Tax efficiency and suitability of savings and investments

Question 1

Deposit accounts and premium bond risk

Answer 1

• Inflation risk
• Interest rate risk
• Default risk
• Taxation and legislation risk

Question 2

UK Multi Assets

Answer 2

Fixed interest element
- Inflation risk
- Interest rate risk
- Credit Ris,k
Equity element
- Systematic risk
- Non systematic risk
- Diversification risk

Question 3

FTSE 100 Tracker
UK Ethical Equity

Answer 3

• Default risk
• Systematic risk
• Diversification risk

Question 4

Global Equity

Answer 4

• Currency risk
• Political risk
• Regulatory risk

Question 5

9 points

What additional information do you need before you need before you can give advice on investments and tax efficiency

Answer 5

• What is the objectives of Tom and Sally’s investments
• What is the income/return on Tom and Sally’s investment
• Willingness to use ISA allowance next year
• Performance of existing funds
• Asset allocation of UK multi asset fund
• Cost and charges of funds and platform for all the investments
• Willngness to transfer assets
• Has Tom and Sally’s CGT exemption been utilised for this tax year
• Has Tom and Sally got any CGT losses that they can carry forward
• Base/purchase cost of Tom and Sally’s investments
• Willingness to put investment into Trust
• Ethical or any ESG consideration that Tom or Sally want to include or exclude
• Do Tom know the amount of inheritance he is likely to recieve form his mother?

Question 6

EIS and tax efficiency - The tax breaks

Answer 6

• Income tax relief of up to 30% on £1m
• Another £1m can be invested in knowledge intensive companies and gain 30% tax relief
• Tax reducer - deducted at the end of the tax calculation
• If you dont owe that amount of tax (in the tax year or when you carry back a tax year) you wont get the full relief
• Can carry back one tax year
• Must hold for three years or tax relief clawed back
• Must hold for three years to be free from CGT
• Reinvestment relief - one year before and three years after the gain has been made into another EIS
• Must be held for three years to be free from CGT
• No CGT payable on death
• If asset sold was eligible for entreprenurial relief e.g sale of business and gains reinvested into EIS, then will still qualify entrepreneur’s relief when investment is cashed in then only 10% CGT not the prevailing rate of CGT
• Must hold for at least 2 year’s to qualify for BR to be free of IHT
• Reinvested funds already qaulified for business relief, business relief is retained immediately rather than having to wait two years, as long as investment into the EIS is with three years of the sale
• Income tax, CGT and IHT advantages to EIS
• Dividend taxable unlike VCT

Question 7

VCT and tax efficiency - The tax breaks

Answer 7

• Tax relief of 30% on upto £200,000
• Tax reducer - deducted at the end of the tax calculation
• May not get full relief if you dont owe that amount of tax
• Cannot be carried back to previous tax years
• Must hold for five years or income tax will clawed back
• Dividends are tax free and dont count towards the dividend allowance
• CGT free from the outset
• Cant use reinvestment relief like EIS or Seed EIS
• Doesnt qualify for BR so in estate for IHT purposes like EIS

Question 8

Factors that you would take into account when your linking the features and benefit of investments such as EIS and VCT

Not recommendationor not what yo

Take into account the taxes they affect

Answer 8

• Level of income tax liability and whether they had a liability from the previous tax year
• EIS can use carry back, but not available to VCT
• Income requirement
• VCT will provide this as dividends are tax free whereas EIS dividend are taxable
  * Existing capital gains tax liability
• VCT capital gains tax free immediately, EIS have to hold investment for 3 years
• Reinvestment of gains from other assets, VCT doesnt mitigate CGT but investment CGT free from outset, whereas EIS will defer the gain until encashment of EIS, but growth on gain tax free after three years
  -Any gains on death will die with the owner if held under EIS
• Qualifying assets
• BR is retained in EIS if invested within 3 years and no 2 year waiting period, no BR for VCT so will be added to estate for IHT
• IHT liability
• EIS reduces IHT liability if held for at least 2 years, VCT will not reduce IHT liability
• Time horizon for investment
• VCT held for five years or income tax clawed back and EIS held for three years or income tax clawed back
• Risk appetite and profile/ATR
• EIS is riskier than VCT becuase invesment is directly in one company and usually small companies, higher risk of fairlure, whereas VCT is effectively a colective investment, the risk is spread across a number of companies, minimum of seven companies

Question 9

14 points workshop Q

Key information you would require from Tom and Sally in order to **advise them on the suitability and tax efficeincy **of their current investment portofolio

Answer 9

• Level of emergency fund
• Any capital requirements
• Penalties or charges to withdraw, transfer or switch on any of savings or investments
• Exemptions and allowances used in this fiancial year
• Performance of the ISAs, total history of contributions
• Whether they plan to pay off any of their mortgage at all
• Term of the objective, investment time horizon
• Previous ISA contributions
• Any prizes in the past for premium bonds
• The value of Tom’s mother’s estate
• Any previous CGT losses
• Remining notice period of the cash deposit
• Wilingness to use ISA allowances in future tax year
• Willingness to use VCT/EIS
• Do Tom’s investments meet his ESG preferences
• Willingness to tranfer assets to save or balance tax

Question 10

12 points Workshop Q

Comment on Tom and Sally’s current income tax and capital gains tax position

Answer 10

• Both Tomand Sally are higher rate tax payers at 40%
• They both have stocks and shares ISAs which are free of income tax and capital gains tax
• The have used their ISA allowance of £2000 for this tax year
• They both invested the maximium amount into premium bonds, tax efficient as prizes are tax free. The have not own any prizes this tax year.
• They both earn interest on their deposit account of 4.75%, which produces an income of £8100 and utilises their PSA £500, but the rest is taxed at 40%
• Tom’s gross income is increased to £100,050 by his share of the gross interest. However, his pension contribution brings down his NAI to £95250.
• He is not far from the threshold of £100,000 where the personal allowance is reduced by £1 for every £2 of income above the income limit
• They dont have any investments which uses their dividend allowance of £500.
• They dont have any investments which utilises their CGT exemption of £3,000 a year.
• The investment bond was assigned by his mother to Tom.
• This transferred the original investment amount and the 5% culmulative withdrawal to Tom. Tom can withdraw £4,000 a year or a culmulative amount of up to £60,000 without an immediate tax charge.
• Any amount over this will create a chargeable event, top slicing can be used to reduce the chargeable event gain and would be taxed at Tom’s highest marginal rate potentially pushing him up to additonal rate of tax and loss of PA
• 20% income tax is automatically deducted from the investment bond
• Further 20% is payable by Tom if chargeable event is triggered
• There is no capital gains or income tax for Tom to pay while the investment bond remains invested

Question 11

8 points

Explain to Tom and Sally why they should consider tranferring some of their cash asssets, to a stocks and shares ISA which invest in an equity based fund in the next tax year

Answer 11

• Tom and Sally are heavily over weighted in cash which is low risk and does not meet their medium risk ATR
• Cash is exposed to inflation risk where the value is being eroded by inflation and interest rate risk where interest rate are startng to fall
• There is no growth on cash, growth on equities
• By transferring to stocks and shares ISA they would be able to
  Benefit from tax free income and growth which will grow above inflation
• There is a wide fund choice which will give them access to global funds and funds related to ESG, passive and active managed funds
  By investing in a equity based fund they are reducing their holdings in cash and increase holdings in equity which is closer to matching their medium ATR
  Reduces the chance of both Tom and Sally exceeding the £100,000 threshold which reduces PA
  Increases diversification
  suitable for longeterm investment
  Equities generally outperform other asset classes

Question 12

8 points Workshop Q

Explain to Tom why the UK multi-Asset funds held within his Onshore Investment Bond may be suitable for investing for the longer term

Answer 12

• Risk rated to match Tom’s medium ATR
• It is diversified in asset classes he will get exposure to alternatives (which include investment which reflect to his interest in commodities and precious metals), property and fixed interest
• Potential for growth
• Correlation of asset classes are controlled so that they include assets that are negatively correlated
• Reduces risk and volatility
• No currency risk as invested only in the UK
• Active professionally managed
• Rebalanced regularly with no tax consequences
• Access to specialist investments such as ETF and ETC, derivatives
• Can switch in the futureif wish to fully or partially encash without any tax implications

Question 13

State five benefits and five drawback for Tom of encashing his onshore investment bond and investing poreeds into a range of Unit Trust

Answer 13

Benefits
* Unit Trust likely to be cheaper for fees and charges
* Less complex and more transparent
* Can use top slicing releif to avoid any ART on stored gain (wont be able to aovid additonal 20% tax though)
* Use CGT exemption for future encashment of unit trusts, can offsetlosses for CGT
* Bed and ISA can be use to fund Stocks and share ISA
* Dividend allowance of £500 can be used and dividend tax of 33.75% lower than income tax of 40%

Drawbacks
* CGT to apply on future encashment and CGT allowances have been reduced
* Dvidiend allowances have also been reduced
* Assign bond in part or full to children for university without tax consequences
* Additional tax charge of 20% payable on gain total 40%, loses future use of 5% tax deferred income
* Advice needed to encash and tax planning
* There would have been no immediate Tax for Tom if the investment was retained in the investment bond.

Question 14

10 points Workshop Q

Expain, in detail, how Tom could use his Onshore Investment Bond to provide him with a tax-efficient regular income and access capitla in the future

Answer 14

• The assignment from his mother meant the 5% culmulative allowance over 15 years was transferred to Tom
• Tom could take 5% per annum which would total £4,000 a year tax deferred income
• Tom could take 5% culmulative up to a maximum of £60,000 tax deferred (15 yrs x £4000)
• If Tom didnt want to use up the 5% deferred income then he could create a chargeable gain by withdrawing in excess of 5% culmulative deferred
• This would trigger a chargeable event and tax would be due
• The excess would be added to Tom’s other income
• Tom is a HRT at 40%
• Investment Bonds are subject to 20% income tax taken from within the fund
• Tom would need to pay an additonal 20% as he is HRT
• Tom can use top slicing to avoid any potential ART liablity
• Tom has the flexibilty of how he take the income or lump sum
• The bond is made up of 100 segments so he could encash full segments or make partial withdrawal across all segments, he can manage this so that his withdrawals are tax efficient
• Investment bonds are exempt form being assessed for longterm care

Question 15

6 points

6 reasons why Tom should consider retaining the Multi-Assest Funds within the Onshore investment bond

Answer 15

• Asset allocation is diversified, reduces volatility and risk
• Risk rated funds can match Tom’s medium ATR
• Actively managed
• Professionally managed and monitored
• Automatic rebalancing within the fund with no tax implications
• Switches to other assets have no tax implications
• Potential for growth
• Non - correlation of assets, correlation is controlled by fund managers

Question 16

8 points workshop Q

Outline four potential benefits and four potentiall drawback to Tom retaining the UK FTSE-100 index tracker fund within his ISA compared to him investing in an actively managed fund

Answer 16

Benefits
* Lower charges compared to actively managed fund. Provides Tom with more potential for growth
* Simple to understand, the index looks to track the FTSE 100, making the fund easy for Tom to understand
* The fund aligns with Tom’s medium ATR
* Provides an average return and over the longterm may outperform an actively managed fund
* No currency risk as UK based

Drawbacks
* Lack of diversification in asset classes and potentially geography,
* Exposed to concentration risk as invested entirely in equities
* Tracking error will underperform the index due to fund manger charges
* Will never outperfom the index in the longterm
* Cant take account of Tom’s ESG investment interest
* Fund manager cant take a defensive stands when markets are expected to fall

Question 17

Explain to Tom and Sally whyit is unsuitable for them to retain the cash intheir deposit account with thier existing bank over the longterm

Answer 17

• Their overweight in cash holdings, which is low risk and does not match their medimu ATR
• The deposit account is exposed to default risk as the balance of £180,000 exceeds the FSCS cover which is 2 x £85,000 per person per banking liscence = £170,000. £10,000 is not covered by FSCS shoud the provide default
• The cash in the account is subject to inflation risk and erode the value of the longterm
• The cash in the account is subject to interest rate risk, interest rates are now falling and should Tom and Sally reinvest at the end of the two year fixed rate period, the interest rate the will recieve will be lower than the interest rate they will recieve now
• The 4.75% interest is reduced as both Tom and Sally are HRT at 40% making the account not tax efficient
• The current interest pushes Tom’s NAI of £95250 near the £100,000 income threshold, where his PA could be tapered down £1 for every £2 over £100,000. Anymore interest will push him nearer or even over
• Theres no potential for growth

Question 18

8 points

Explain the key reasons why Tom and Sally should invest some of their current cash holding in other assets

Answer 18

• Tom and Sally’s portfolio is heavily weighted in cash at 40%, which is low risk and does not meet their medium ATR
• The cash is subject interest rate risk, interest rates are falling reducing the interest earned on cash
• Due to the little interest recieved the cash is subject to inflation risk and the value will be eroded over time
• There is no potential for capital growth
• The interest on the deposit account result in tax inefficiency as any amount exceeding Tom and Sallys PSA 2x £500 is subject to 40% tax as Tom and Sally are HRT
• Its subject to default risk as the holdings of £180,000 exceed the FSCS cover of 2 x £85000 per person per bank liscence = £170,000, £10,000 is not covered by FSCS should the provider fail
• Tom and Sally can invest some of the cash in their stocks and shares ISA in the next tax year, they have an allowance of £20,000 a year
• The investment would benefit from tax free income and growth, this will help it grow faster than if it was in a taxable environment
• The cash could be tranferred to assets that utilises their £500 dividend allowance saving and any further dividend income would be taxed at a lower rate of 33.75% instead of £40% income tax
• The cash could be transferred to assets that utilises Tom and Sally’s annual CGT exemption of 2 x £3,000 a year and CGT higher rate tax is only 20% compared 40% on income tax
• Utilising both CGT and Dvidiends is more tax efficient

Question 19

8 points workshopQ

Explain how Tom and Sally why National Savings and Investment Premium Bonds may not be suitable to meet their longterm objectives

Answer 19

• They have excess cash
• Interest in the form of prizes which are not gauranteed and are variable, may not win prizes
• Tom and Sally have recieved no prizes in this finanical year
• Does not meet their medium ATR
• Subject to inflation risk, with little to no prizes value will erode rapidly
• There is very limited potential for growth in the long term/no capital growth
• Suitable for short tem holdings
• No real returns to aid longerm income needs

Question 20

9 points workshop Q

Explain the factors that should be taken into consideration when identifying a suitable level of emergency fund for Tom and Sally

Answer 20

• Their regular monthly expenditure which totals £87664 per year, how much can be covered
• Tom and Sallly have no CIC or IPI cover in event of diagnosis of serious illness and longterm illness
• Both have employers 3 months full pay and 6 months half pay to act as a buffer before accessing their emergency fund
• Tom and Sally’s disposable income exceeds £3,000 a month
• They have 40% of savings and investment portfolio in cash and so have a lot of liquid assets to fall back on as emergency fund
• They have mortgage re-payments to meet mortgage liabilities but no other debts
• Tom and Sally have built up a large amount of investment assets how accessible are they
• Amelia and Noah are dependent on them financaillyand likely to be for at least 8 years
• Health and longevity

Question 21

10 points workshop Q

Outline the process you would follow to enable you to review the performance of Tom and Sallys existing stocks and shares ISAs

Answer 21

• Obtain a letter of authority in order to obtain information from their platform provider about the stocks and share ISA
• Once the information has been recieved
• Confirm date of purchase
• Review for Tom’s ISA and Sally’s ISA the total they have each paid into their ISA taking into account the total withdrawals if any
• Calculate performance history
• Determine the asset allocaiton
• Compare the performance against a bench mark to confirm if over or underperform against the same type of funds
• Review the projected returns for each ISA
• Review charges
• Review volatility and risk rating of funds
• Assess against medium ATR and CFL

Question 22

Tom and Sally are concerned that some of their investments may not suit their needs for the longer term. Comment on the ongoing suitablilty of Tom and Sally’s stocks and shares ISA holding

Answer 22

• ISA provides tax free growth and income
• Tom’s ISA matches his medium ATR
• Its unclear and unlikely if any companies meet his ESG investment requirements
• Sally’s ISA matches her medium ATR
• The UK Ethical Equity fund meets her ESG investment requirements
• Both Tom and Sally’s ISA’s are only exposed to the UK market, there is no geographical diversification, and so there is a high concentration risk
• Their investment is entirely equity base. There is no diversification in asset allocation such as alternatives, property or fixed interest
• Tracker funds are subject to extreme volatility and fund managers unable to take a strategic stance in falling market
• Tom and Sally have a medium to high CFL and so can tolerate more volatility
• They have a reasonably long time horizon which support higher volatility
• ISA’s are held in accummulation units which may not be appropriate when they cease to work
• Funds can be reviewed and switched within the ISA wrapper

Question 23

10 points Workshop Q

State the factors relating to Tom and Sallys investment portfolio that you would **take into account when reviewing **the suitability of investments

Answer 23

• The cost and charges on ISA and Investment Bond
• Winnings from Premium Bond
• Remaining term and any penalties to withdraw for Fixed Rate deposit
• Dividend income on the ISAs
• Overall asset allocation
• Risk level and volatility of the funds
• Whether investments in portfolio match Tom and Sally’s medium ATR
• Tom and Sally’s CFL
• Performance history of the funds in the investments
• Investment time horizon
• Number of funds and investments available on platform and with investment bond provider
• Penalties to switch or transfer from ISA and investment bond
• Whether Tom and Sallly want income or capital or both objective
• Lack of diversification in asset allocation and geography
• Original investment amount and any withdrawals
• Tom and Sally’s willngness to transfer assets
• Unused 5% culmulative deferred tax withdrawal

Question 24

7 points workshop Q

Tom is considering investing funds into VCT or an EIS in future years. Outline the factors that would influence his course of action

Answer 24

• The level of income tax liability this year and whether Tom has any from last year
• Whether income is required or if the focus is on capital gains
  Dividends from VCT tax free and not impact ANI
• Whether Tom has a existing or potential capital gains liabilty -
• Ability to reinvest any investment proceeds liable to capital gains and defer capital gains later
• Tom’s IHT liabililty concerns and the ability to reduce his estate with reliefs
• The time frame he wishes to invest for
• Tom’s ATR and CFL - as VCT more diversification and EIS investment into one company
• The amount that Tom is willing to invest, the immediate impact of the investment
• Previous experience in this area

Question 25

8 points workshop Q

State four benefits and four drawbacks for Tom on investing in an Enterprise Investment Scheme

Answer 25

Benefits
* 30% tax relief, can use against income in this tax year and the previous tax year, must hold EIS for 3 years
* Capital gains growth, CGT free after 3 years
* Can reinvest EIS into another EIS within 3 years to benefit from tax relief again and capital gains after 3 years
* Can reinvest proceeds from selling a business and retain 10% business asset disposal relief upon selling EIS after 3 years
* Business Relife if held for at least 2 years
* Potential for growth
* Can use losses in EIS to offset taxable gains elsewhere

Drawbacks
* 30% tax relief and IHT exemption lost if not held for at least 3 years
* Dividends are taxable
* No immediate CGT relief
* High risk as investment in one company and usually start up
* Advice required and so advice fees
* Cost and charges of investment is high
* Not in line iwith Tom’s medium ATR

Question 26

8 points workshop Q

Explain in detail to Tom and Sally why they may wish to consider a portfolio of global & UK passive equity tracker funds to invest some of their surplus holdings

Answer 26

• Provides geographical diversification to their existing portfolio, reducing the exposure to risk with investing in just UK market
• Equities will provide better growth over the long term and grow above inflation
• The funds will complement the existing funds and align with their medium ATR
• Their CFL is medium to high and so Tom and Sally are able to expereience a higher level of volatility
• Cost and charges are lower than actively managed funds and so better potential for growth
• Simple to understand and ease of access to market
• Provides dividend income and utilised both Tom and Sallys DA £500 x 2
• Provides average return and wont underperform the market over the longterm

Question 27

6 points

Identify the key drawbacks for Tom & Sally using passive Equity tracker funds within their portfolio

Answer 27

• Index tracker error and underperform average return due to the deduction of fund manager costs
• No choice in companies invested in and they may not meet Tom and Sally’s ESG investment requirements
• Fund managers are unable to take a strategic stance in a falling market
• As the market is being tracked result in the fund being volatile
• Does not aim to beat the market
• Single asset classes, all equities no diversification
• Does not seek to generate income