension credit
2-year limit for some applicants
Since 6 April 2018, payable as a loan not a benefit
o Repayable with interest on sale of home
Planning and Redundancy
Emergency reserve
Unemployment insurance
Flexible mortgage - payment holiday
Redundancy lump sum - keep safe and accessible and use sparingly
Most important planning is to reduce spending
Unemployment cover advantages:
o Client has reassurance that mortgage interest will be paid for stated period
Disadvantages:
o Policy may never pay out
o Policies are expensive
o Benefit paid for set period
Longer-Term Saving and Investment
Shorter-term reserve should be cash based
Remaining investments should be for longer-term needs
Pre-retirement - focus is on accumulation and post-retirement focus is on income/lump sum
generation
Investment policy statement should contain:
o Purpose of investment
o Income/growth objectives
o Timescale
o Statement about client’s risk profile
o Statement about asset allocation
o Other issues e.g., SRI
Asset Allocation
Most of the difference in investment comes from asset allocation and not stock/fund selection
Asset allocation may be completed in-house or outsourced
Ethical Issues
Consider client’s themes, e.g. environmental issues or animal rights and the fund manager’s approach.
Fund Selection
In-house or outsource to discretionary investment management firm - generally based on:
o Strength of investment process
o Continuity of manager
o Proven investment style
o Clearly defined investment objectives
o Strong and consistent past performance record
Income or growth consider tax implications
Active or passive: passive funds becoming increasingly popular as deliver asset allocation at lower
cost and difficult to predict which active managers will outperform
Fund of fund or fund of choice - fund of fund can provide simple, managed solutions/valuable on
smaller portfolios
Fund managements styles
o Absolute return aim for positive returns in all markets, rather than aim to beat a
benchmark
o Bottom-up pick stock based on fundamental analysis (value investing)
o Top-down pick sectors in economy then pick stock within sector
o Sector rotation top-down manager switches sectors/industries based on economic and
technical indicators
Fund charges - ensure client is getting value for money
Fund Recommendations and Risk
Past performance - basis of fund selection may be past performance
Diversification - in 2008/09 all international markets and most asset classes moved together
Investment planning is more of an art than a science and portfolios may not behave as expected
particularly over the short-term
Tax Wrapper Selection
ISA
Initial Input: No relief
Growth: Tax free
Encashment: Tax free
Tax Wrapper Selection
Collectives
Initial Input: No relief
Growth: Income taxable / internal gains tax free
Encashment: CGT on gains
Tax Wrapper Selection
UK life assurance policies
Initial Input: No relief
Growth: Income and internal gains deemed to have been taxed at basic rate
Encashment: No CGT, Qualifying tax-free, Non-qualifying gains subject to higher rates of income tax
Tax Wrapper Selection
Offshore life assurance policies
Initial Input: No relief
Growth: UK tax free, Except withholding tax.
Encashment: No CGT, Full income tax on gains.
Tax Wrapper Selection
Registered pensions
Initial Input: Full relief, subject to limits.
Growth: Tax free
Encashment: 25% tax free, 75% taxable.
Tax Wrapper Selection
EISs
Initial Input: 30% income tax relief, Tax reducer (hold for 3 years) CGT deferral relief available.
Growth: Taxable dividends.
Encashment: CGT free on disposal (after 3 years).
Tax Wrapper Selection
SEISs
Initial Input: 50% income tax relief, Tax reducer (hold for 3 years) CGT reinvestment relief available.
Growth: Taxable dividends.
Encashment: CGT free on disposal (after 3 years).
Tax Wrapper Selection
VCTs
Initial Input: 30% income tax relief, Tax reducer (hold for 5 years).
Growth: Tax free.
Encashment: CGT free on disposal (from outset).
Tax Wrapper Selection
Tax wrappers are simply containers
They should be considered on the basis of the initial input, growth and encashment
ISA
Provides biggest tax advantage for most investors for cash and fixed interest
Less so now personal savings allowance in place
Also consider IHT disadvantages
£20,000 (2021/22) limit spread across all four (IFISA, cash (including H2B), stocks and shares or
Lifetime)
Help to Buy ISA
o Every £200 saved, government bonus £50 up to max £3,000 on £12,000 savings
o Bonus on home purchase up to £450k in London, £250k elsewhere
o Closed to new savers 30 Nov 2019
o Existing savers can continue to contribute until 1 Dec 2030
Innovative Finance ISA
o Peer to peer ISA, separate to cash/stocks and shares ISA
Lifetime ISA
o Since April 2017, available to under 40s to save for first home/retirement
o Up to £4,000 per year of £20,000 overall limit, £1,000 government bonus
o Withdraw funds for purpose other than house purchase before age 60 generally lose bonus,
interest/growth on bonus plus 5% charge
Junior ISA
o For children not eligible for child trust fund /children wishing to transfer from child trust fund
o At 16, child takes control of account and can decide where to invest
o At 18, becomes adult ISA
o Parental settlement rules don’t apply
Continuing ISA
o On death, ISA becomes continuing account of a deceased investor (continuing ISA)
o No further funds added
o Income and capital continue to accrue tax-free until earlier of estate being administered, ISA
closed, 3 years and one day from death
Additional permitted subscription
o If an ISA holder in a marriage or civil partnership dies their ISA benefits can be passed to their
spouse/civil partner via an additional ISA allowance
o The surviving spouse/civil partner can invest as much into their own ISA as their
spouse/partner used to have in addition to own annual limit
o If higher, the value at the point the deceased’s ISA stopped being a continuing account can
be invested, rather than the value at date of death.
Collectives
Subject to tax on income they generate but free of tax until encashment
Can use CGT annual exempt amount then taxed at 10% or 20%
Most appropriate for growth-oriented investments
UK Life Assurance Policies - Onshore Bonds
Broadly equivalent to basic rate tax on accumulating income and gains
Non-qualifying policies (bonds) may be subject to higher rate tax on encashment
Less suitable than collectives for clients unlikely to pay CGT but may be advantageous for higher
rate taxpayers using 5% withdrawals
Non-UK Life Assurance Policies - Offshore Bonds
Less attractive than onshore policies unless investor likely to move overseas and suffer no tax on
encashment
Peer to Peer (P2P) Lending
Not strictly a tax wrapper but becoming a more mainstream method of investment encouraged
by becoming eligible for ISAs in 2015 and introduction of Innovative Finance ISA in 2016
But not covered by FSCS
Longer-Term Saving and Investment Priorities
First consider repaying debt
Next consider purpose of investment (older clients - pensions and younger clients may prefer ISAs
for access before age 55 and can switch fund into pension later)
Longer timescales allow greater exposure to volatile investments
Flexibility - may be penalised for early access to the funds
Education Funding
2021 average boarding fee in sixth form £12,573 per term
2021 average day school fee in sixth form £5,489 per term
Since 2017 - university fees up to £9,250 a year in England
Can be financed by loans
Loan is repaid at annual rate of 9% of the former student’s income that is over £27,295 a year
Undergraduate education - affluent parents have bought property for student/s to live in
Support now available for Masters and PHDs in form of loans, also need to consider loss of
earnings
Lifetime cash-flow projection would identify periods of heavy expenditure e.g., children attending
expensive schools at the same time
Advisable to build up a school fee reserve (emergency fund) to avoid having to withdraw child
from school in event of financial difficulties
Advance Provision
Long time scale so greater ability to take on risk
Flexibility - appropriate vehicles = ISA, collectives and cash deposits, ISAs especially useful as taxfree returns, £20,000 allowance, wide choice of funds / providers, flexible and APS means can pass on built-up funds to surviving spouse/civil partner within ISA wrapper. But, £20,000 per annum may not be enough, cash ISA no growth, P2P not protected by FSCS, Lifetime ISA not accessible
Some schools offer discount for advance payments but no investment protection from school
Grandparents
Borrowing
Ensure protection needs (life/health) considered
Retirement Planning
Key aim is to maintain a reasonable lifestyle when stop work
Level of retirement income would be established when developing lifetime cash flow projection
Most people need 60% - 80% of their pre-retirement income
Most clients require a core of safe and dependable income to last the rest of their lives
Financial Planning for Retirement
DB schemes - most comprehensive offering security and choice, may need to top-up/check security of scheme although Pension Protection Fund (PPF) available
Employer payments - if employer will contribute then should almost always join
PP, SIPP, or Stakeholder - planner needs to justify why PP/SIPP is at least as good as stakeholder
Lifetime allowance - £1,073,100 (2021/22) should seek specialist advice if close to limit or if have a protected allowance
Automatic enrolment now obligatory for all eligible jobholders (although can choose to opt out)
NEST qualifying trust-based occupational pension scheme, no cap on annual contributions, transfers in and out permitted, contribution charge 1.8%, annual management charge 0.3%
Relative advantages and disadvantages of saving through a pension plan or stocks and shares ISA
Pensions
Tax relief on contributions up to £40,000 pa (less if tapered AA or MPAA apply)
Employer contributions
Fund income and growth free from tax
25% of fund at retirement is tax free
Fund earmarked for retirement and cannot usually be accessed until age 55
Relative advantages and disadvantages of saving through a pension plan or stocks and shares ISA
S&S ISA
No tax relief on contributions
No employer contributions
£20,000 maximum contributions pa
Fund income and growth free from tax
Fund can be accessed at any age, tax free and without penalty
Pension Tax Relief
Tax efficiency varies according to client’s circumstances
Higher rate taxpayers whose pension contributions are funded by their company and would otherwise pay tax at 40% or 45% and NICs on their remuneration will benefit the most
Maximum tax relief is 45% plus 13.8% employer and 2% employee’s NICs
SIPPs and Investment Choice
May be extra costs with SIPP - need to justify this
Investment strategy should relate to client’s overall investment strategy
Some investments may be more tax efficient if held in SIPP (than directly or via collectives)
Pension Switching / Transferring out
May be beneficial to consolidate PPs
Must have FCA permission to advise on pension transfers
Member must seek advice if safeguarded benefits (e.g., DB) exceed £30,000
Gaps in Retirement Provision
Retirement goals may have to be revised based on resources available
Identify any other potential resources e.g., downsize house
Considering adjusting risk profile and taking on more risk
Consider postponing retirement
Ultimately may need to borrow in retirement via equity release
Planning at Retirement and Beyond
Clients will depend on accumulated assets at retirement
Pension options:
o Is tax free cash required?
o Invest tax-free cash and other assets to produce income
o Repaying outstanding liabilities
o Providing adequate (inflation-linked) income from remaining 75% of fund
o Provide survivor pension
DB Schemes
Main question is whether to commute pension and take tax-free lump sum
Lump sum is certain (not contingent on survival)
Commutation doesn’t normally affect size of survivor’s benefits
Most clients have a need for a lump sum e.g., repaying debt
Pension freedom rules do not apply to DB schemes, to take advantage client must transfer out
but this can only occur if the scheme permits this and only then after receiving financial advice if
value more than £30k
DC Schemes
Wake up packs
o Issued on 50th birthday
o Generic warning re: risks on accessing pension pot
o Further packs sent on further birthdays (every 5 years)
Annuity (conventional or flexible)
o Bought from life office
o Based on life expectancy
o Secure income paid throughout life
o Can inflation link
o Flexible annuities - greater flexibility than conventional lifetime annuities - advantages of income for life combined with some of the pros of drawdown, but greater risk and costs
Flexi-access drawdown
o Take 25% PCLS then remainder as a regular or ad-hoc income or as lump sums when required
subject to tax at marginal rate and triggering of £4,000 MPAA when amount in excess of PCLS
taken
o Benefits can take tax-free cash and no income, control, annuity purchase less attractive
when relatively young, may have other sources of income, annuity rates low, flexible income,
large fund size, sophisticated investor, death benefits and estate planning (fund can remain
in pension environment for generations)
o Drawbacks charges, no mortality cross subsidy, risk, annuity rates may not rise, MPAA,
capital erosion, complexity
Capped drawdown
o No new contracts but existing ones can continue providing withdrawals remain within GAD
limits, where they exceed them the contract goes into flex-access drawdown and the MPAA
is triggered
Flexible drawdown not available since April 2015
UFPLS
o 25% of each lump sum payment tax free
o Remainder charged at marginal rate
o Advantages lump sum, 25% tax free, fees lower than FAD
o Disadvantages remainder of lump sum charged to income tax, may outlive funds, provider
may not offer it, triggers MPAA
Phased retirement
o The use of flexi-access drawdown/UFPLS to delay annuity but provide required retirement
funds in the meantime
o Advantages - if believe annuity rates will increase and allows annuity decision to be deferred
o Disadvantages - no lump sum at retirement, no guarantee annuity rates will increase, and
fund value may decrease, complex and costly
Short-Term Annuities
After tax-free cash, purchase short-term annuities
Simpler to administer than drawdown
But doesn’t offer long-term security
Two-Pool Theory
Safety pool:
o Short to medium term horizon - use to draw income
o Client and planner agree annual income requirement
o Multiply by number of years expect a recovery to take
o Pool should consist of e.g., cash, NS&I products, and short-dated gilts
o This pool is topped up from the long-term adventurous pool
Long-term pool:
o Adventurous - longer-term horizon
o Replaces safety pool when money runs out and provides another adventurous pool for next
few years
o Able to take greater risk in knowledge that short-term income is covered, therefore invest in
equities, property, and possibly alternative investments e.g., commodities
Two-Pool Theory
Advantages
Provides strong defence against market downturns
Spendable income for chosen period is secure
Allows focus on growth for adventurous pool
Able to ride out a major stock market fall
Two-Pool Theory
Disadvantages
Safety pool not immune to risk
Not possible to protect against major investment disasters
May underestimate recovery time
Post Retirement Planning Long-Term Care
Providing long-term care is likely to be based on:
o Providing for future possible needs - building up assets or using specialist long-term care insurance
o Providing for immediate needs when client is/about to go into long-term care
o Ensuring LPA/EPA is set up to ensure client’s affairs are covered in the event of losing ‘mental capacity’
Post Retirement Planning - Estate Planning
Cost and control of assets are major considerations, main aims are usually:
o Estate is not eroded by costs of long-term care
o Someone can make decisions for them in the event of losing ‘mental capacity’
o Assets distributed in accordance with wishes when they die
Estate planning may mean client forgoes income or capital or both with no guarantee of effectiveness for IHT purposes, also will need to be based on assumptions about when death may occur and size of estate
Wills
Ensures assets are given in accordance with client wishes
Provides guardianship for children
Facilitates tax planning
Alternative is intestacy, NB co-habitees do not inherit
o First £270k plus chattels goes to spouse/civil partner
o Remainder split 50:50 surviving spouse/civil partner and children
IHT Mitigation
Most schemes reduce flexibility and access to income or capital
Capital plans
o Gifts of investment (outright or into trust) aims to pass assets out of estate - value accrues free of IHT and gift is a PET
IHT Mitigation
Discounted gift trust
Features
Cash lump sum gifted into bare (PET) or discretionary (CLT) trust
Invest in investment bond
Fixed payments are made from bond to settlor
5% rule often used
PET/CLT is less than cash gifted as discount given to reflect the fact some of the funds come back to the settlor
Medical underwriting required
Settlor should spend returned funds
Pros
Effective for IHT
Regular income
Neither GWR nor POAT apply
Discount
If value under available NRB, no IHT charges (immediate, periodic, exit) for discretionary trust
Cons
Inflexible income
5% runs out after 20 years
Bond CGT inefficient
IHT Mitigation
Loan trust
Features
Settlor creates trust
Makes interest-free cash loan to trust
Trustees buy investment bond
Capital remains in estate (loans repayable on demand / death)
5% rule can be used to make loan repayments
Or lump sums can be taken
IHT charges (immediate, periodic, exit) are after deduction of loan
No exit charge on loan repayments
Pros
Growth outside of estate straight away
Full access to capital
‘Income stream’
Cons
Capital remains in estate
5% runs out after 20 years
Should spend returned funds
No immediate benefit
Trustees should ensure trust always has enough to repay the loan
IHT Mitigation (continued)
Business relief - if transferred as lifetime gift or on death at least 2 years after acquisition then 100% relief and free from IHT
Life assurance: written in trust to cover potential IHT liability
o Ensures funds are available to pay IHT on lifetime gifts (if death occurs within 7 years)
o Provides cash to pay IHT on death
o Able to use annual/normal expenditure exemption
Drawback is that regular commitment is needed thus reducing spendable income
Trusts
Advantages
- Beneficiaries cannot access without trustee agreement
- Tax planning flexibility e.g., skipping a generation
- Can hold assets for benefit of a minor
Disadvantages
- Complex
- Expensive to administer
- Can lead to additional income tax, CGT and IHT
Disclosure of tax avoidance schemes
New schemes must be disclosed to HMRC
Product Evaluation, Research and Selection
Evaluate and select best products to fit client’s needs
Systematic analysis
Protection - cost, financial strength, and underwriting
Investment funds - asset class, markets, income, or growth etc/take into account past performance
Discretionary investment managers - cost, risk profiles, benchmarks
Tax wrappers and platforms - cost, strengths in administration
Product Intervention and Product Governance Sourcebook (PROD) financial planner should understand their client bank so they can design solutions and services that work for clients and client segments
Consistent product and service selection - in line with fair treatment of customers
Review existing products - recommend the product that best suits clients needs
Adviser and paraplanners should document and record their research and justification/adviser should understand any draft recommendations that a paraplanner has done
Planning for Events and Circumstances
Marriage/Civil Partnership
o Bank account - merge or keep separate
o Income/expenditure planning - perhaps new living arrangements
o Wills - existing wills nullified by marriage
o Spending and saving - compatibility is important
o Financial protection - what is needed and how much to pay for them
o Domicile - spouse can elect to be treated as UK domicile and qualify for spouse exemption
o Pre-nuptial agreements - consider financial/legal issues in event of relationship breakdown
Divorce
o Income/expenditure planning - recast lifetime and cash-flow projections
o Value investments and split if required
o Value pension entitlements - offset, splitting or earmarking
o Rearrange mortgage
o Rearrange life/health insurance
o Re-write will and change EPA, LPA
Relationship breakdown
o Dependant partner has fewer rights than dependant spouse
o More limited options for pensions than in divorce
o CGT on transferring assets
Birth / adoption of child
o Consider advantages/drawbacks of marriage if not married
o Will experience additional expense and possible reduction in income
o Compile short and long-term budget for immediate expenses and maintaining/ educating child
o Review life and health insurance
o Might be requirement to move to a larger house
o Make/review will
Helping grown up child buy property
o Buy/become joint owners with child
o Gift/lend money to buy house, re-mortgage/ equity release own home to provide funds for child
o Act as guarantor on child’s mortgage
o Use family offset mortgage
- Parents must be sure they understand their obligations to the lender/impact it has on their own financial objectives
Inheriting a lump sum or property
o Clients should reconsider aims and goals in light of greater financial freedom
o Endowment effect - clients wishing to hold onto assets inherited - need to emphasise importance of suitable investing for client and not to hold in current form
o Risk - clients may take too much or too little risk with inheritance
o Strategy - should normally sell inherited asset and needs and circumstances
Death of a spouse/partner
o New personal circumstances - where survivor and family want to live
o Disposal of assets - will, intestacy, trust (ownership of home is crucial)
o Adequacy of provision for survivor/dependant - is there enough to live on
o Deed of variation - able to change provisions of will or intestacy/needs to be within 2 years of death
o Financial capability of survivor
Need for short-term finance
o Define level and duration of need
o Check client can repay loan
o Check there are no other immediate sources of finance
o Seek most inexpensive form of borrowing
o When loan repaid emphasise need to save instead of borrowing
Redundancy
o Crucial issue is how quickly they are likely to be re-employed
o Need series of steps e.g., economise, spouse/partner to work more, sell assets
Serious illness
o Need to consider prognosis and whether they can return to work
o Prognosis - if likely to recover and go back to work establish timescale
o If long term condition, consider access to pension fund
o Work situation - employer may provide long-term benefits and take employee back or might be no sick pay
o Chances of re-employment
Entry into long-term care
o Determine financial aims - ensure State pays or ensure finances last to provide comfortable
few years with some estate left for relatives
o Need to use up capital each year and invest it to provide a reasonable return
o PLA - generally most reliable way to turn capital into a lifetime income, much of the regular payment is tax-free as return of capital, PSA can be used
o Important to establish LPA as soon as possible
Explaining and Justifying the Recommendations
Financial plan must be set out in a report
Report should provide main agenda for meeting
FCA expects planners to produce ‘suitability reports’
Report provides a permanent reminder of strategy
Functions of Report
Set out current position
Set out objectives
Make recommendations
How to Make Report Effective
Logical structure:
- Introduction - purpose of report
- use tabular form and divide up main sections
- note risk profile
Recommendations - in each area needs have been established
Review procedures and further work e.g., additional meetings
Revisions, reviews and monitoring - emphasises need to review due to changing circumstances and evolving environment
Economy of length:
- If too long take text out of main body and put in a schedule/appendix
- Avoid duplication of information contained in key features
- Write concisely
Accessible language:
- Avoid jargon
- Give full meaning of acronyms
- Use short sentences and paragraphs
Attractive layout:
- Break up report into sections
- Set out quantitative information in tabular form
- Use diagrams, graphs, and charts
- Use clear summaries
Exam Conditions
Generally shorter answers required due to time constraints
Bullet style answers generally required
Technical terms/abbreviations e.g., ISA are acceptable
Exam normally focuses on specific aspect instead of complete financial plan
Who are banks and building societies owned by?
Banks are owned by shareholders and building societies are owned by their account holders.
What can individuals and companies have protection needs on?
HINT: 4 things.
Physical assets
Earnings
Profit potential
Financial transactions
What do fixed-interest investments offer the investor?
A fixed rate of return and a fixed redemption value at maturity.
What is debt consolidation?
Where a new loan is negotiated to repay existing debts
What is the difference between restricted (multi-tied advice) and restricted (tied advice)?
Restricted (multi-tied advice) is provided based on a limited range of providers
Restricted (tied advice) is restricted to a single provider
