Topic 1 Flashcards
1.1 How would you define money?
A,a medium of exchange – it can be exchanged for goods and
services;
B, a unit of account – a common denominator against which the
value of goods and services can be measured; and
C, a store of value – money received as payment today can be
stored until required
1.2a What is intermediation?
Companies with surplus liquidity lend to companies with a cash deficit to increase the value of their funds in the future.
A financial intermediary is a middle person for example a bank/building society that borrows from the surplus party to lend to the deficit. The intermediary charges interest on the loan to the deficit company and pays some of that back to the surplus party.
1.2b what is disintermediation?
Lenders and borrowers interact directly rather than through an intermediary.
1.2.1 what are the four elements of intermediation? (Need)
Geographic location
Aggregation –
The lender might not have enough money available to satisfy the borrower’s
requirements. Intermediaries can overcome this size difference
by aggregating small deposits.
Maturity transformation – the borrower may need the funds for a longer period of time than the lender is
prepared to part with them. The majority of deposits are very short term
(eg instant access accounts), whereas most loans are required for longer
periods. Intermediaries are able to overcome this by offering a wide
range of deposit accounts to a wide range of depositors, thus helping to
ensure that not all of the depositors’ funds are withdrawn at the same time.
Risk transformation – individual depositors are generally reluctant to lend
all their savings to another individual or company, mainly because of the
risk of default or fraud. However, intermediaries enable lenders to spread
this risk over a wide variety of borrowers so that, if a few fail to repay (ie
default), the intermediary can absorb the loss.
Risk intermediation?
(Insurance)
Insurance, which can be defined as “a means of shifting the burden
of risk by pooling to minimise financial loss”. Insurance involves individuals
contributing – via their insurance premiums – to a fund from which the losses
of the few who experience certain adverse circumstances are covered. Insurance is an intermediation like banks.
What are product sales intermediaries?
They intermediate between banks and insurance to customers. (Mortgage advisors)
1.3.1what does the Bank of England do?
It acts as a banker to the government, supervises the economy
and regulates the supply of money.
What are the 7 main functions of the Bank of England in the UK economy?
Issuer of banknotes – the Bank of England is the central note-issuing
authority and has a duty to ensure that an adequate supply of notes is in
circulation.
Banker to the government – The Bank provides finance to cover any deficit by making
an automatic loan to the government. If there is a surplus, the Bank may
lend it out as part of its general debt management policy.
Banker to the banks – In
this capacity, the Bank can wield considerable influence over the rates
of interest in various money markets, by changing the rate of interest it
charges to banks that borrow or the rate it gives to banks that deposit.
Adviser to the government - it has built up a
specialised knowledge of the UK economy over many years, is able to advise
the government and help it to formulate its monetary policy. It sets the base rate is to ensure that the government’s
inflation target is met.
Foreign exchange market – the Bank of England manages the UK’s official
reserves of gold and foreign currencies on behalf of the Treasury.
Lender of last resort – the Bank
of England traditionally makes funds
available when the banking system is
short of liquidity to maintain confidence
in the system. This function became very
important in 2007–09 following a run on
Northern Rock and subsequent liquidity
problems for a number of other banks.
Maintaining economic stability – the Financial Policy Committee sits within
the Bank of England. It looks at the economy in broad terms to identify and
address risks that affect economic stability.
What are gilt-edged securities?
They are loans
to the government.
What is the Bank of England role as a Regulator? (In terms of dates and events with the treasury, FCA and PRA)
The Financial Services Act 2012, effective from 1 April
2013, divided responsibility for financial stability between
the Treasury, the Bank of England and two new regulators:
the Financial Conduct Authority (FCA) and the Prudential
Regulation Authority (PRA).
The Bank of England and Financial Services Act 2016 modified
the Financial Services Act 2012 to give more powers to the Bank
by bringing the PRA within it, ending its status as a subsidiary,
and establishing a new Prudential Regulation Committee (PRC).
1.3.2 what is a proprietary and mutual organisation?
The great majority of the large financial institutions are proprietary
organisations, which means that they are limited companies. As well as dividendes and ownership the shareholders can also contribute to
decisions about how the company is run by voting at shareholders’ meetings.
By contrast, a mutual organisation is one that is not constituted as a company
and does not, therefore, have shareholders. The most common types of mutual
organisation are building societies,
A mutual organisation is, in effect, owned by its members, who can determine
how the organisation is managed through general meetings similar to those
attended by shareholders of a company.
What is demutualisation?
Since the Building Societies Act 1986, a building society has
been able to demutualise – in other words, to convert to a bank
(with its status changed to that of a public limited company).
Such a change requires the approval of its members. This is partly because
of the windfall of free shares to which the members have been
entitled following the conversion of the building society to a
company.
A number of building societies demutualised in the late 1980s
and early 1990s as a result of the change in the law.
The possibility of a windfall for members led to a spate of
‘carpetbagging’ in the 1990s. This refers to the practice of
opening an account at a building society that is expected to
soon convert, purely to obtain the subsequent allocation of
shares. In response, societies considering conversion sought
to protect the interests of their long-term members by placing
restrictions on the opening of new accounts.
In the past, some mutual life assurance companies, including
Aviva and Standard Life Aberdeen, have also elected to
demutualise.
1.3.3 what is a credit union?
A credit union is a mutual organisation run for the benefit of its members. In
the past, the members had to share a ‘common bond’, for example, by working for the same
organisation, living in a particular area or belonging to a particular club or
other association.
They changed the Credit Unions Act 1979 and on 8 January 2012 credit unions no longer had to prove that all
members have something in common. As a result, they can now provide services to different groups of people, not just people with this ‘common bond’.
To join a credit union, the member must meet the membership requirements,
pay any required entrance fee and buy at least one £1 share in the union.
Credit unions can choose whether to offer ordinary shares (which are paid up and bring all the benefits of credit union membership), or deferred shares,
which are only payable in special circumstances.
All members of the credit union are equal, regardless of the size of their shareholding.
Traditionally, credit unions operated in the poorer communities as an
alternative to ‘loan sharks’, providing savings and reasonably priced short-
and medium-term loans to their members. In more recent years, it has been Recognised that credit unions have a strong role to play in combating financial
exclusion and delivering a range of financial services and financial education
to those outside the mainstream. The government has therefore supported
a number of initiatives and enacted legislation to widen the scope of the
movement.
Credit unions are owned by the members and controlled through a voluntary
board of directors, all of whom are members of the union. Board members
are elected by members at the annual general meeting (AGM). Although the
directors control the organisation, the day-to-day management is usually
carried out by employed staff. Credit unions are authorised and regulated by
the Financial Conduct Authority (FCA), and savers are protected through the
Financial Services Compensation Scheme (FSCS).
What products and services does a credit union offer?
Credit unions offer simple savings and loan facilities to members. While some
credit unions offer a fixed rate of interest on savings, most offer a yearly
dividend pay-out. Credit unions that choose to pay interest must
show that they have the necessary systems and controls in place and have at
least £50,000 or 5 per cent of total assets (whichever is greater) in reserve.
Members’ savings create a pool of money that can be lent to other members;
the loans typically have an interest rate of around 1 per cent of the reducing
balance each month (with a legal maximum of 3 per cent of the reducing
balance).
They also have basic
bank accounts, insurance services and mortgages.
Top topic in test:
A unique feature of credit unions is that members’ savings
and loan balances are covered by life assurance.
This means that any loan balance will be paid off on death,
and a lump sum equal to the savings held will also be paid,
subject to overall limits.
1.3.4 What is the difference between retail and wholesale banking?
What is an interbank market?
wholesale transactions are much larger than retail ones. the end-users of retail services are normally individuals and small businesses, whereas wholesale services are provided to large companies, the
government and other financial institutions.
Retail banking is primarily concerned with the more common services provided to personal and corporate customers, such as deposits, loans and payment systems.
Wholesale banking refers to the
process of raising money through
the wholesale money markets in
which financial institutions and
other large companies buy and sell
financial assets. This is the method
normally used by finance houses,
but the main retail banks also use wholesale banking in order to top up deposits from their branch networks as necessary very quickly from the interbank market.
Wholesale banking operations are riskier than retail banking. Following the 2007–09 financial crisis, regulators sought to ensure that banks involved
in both retail and wholesale banking did not expose their retail customers’
deposits to risk as a result of their wholesale operations. This approach is
referred to as ‘ring fencing’ and was implemented in the UK banking sector on 1 January 2019.
Building societies are also permitted to raise funds on the wholesale markets,
but are restricted to 50 per cent of their liabilities; the remainder must come
from deposits. For banks, there is no restriction.
Some organisations are clearly based at the wholesale end of the market,
notably product providers such as life assurance companies and unit trust
managers. Other organisations and individuals, such as insurance brokers and financial advisers, are purely retailers of the products and services offered by the providers. That said, the distinction between ‘retail’ and ‘wholesale’
in financial services is much less obvious than it used to be, with many institutions operating in both areas. Product providers that sell direct to the public or through their own dedicated sales forces are, in effect, operating in
both a wholesale and retail capacity.
Interbank market: A very large market which recycles surplus cash held by banks, either directly between banks or more
usually through the services of
specialist money brokers.
1.3.5 what are Libor and Sonia?
The London interbank offered rate (Libor). Libor used to act as a reference rate for the majority of corporate lending, for which the rate is quoted as Libor plus
a specified margin. Libor rates were fixed daily and varied in maturity from
overnight through to one year.
Libor was an average calculated using the information submitted by major
banks in London regarding the interest rates they were paying to borrow from
other banks. It was supposed to be an assessment of the health of the financial system, and the confidence felt by the banks as to the health of that system
was reflected in the rates they submit.
In 2012, it was discovered that banks were falsely inflating or
deflating the rates they claimed to be paying so as to profit
from trades, or to give the impression that they were more
creditworthy than they were.
A review recommended that banks submitting rates to Libor
must base them on actual interbank deposit transactions,
and not on what rates should be or are expected to be. It also
recommended that banks keep records of the transactions
to which the rates relate and that their Libor submissions be
published.
The activity of “administering and providing information
to specified benchmarks” came under the regulation of the
Financial Conduct Authority (FCA) from April 2013. Under the
Financial Services Act 2012, knowingly or deliberately making
false or misleading statements in relation to Libor-setting
became a criminal offence. Responsibility for administering
Libor passed to Intercontinental Exchange Benchmark
Administration in 2014
In 2016, the EU developed a Benchmarks Regulation, which
the UK retained post-Brexit and now forms the backbone of
the UK’s regulatory framework for benchmarks such as Libor
and Sonia.
As a result of the Libor scandal, a shift has been made to Sonia (sterling overnight
index average). Sonia was introduced in 1997 and has been administered by the
Bank of England since 2016, with calculation and publication responsibilities
also passing to the Bank following a reform of Sonia in 2018 (Bank of England,
2021). It is based on actual transactions and reflects the average of the
interest rates that banks pay to borrow sterling overnight from other financial
institutions and other institutional investors. Sonia is an important benchmark
used by financial businesses and institutions to calculate the interest paid on
swap transactions and sterling floating rate notes.
How can a bank involved in wholesale banking raise money quickly
in order to finance business activities?
a) By a further issue of shares.
b) By borrowing from the Bank of England.
c) By calling in their debts.
d) From the interbank market.
d) From the interbank market.
What are the four main reasons why individuals and companies
need financial intermediation?
Geographic location – lenders and borrowers are not necessarily able
to find each other and deal directly with each other.
Aggregation – an individual lender might not have enough funds to
fulfil a borrower’s requirements.
Maturity transformation – the borrower might need funds for longer
than the lender is prepared to lend.
Risk transformation – the lender might be reluctant to lend all their
funds to one borrower, in case that borrower is unable to repay.
What is the key difference between a mutual organisation and
a proprietary organisation?
A mutual organisation is owned by its members – in the case of a building
society, these are savers and borrowers; for a life assurance company
they are the policyholders. A proprietary organisation is owned by its
shareholders and is a limited company.
A financial transaction that is carried out directly between an
organisation with surplus funds to lend and one that needs to
borrow is an example of:
a) demutualisation.
b) disintermediation.
Disintermediation.
Which one of the following is not a role of the Bank of England?
a) To regulate the supply of money and manage gold reserves.
b) To act as financial ombudsman in resolving customer
complaints about banks.
c) To act as adviser to the government.
d) To set interest rates.
To act as financial ombudsman in resolving customer complaints about
banks.
Which institution issues UK banknotes?
a) The Bank of England.
b) The Treasury.
c) The Royal Mint.
The Bank of England. The Royal Mint issues coins.
Credit unions cannot pay interest on savings. True or false?
False. Credit unions can pay interest on savings as long as they have the
necessary systems and controls in place and have at least £50,000 or 5 per
cent of total assets (whichever is greater) in reserve.
Freshfood Ltd supplies fruit and vegetables to market traders
and small shops. The banking transactions it carries out are an
example of:
a) wholesale banking.
b) retail banking.
Retail banking. Wholesale banking involves providing funds to other
financial institutions or very large corporate clients.
Who is responsible for administering Sonia?
a) The FCA.
b) The Bank of England.
c) The Monetary Policy Committee.
d) The Prudential Regulation Authority.
The Bank of England is the administrator for Sonia. The FCA used to
regulate the Wholesale Markets Brokers’ Association as the calculation and
publication agent. In April 2018, the Bank of England assumed calculation
and publication duties.
2.1 what are the four key macroeconomic objectives?
Price stability – involves a low and controlled rate of inflation. It does
not mean, however, that zero inflation is desirable and there is a body
of economic opinion that believes that moderate inflation can stimulate
investment, which is good for the economy.
Low unemployment – involves expanding the economy so that there is
more demand for labour, land and capital.
Balance of payments equilibrium – a situation in which expenditure on
imports of goods and services and investment income going abroad is
equal to (ie in equilibrium with) the income received from exports of goods
and services and the return on overseas investments. The exchange rate
of the country’s currency is linked to the balance of payments, and most
governments aim to keep the price of currency stable at a level that is
not so high that exports will be discouraged but not so low as to increase
inflation.
Satisfactory economic growth – the output of the economy is growing in
real terms over time and standards of living are getting higher.
2.1 The four objectives of macroeconomics tend to fall into two pairs. What are these pairs and why?
How generally do governments trade off objectives against each other?
policies to reduce unemployment will also boost growth;
measures to reduce inflation will also help to improve the balance of
payments.
Governments generally have to trade off objectives against each other, ie they
want price stability but know that the price of getting rid of inflation altogether
would be very high unemployment, so they accept a low inflation rate to avoid
pushing the economy into recession.
What are the four phases of economic activity and what is their pattern?
Recovery and
expansion:
Interest rates, inflation and unemployment are low.
Consumers have money to spend. Demand for goods
and services rises, pushing prices up. Share prices
improve as businesses flourish.
Boom: to prevent the economy from overheating, the Bank of
England may intervene by putting up interest rates to
control consumer spending and dampen inflation.
Contraction or
slowdown:
Once the interest rate rises start to bite, consumer
spending falls. Demand for goods and services falls,
profits fall (as do share prices) and unemployment
rises. Inflation slows down.
Recession: As the economy heads towards its lowest level of
activity, the Bank of England may intervene to reduce
interest rates in a bid to stimulate demand and set the
economy on the path back to recovery.
What is the consumer price index?
A measure of the change in price of
a ‘basket’ of consumer goods and
services over a period. Items to be
included in the ‘basket’ are reviewed
regularly to ensure it provides an
accurate reflection of consumer
spending. It is the equivalent of the
Harmonised Index of Consumer Prices
(HICP) used within the eurozone.
2.2 what is monetary policy?
Measures taken to control
the supply of money in the
economy (eg by raising or
lowering interest rates) in
order to manage inflation.
What is the function of the MPC in relation to interest rates, and how do they go about their role?
Interest rates are set by the Bank of England’s Monetary Policy
Committee (MPC).
Each member of the MPC has expertise in the field of economics
and monetary policy. The MPC usually meets eight times a year
over three days to set the interest rate that it judges will enable
the inflation target to be met. The minutes of the meetings are
published simultaneously with the interest rate decision.
To help produce its projections, the MPC uses a model of
the economy that provides a framework to organise thinking
on how the economy works and how different economic
developments might affect future inflation.
Every quarter, the Bank publishes its Inflation Report, which
gives an analysis of the UK economy and the factors influencing
policy decisions.
2.2.1 what is the impact of interest rate changes?
If the MPC decides to change the Bank rate, the banks and similar
deposit-takers follow suit. Whether lending or taking deposits, a bank will apply a margin between the rate at which it borrows money and the rate at which it lends the money out, in order to cover costs and generate a profit.
2.3 What is a fiscal policy?
The adjustment of levels of taxation and public spending in a way that is
intended to achieve the government’s macroeconomic objectives.
Because the public sector is responsible for taking a large amount of money
from the private sector and for making large amounts of expenditure on its
behalf, any changes have a significant effect on the economy as a whole.
How is the budget for the UK set out?
Each year the Chancellor of the Exchequer makes a Budget
statement to the House of Commons outlining the state of
the economy and the government’s proposals for changes
to taxation. The House of Commons debates the Budget and
scrutinises the subsequent Finance Bill, which enacts the
Chancellor’s proposals.
The Budget also includes forecasts for the economy, which are
provided by the Office for Budget Responsibility (OBR).
What is a public sector net cash requirement?
A government that has a deficit must borrow to finance it. The public
sector net cash requirement (PSNCR) is a cash measure of the public
sector’s short-term net financing requirement.
How does Fiscal Policy have macroeconomic effect on the economy and inflation?
Changes in taxation affect the market for financial services and products in
two main ways. What are they?
Increased general taxation reduces the amount of money available for
investment or to fund loan repayments.
Tightening of the taxation regime in relation to particular products or
activities makes them less attractive to investors. For example, in April
2016 a stamp duty land tax supplement was introduced in respect of the
purchase of second properties. This followed concern that first-time buyers
were being priced out of the housing market as a result of demand from
buy-to-let landlords.
What is the impact of Brexit?
On 23 June 2016, the British public voted in a referendum for
the UK to leave the European Union (referred to as Brexit).
The UK stopped being a member of the European Union (EU)
on 31 January 2020. During a transition period that ran until
31 December 2020, the UK continued to follow all the EU’s
rules and its trading relationship remained the same (BBC,
2020).
As the UK onshored aspects of the EU’s financial regulatory
framework (ie retained certain EU laws and regulations in UK
statue), legislation and wider issues relating to the UK, and its
legacy of membership of the EU covered in this text, remain
important areas within the syllabus for this qualification.
The Retained EU Law (Revocation and Reform) Bill was
introduced in the House of Commons in September 2022. The
Bill provided the government with the required provisions to
allow for the amendment of retained EU law and removal of
most of the special features it had in the UK legal system via a
sunset clause by the end of 2023.
What is the impact of EU legislation on the financial services sector?
Post-Brexit, when the EU changes a regulation or introduces
new regulation, the UK considers whether to adopt the new
regulation or develop an alternative approach; and, in the case
of reformed EU regulation, whether it wishes to amend the
legislation it onshored before Brexit.
Examples of EU directives include the following.
The EU Mortgage Credit Directive (MCD) aimed to
harmonise regulation of the EU mortgage credit market
and promote competition. You will find out more about
the FCA’s regulations in relation to mortgage advice and
product sales in Topic 21.
The deposit protection limits under the FSCS are set in
reference to the European Deposit Guarantee Schemes
Directive. This directive requires that the sterling scheme
is revalued every five years to make sure that the level of
protection remains in line with the €100,000 provided for
under the EU-wide scheme.
What is the impact of Brexit on regulation?
The UK’s financial services regulators – the Prudential
Regulation Authority and Financial Conduct Authority – are
not formally part of the ESFS (European system of financial supervision) post-Brexit. However, the ESAs (European supervisory authority)
still retain some jurisdiction over UK financial institutions as
third-country institutions where they are providing service to
clients in an EU member state. As such, the ESFS remains an
important area within the syllabus for this qualification.
2.4.2 what is the single supervisory mechanism? And what does it do?
The Single Supervisory Mechanism (SSM) is the name for the mechanism by
which the European Central Bank holds responsibility for the supervision and
monitoring of banks in EU member states.
The SSM provides a common approach to banking supervision. The ECB ( European central bank) is
supported by national regulators and it is the ECB that has the final decision
on supervisory matters.
Post-Brexit, which of the following is correct when the EU
changes a regulation or introduces new regulation?
a) The UK is legally required to adopt or implement the new
or reformed EU regulation.
b) The UK is legally required to ignore the new or reformed
EU regulation entirely.
c) The UK should consider whether it adopts a new regulation
or develops its own alternative approach; and, in the case
of reformed EU regulation, whether it wishes to amend the
legislation it onshored before Brexit.
c) The UK should consider whether it adopts a new regulation
or develops its own alternative approach; and, in the case
of reformed EU regulation, whether it wishes to amend the
legislation it onshored before Brexit.
The European Union has issued a new regulation. This means
that each member state:
a) has the choice whether or not to adopt the regulation.
b) must pass legislation to implement the regulation within
two years.
c) is bound by the regulation in its entirety regardless of
existing legislation.
d) has the choice of how to adopt the regulation’s objectives.
c) is bound by the regulation in its entirety regardless of
existing legislation.
What are the four levels of regulatory oversight in UK?
1) Acts of Parliament that set out what can and cannot be done, including
any onshored EU legislation.
2) Regulatory bodies that monitor the regulations and issue rules about how
the requirements of the legislation are to be met in practice. The main
regulatory bodies in the UK are the Prudential Regulation Authority (PRA)
and the Financial Conduct Authority (FCA).
3) Policies and practices of the financial institutions themselves and the
internal departments that ensure they operate legally and competently, eg
the compliance department of a life assurance company.
4) Arbitration schemes to which consumers’ complaints can be referred. In
most cases, this is the Financial Ombudsman Service.
1) What is meant by a ‘macroeconomic objective’?
1) An objective that relates to the economy as a whole, rather than to a
specific sector or individual company.
2) What are the four key macroeconomic objectives that UK
governments generally seek to achieve?
2) Price stability, low unemployment, a balance of payments equilibrium and
satisfactory economic growth
3) What is a potential negative consequence of expanding
economic growth to reduce unemployment?
3) Measures taken to expand the economy (eg reducing interest rates and
taxation) increase the demand for goods and services, which is likely to
result in a rise in inflation.
4) All governments aim to achieve zero inflation. True or false?
4) False. They aim to keep prices stable, but seeking to reduce inflation to
zero is likely to increase unemployment.
5) What is the UK government’s inflation target and how is it measured?
5) The UK government’s inflation target is 2 per cent with a maximum divergence
either side of 1 per cent. It is measured by the Consumer Prices Index
6) Disinflation means that:
a) prices are rising faster than previously.
b) prices are falling.
c) prices are rising but more slowly than previously.
d) prices are staying the same.
6) c) Prices are rising but more slowly than previously.
7) In June, the Monetary Policy Committee (MPC) decides to raise
the Bank rate by half a percentage point. In August, Paul and
Amanda’s mortgage payments increase. Explain how these two
events are likely to be linked.
7) Paul and Amanda must have a variable‑rate mortgage, so the amount they
pay each month is likely to rise and fall broadly in line with changes in the
Bank rate.
8) Which of the following economic measures taken by a
government would not help to achieve a budget surplus?
a) Increasing taxation.
b) Increasing public spending.
c) Reducing public spending.
8) b) Increasing public spending. To achieve a budget surplus a government
must cut public spending, raise taxes, or both.
9) A new piece of EU legislation is being introduced. It is being
implemented at the same time and in exactly the same way
across all member states. This indicates that the legislation is
in the form of:
a) a directive.
b) a regulation.
9) A regulation. Member states have flexibility in the way they introduce directives.
10) Which UK body and which EU body are responsible for
monitoring the financial system for systemic risk and taking
steps to reduce it (refer back to Topic 1 if necessary)?
10) The Bank of England for the UK and the European Systemic Risk Board
(ESRB) for the EU.
3.2.1 how do we decide to tax someone on whether they are classed as residence?
Residence mainly affects income tax and CGT. Any person who is present in
the UK for at least 183 days in a given tax year is regarded as automatically UK
resident for tax purposes.
What is Domicile? And how is it applied?
Domicile is best described as the country that an individual treats as their home, even if they were to live for a time in another country.
Everyone acquires a domicile of origin at birth. This is the domicile of their father on the date of their birth (or the domicile of the mother if the parents are not married).
A person can change to a different domicile (known as domicile of choice) by going
to live in a different country, intending to stay there permanently and showing
that intent by generally ‘putting down roots’ in the new country and severing
connections with the former country. There is no specific process for this.
What is Domicile important?
Domicile mainly affects liability to IHT.
If a person is domiciled in the UK, IHT (inheritance tax) is chargeable on assets anywhere in the world, whereas for persons not domiciled in
the UK, tax is due only on assets in the UK.
People who are not UK‑domiciled but have been resident in the
UK for tax purposes in at least 15 of the previous 20 tax years
are deemed to be UK‑domiciled for IHT purposes.
Which of the following people would be most likely to be a ‘UK resident’?
a) Susan, who normally lives in Spain but spends three months a
year working for the family business in England.
b) Antoine, a French surveyor, whose eight‑month contract in
Devon with a construction company started in May.
c) Max, who moved to London from Cologne on 6 January for a
seven‑month teaching contract.
d) Brenda, who spends 180 days a year in the UK and the remainder
in the USA.
1) b) Antoine. Answer c) is not correct because three months of Max’s contract
are in one tax year and the rest in the following year. He will not spend 183
days in either tax year in the UK.
Which of the following will not be subject to UK inheritance tax
upon death?
a) UK property owned by Paolo, who has lived in the UK for three
years but is not UK domiciled.
b) Overseas property owned by Kavita, who was born in the US (to
American parents) but has lived in the UK for the past 18 years.
c) Overseas property owned by Helena, who is UK resident but
not UK domiciled nor deemed domiciled.
d) Overseas property owned by David, who is UK domiciled but
resident in France.
2) c) As Helena is not UK domiciled she will not pay IHT on overseas assets.
How is the income of a child that arises from a settlement or arrangement made by their parents is normally treated?
It is treated as the parents’ income for tax purposes. In
this situation, the child’s unused allowances cannot be set against this income
For a child, which of the following would be subject to income tax?
a) All earned income.
b) An educational grant.
c) Any earned income that exceeds their personal allowance.
d) A settlement from their parents.
c) Any earned income that exceeds their personal allowance. The
settlement from their parents (answer d) will be taxed as the parents’
income, the educational grant (answer b) is tax‑free, and they would
not pay tax on all of their earned income (answer a), only that which
exceeds their personal allowance.
Who is liable for income tax?
All UK residents, including
children, may be subject to income tax, depending on the type and amount of
income they receive.
3.3.1 what are the 7 allowances in tax?
Personal allowance – the personal allowance threshold usually determines
the rate above which income tax is charged. Individuals whose annual
income exceeds an upper threshold have their personal allowance reduced,
sometimes to zero, depending how much their earnings exceed the
threshold.
Marriage allowance – it is possible for an individual to transfer part of
their personal allowance to their spouse or civil partner, providing the
transferor is not liable to income tax at all and the recipient is not liable to
income tax at the higher or additional rate.
Married couple’s allowance – this allowance is available if one partner in a
marriage or civil partnership was born before 6 April 1935. The allowance is
provided as a tax reduction and is limited to a percentage of the applicable
allowance amount.
Blind person’s allowance – this allowance is available to those registered
as blind with a local authority. If the allowance cannot be used by the
individual, it can be transferred to their spouse or civil partner.
Personal savings allowance (PSA) – is a tax-free allowance that enables
savers to earn interest on savings without paying tax on that interest. The
allowance depends on the individual’s income tax band. There is no PSA for
additional-rate taxpayers.
Dividend allowance (DA) – individuals receive a dividend allowance each
year. Any dividend income above the DA is taxable, but special rates apply.
Dividends on any shares held in an ISA are also tax-free.
Allowances for property and trading income – so‑called
‘micro‑entrepreneurs’ who supplement their main income with property
or trading income are entitled to an additional allowance. There are two
separate allowances, one for trading income and one for property income.
The allowances apply to those who, for example, make small amounts of
money by selling on eBay or by renting a room in their house or a parking
space. If trading/property income is less than the allowance, then no tax is
payable on that income; if it is more than the allowance, then the individual
has the choice to either deduct the allowance from trading/property income
or calculate profit in the usual way and deduct allowable expenses
What are the three deductions that can be taken from the gross amount before tax?
certain pension contributions (within specified limits) – for example, a
scheme set up by an employer;
certain charitable contributions;
allowable expenses – such as costs incurred in carrying out one’s
employment.
How are deductions made more self employed people?
allowable expenses can only be incurred “wholly and
exclusively for the purpose of trade”, while for employed persons they must
be incurred “wholly, exclusively and necessarily” while doing the job.
When all the relevant deductions have been made from a person’s gross
income, what remains is their taxable income. This is the amount to which the appropriate tax rate(s) is applied in order to calculate the tax due.
3.3.3 If someone’s income comes from different sources, what is the set order in which income tax is applied?
1) First, tax is calculated on non‑savings income, such as earned income,
self‑employed net profits, pension income and rent received.
2) Second, it is applied to savings income, ie interest received.
3) Third, income tax is calculated on dividends.
4) Finally, any chargeable gains on non‑qualifying life assurance policies are
brought into the calculation.
3.4.1 explain and give an example of income tax taken at source?
In some cases, HMRC collects income tax at source, ie from the person who
makes the payment, not the recipient.
An example of where tax is deducted at source is PAYE.
Employers deduct tax weekly or monthly (as appropriate) from wages and
salaries, which are then paid to the employee net of tax.
Some other types of income are taxed at source, such as income from certain
trusts.
What are the two categories savings income will fall into?
Tax‑free – including income from ISAs and some National Savings and
Investments accounts.
Paid gross without deduction of tax but subject to tax in the hands of the
individual – including interest from bank and building society accounts – if
in excess of the personal savings allowance.
Explain the four stage process which broadly explains the calculation of personal liability to income tax
1) Work out the total income.
2) Make appropriate deductions, eg allowable expenses or
certain pension contributions.
3) Deduct the personal allowance and other reliefs (eg blind
person’s allowance) to arrive at the taxable income.
4) Apply tax at the current rates to the appropriate bands of
income.
3.5.1 explain gift aid and it’s effect on tax
When a gift is made using Gift Aid, the charity can recover the basic‑rate
tax (20 per cent) that is assumed to have been paid on the amount of the gift, increasing the value of the net gift. For example, a gift of £80 from an
individual who pays income tax is treated as a gift of £100: the donor pays £80
and the charity reclaims £20 from HMRC. Effectively, this is an uplift of 25 per cent (as £20 is 25 per cent of £80).
In addition, the donor making the gift has their basic‑ and higher‑rate tax
thresholds extended by the value of the gross gift.
3.5.2 explain payroll giving
This enables employees to make tax‑efficient gifts by having a charitable gift
deducted from their salary before income tax is charged. By making a gift in
this way, tax relief is granted on the value of the gift at the individual’s highest
rate of income tax.
Explain class one national insurance contributions
Paid by employees at a percentage on earnings between
certain levels, known as the primary threshold and the
upper earnings limit with a reduced percentage payable on
earnings above the upper limit.
They are also paid by employers on most employees’
earnings above a lower limit called the secondary threshold
– but with no upper limit.
No employer NICs are paid in respect of employees and
apprentices under a certain age on earnings between the
primary threshold and the upper earnings limit.
Explain class 2 national insurance contributions
Flat‑rate contributions paid by the self‑employed if their
annual profits exceed the small profits threshold or
deemed paid if their annual profits exceed the small profits
threshold but are below the lower profits threshold.
They are quoted as a weekly amount.
They are collected through self‑assessment in a single
lump sum.
Explain class three national insurance contributions
Voluntary contributions that can be paid by people who
would not otherwise be entitled to the full state pension or
sickness benefits.
This can occur because a person has, for instance, taken a
career break or spent some time working overseas.
They are flat‑rate contributions.
Explain class four national insurance contributions
Additional contributions payable by self‑employed people
on their annual profits between specified minimum and
maximum levels, with a reduced rate payable above the
upper limit, as for Class 1.
They are paid to HMRC in half‑yearly instalments by
self‑assessment.
explain who issues individuals with their tax code and how the
tax code is used?
In order to deduct the right amount of
tax, the employer is supplied with a tax code for each employee: the tax code
relates to the amount that the employee can earn without paying tax. The employer then supplies it to the employee.
describe how a self‑employed person pays income tax?
People who are self‑employed
pay income tax directly to HMRC on the basis of a declaration of net profits. For a self‑employed person, net profits are
broadly the equivalent of the gross income of an employee, ie they are the
amount on which income tax is based. They are calculated by taking the total
income of the business and deducting allowable business expenses and capital
allowances.Many taxpayers calculate their own liability and submit their figures online to
HMRC for approval. HMRC will perform the tax calculation for those sending
in their figures on paper, although the submission deadline for this is earlier.
This process is called self‑assessment. Some self‑employed people use an
accountant to prepare their accounts and to deal with HMRC on their behalf.
Self‑employed people pay their income tax and Class 4 NICs in two equal
parts. The first payment is due on 31 January of the tax year in which their
business year ends; the second is due on 31 July, six months later. Any under
or overpayment is then rectified on the 31 January following the end of the tax
year. Class 2 NICs are also due in one lump sum on this date.
explain how the starting‑rate band and personal savings
allowance work?
Personal savings allowance (PSA) – is a tax-free allowance that enables
savers to earn interest on savings without paying tax on that interest. The
allowance depends on the individual’s income tax band. There is no PSA for
additional-rate taxpayers.
1) A person who is UK resident for tax purposes only pays income
tax on earnings generated in the UK. True or false?
1) False. They are liable for income tax on income generated anywhere in the
world, but the UK has reciprocal tax treaties (double taxation agreements)
with many countries to ensure that people are not taxed twice on the same
income.
2) A person may become UK domiciled once they have been
settled in the UK for a number of years. True or false?
2) True, as long as their actions indicate that their change of residence is
permanent and they have severed links with their original country of
domicile.
3) Which of the following is not assessable for income tax purposes?
a) Tips.
b) Interest from bank and building society deposits.
c) Lottery prizes.
d) Rents from land and property.
3) c) Lottery prizes.
4) In what order of priority is income taxed?
4) Non‑savings income, then savings income, then dividend income.
5) Blind person’s allowance can be transferred to a spouse or
civil partner if the blind person does not use the allowance.
True or false?
5) True. Blind person’s allowance can be transferred to a spouse/civil partner
if the original recipient does not pay tax or use all their allowance.
6) Emma worked abroad for five years but is now back working in
the UK. What class of National Insurance contributions could she
pay to improve her contribution record for the state pension?
6) Class 3.
7) Mike earns £22,000. He also receives £500 interest on his
savings from a building society deposit account. Calculate the
income tax payable.
7) On earnings:
£22,000 – £12,570 (personal allowance) = £9,430
£9,430 × 20% = £1,886
There is no tax to pay on savings income because, as a basic‑rate taxpayer,
Mike has a personal savings allowance of £1,000.
8) Roopa is a company director. In the current tax year, she draws
a salary of £12,570. She has dividend income of £27,000.
Calculate the income tax payable.
8) Total income is £39,570
Salary falls within personal allowance of £12,570 so no tax is paid on this.£2,000 of dividend income is taxable at 0 per cent.
The remaining £25,000 all falls within the basic rate tax band and is taxed
at 8.75 per cent.
Total tax is £2,187.50 (£25,000 × 8.75%).
9) Jemma is self‑employed and is in receipt of blind person’s
allowance of £2,870. In the current tax year, her gross profit
is £20,000 and she has allowable expenses of £2,500. She has
to pay Class 4 NICs at 9 per cent on her taxable profit above
£12,570. Calculate the income tax and Class 4 NICs payable.
9) Income tax:
£20,000 Gross profit
(£2,500) Allowable expenses
(£12,570) Personal allowance
(£2,870) Blind person’s allowance
Taxable income: £2,060
Tax: £2,060 × 20% = £412
Class 4 NICs:
£20,000 – £2,500 = £17,500 taxable profit
£17,500 – £12,570 × 9% = £443.70
10) Ashok’s salary is £75,000 and he is paid savings interest of
£650. He also has dividend income of £7,000. Calculate the
income tax payable.
10) Tax on earned income:
£75,000 Income
(£12,570) Personal allowance
£62,430 taxable earned income
£37,700 × 20% = £7,540
£62,430 – £37,700 = £24,730 × 40% = £9,892
Savings interest:
£500 (PSA) × 0% = £0
£150 × 40% = £60
Dividend income:
£2,000 (DA) × 0% = £0
£5,000 × 33.75% = £1,687.50
How do people pay tax on their savings and investments income?
Interest on deposits is paid gross to all customers, and individuals have to
advise HMRC to deduct tax via their tax code or pay via self‑assessment.
For those on low incomes a starting rate of 0 per cent applies to the first £5,000
of savings income. The starting-rate band reduces as taxable non‑savings
income is received, and the starting rate does not apply at all where income
received exceeds an individual’s personal allowance plus the starting‑rate
band.
Additionally, there is a personal savings allowance (PSA) for basic‑rate taxpayers
and a lower allowance for higher‑rate taxpayers: savings income falling within
these limits is subject to 0 per cent tax. In calculating eligibility for the PSA, all
of an individual’s income is taken into account in assessing whether they are
a basic‑ or higher‑rate taxpayer.
What is bed and breakfasting in terms of capital gains tax?
One issue with CGT is that it becomes due on the whole gain
in the year it is realised, even where the gain has been made
over a longer period. Only one annual exempt amount can be set
against what may be many years’ worth of gain.
Historically, holders of shares and unit trusts could minimise
the effect of this by ‘bed and breakfasting’: selling their holding
each year and repurchasing it the following day, thus realising a
smaller gain that could be covered by that year’s allowance.
Nowadays, any shares and unit trusts that are sold and repurchased
within a 30‑day period are treated, for CGT purposes, as if those
two related transactions had not taken place, rendering this
loophole ineffective.
4.1.1what kind of assets are exempt of capital gains tax?
CGT applies to gains made since 6 April 2015 by individuals or trustees who
are not UK resident on residential property located in the UK. Gains made
during ownership prior to this date are ignored.
Gains that accrue to non‑UK residents on non‑residential property have been
subject to tax since 6 April 2019.
A non‑resident individual might still be able to claim private residence relief if they live in the property for at least 90 days during a tax year.
What happens if a loss is made on disposal of asset?
the loss can be offset against gains made elsewhere. It must be offset first against gains in the year the loss occurred.
Residual losses may then be carried forward to future
years. A capital loss cannot be carried back to a previous year.
Given that capital losses can be carried forward but the annual exempt amount
cannot, capital losses brought forward are used only to the extent necessary
to reduce gains to the level of the annual exempt amount. Residual losses are
then carried forward.
How do you calculate CGT liability?
1) Calculate the amount of the gain.
2) Deduct the CGT annual exempt amount (if this has not been
used against other gains in the same tax year).
3) Deduct any losses that can be offset against the gain.
4) What remains is the taxable gain.
5) Add taxable gain to taxable income to establish what rate(s)
of CGT should be paid.
6) Apply tax at appropriate rates. There may be different rates
for taxable gains that fall in the basic‑rate income tax band
and those that fall outside it. There may also be a surcharge
where the gain results from the sale of property not subject
to private residence relief.
What is private resistance relief?
This is available when someone sells the property they have lived in as their main or only residence. The ‘main residence’ does not have to
be a house or flat – it could be a houseboat, or a fixed caravan.
If someone has more than one property and shares their time between each,
they may nominate the property on which they want to claim private residence
relief.
There are rules relating to how long an individual may spend away from the
property and still be eligible for the full relief. For example, if someone owns
a house but spends part of the year living away in accommodation provided
with their job, the house is treated as their main residence for private residence
relief purposes.
There are also rules relating to the use of the property for business purposes
and to the size of the garden on which full relief can be claimed.
What is business asset disposal relief?
Business owners are required to pay capital gains tax when they sell (dispose of)
trading businesses or assets used in those businesses and from certain disposals of shares in trading companies.
However, they may be able to pay a lower rate of
tax on gains on qualifying assets if they meet certain conditions. This is commonly
known as business asset disposal relief (previously entrepreneurs’ relief) and is
available to both sole traders and limited companies.
For owners of limited companies, eligibility depends on holding at least 5 per cent of the ordinary share capital of the business, which enables them to exercise at least 5 per cent of the voting rights in that company. In addition, they must also
be entitled to at least 5 per cent of the distributable profits and net assets of the company. Most property letting businesses do not qualify for this relief.
Business asset disposal relief also applies to gains resulting from investment into unlisted
companies.
What is roller over relief?
roll‑over relief may be
claimed if the assets disposed of are replaced by other business assets. This
means that, instead of CGT falling due on the original disposal, it is deferred
until a final disposal is made.
The replacement asset must be bought within a period of one year before and
three years after the sale of the original asset.
Relief can be claimed up to the lower of either the gain or the amount reinvested.
What is hold over relief?
What gains may be wholly or partly passed on in the case of a gift or sale at under value?
CGT on any gain arising on the gift of certain assets can normally be
deferred until the recipient disposes of it.
Gains may be wholly or partly passed on to the recipient in the case of gifts (or
sale at under value) of the following broad categories of assets:
assets used by the donor in their trade or the trade of their personal
company or group;
shares in the transferor’s personal company or in an unlisted trading company;
agricultural property that would attract relief from inheritance tax;
assets on which there is an immediate charge to inheritance tax.
What is residence nil rate band?
If part of the estate includes a residence that is being left to children or other
direct descendants an additional residence nil‑rate band
(RNRB) applies.
When calculating IHT due on the estate, the RNRB is deducted from the
estate’s value on death.
Where the RNRB is unused, in full or in part on death, the unused balance
can be carried forward for use upon the death of a surviving spouse or civil
partner. the unused percentage is
carried forward rather than the unused value.
This means that the maximum amount exempt from IHT between married
couples or civil partners is effectively £1m (ie £175,000 × 2 RNRB and £325,000
× 2 NRB).
What is a potentially exempt transfer for inheritance tax?
IHT is also payable in certain circumstances when assets are transferred from a person’s estate during their lifetime (usually in the form of gifts). Most gifts
made during a person’s lifetime are potentially exempt transfers (PETs) and
are not subject to IHT at the time of the transfer.
If the donor survives for seven years after making the gift, these transactions become fully exempt and no IHT is payable.
In July 2019, Joan made a gift to her daughter of £350,000. She
had made no other gifts in her lifetime. Joan died in October 2023
leaving a total estate worth £420,000. Let’s say the full rate of IHT
is 40 per cent on estates over the nil-rate band of £325,000. How
much IHT is due on the gift?
a) £5,000
b) £6,000
c) £8,000
d) £10,000
b) £6,000. The gift uses the available nil‑rate band of £325,000, leaving an
excess of £25,000 above the nil‑rate band. Joan died between four and five years after the gift, so the £25,000 excess is liable for IHT at 60 per cent of the
full rate (ie 40% × 60%).
What is a chargeable lifetime transfer?
Some lifetime gifts – notably those to companies, other organisations and
certain trusts – are not PETs but chargeable lifetime transfers, on which IHT
at a reduced rate is immediately due.
The reduced rate of IHT is only applied to the excess over the nil‑rate band. As with PETs, the full amount of IHT is due
if the donor dies within seven years (subject to the same taper relief).
What gifts and transfers are exempt from inheritance tax?
transfers between spouses and between civil partners both during their
lifetime and on death, provided that the receiving spouse/civil partner is
UK domiciled;
small gifts of up to £250 (cash or value) per recipient in each tax year;
donations to charity, to political parties and to the nation;
wedding/civil partnership gifts of up to £1,000 (increased to £5,000 for
gifts from parents or £2,500 from grandparents, or from one spouse/civil
partner to the other);
gifts that are made on a regular basis out of income and which do not affect
the donor’s standard of living;
up to £3,000 per tax year for gifts not covered by other exemptions. Any
part of the £3,000 that is not used in a given tax year can be carried forward
for one tax year, but no further.
An advantage of registering is that VAT paid out on business expenses can be
reclaimed.what are two disadvantages?
the firm’s goods or services are more expensive to customers
(by the amount of the VAT that the firm must charge);
the additional administration involved in collecting, accounting for and
paying VAT.
What is stamp duty and stamp duty reserve tax?
Stamp duty is payable on paper documents that transfer the ownership of
financial assets, such as shares and bearer instruments over a certain amount.
Stamp duty reserve tax (SDRT) is charged on transfers that are completed
electronically. If the transaction is carried out through CREST, which is an electronic settlement and registration system, SDRT is deducted automatically
and passed to HMRC.
What is stamp duty and land tax relief for first time buyers?
First‑time buyers can claim a discount (relief), which is
tapered depending on the price of the residential property.
For properties below a certain amount, first-time buyers will
not be liable for any SDLT and for properties in excess of a
certain amount, the relief is not applicable.
The relief was extended to qualifying shared-ownership
property purchasers in the 2018 Budget.
What is withholding tax?
The phrase ‘withholding tax’ refers to any tax on income that is levied at
source before that income is received. So, technically, income tax paid by UK
employees is a withholding tax.
However, the phrase is normally understood to apply to tax that is levied in
a particular country on income received in that country by those who are
non‑resident in that country (eg non‑resident entertainers and professional sportspeople); this could be earned income or investment income.
The aim is to ensure that the income does not leave the country without being
taxed. The UK has reciprocal tax treaties (double taxation agreements) with
over 100 other countries to prevent the same income from being taxed twice.
1) Melanie bought a painting in a charity shop for £40. It turned
out to be by a well‑known artist, and she sold it three years
later for £2,000. She had to pay CGT on the gain she made.
True or false?
1) False. Gains made on ‘chattels’ (movable objects such as jewellery, antiques
and paintings) are exempt from CGT if their value is £6,000 or less.
2) For how many years can the annual exempt amount for CGT be
carried forward?
2) The CGT annual exempt amount cannot be carried forward at all.
3) To qualify for roll‑over relief, a business must replace an asset
not more than five years from the date of disposal. True or
false?
3) False. Assets must be replaced within three years after the date of disposal.
4) Inheritance tax would be charged on which of the following?
a) The total value of the deceased’s estate.
b) The total value of the estate above the available nil‑rate band.
c) The value of the estate less any gifts that have been made
in the previous seven years.
4) b) Inheritance tax would be payable on the total value of the estate above
the available nil‑rate band.
5) Tax on a chargeable lifetime transfer in excess of the available
nil‑rate band is payable:
a) immediately, at the full rate.
b) only if the transferor dies within seven years of the transfer.
c) immediately, at a reduced rate.
5) c) Immediately, at a reduced rate of 20 per cent.
6) What kind of tax is payable when shares are purchased
electronically?
6) Stamp duty reserve tax.
7) Sanjay, a basic‑rate taxpayer with taxable income of £12,000,
purchased UK listed company shares for £11,300 in May 2017.
He sold them for £25,400 in August 2023. He has no other
gains or losses (current or carried forward) in the current tax
year. Ignoring any costs, calculate his capital gains tax liability
assuming an annual exempt amount of £6,000 and a basic rate
of 10%.
7) Gain: £25,400 – £11,300 = £14,100
Taxable gain: £14,100 – £6,000 = £8,100
Capital gains tax payable: £8,100 × 10% = £810
8) Sarah, a basic‑rate taxpayer with taxable income of £17,000,
bought some shares in May 2018 for £15,000 and sold them in
October 2018 for £10,100, making her a loss of £4,900 in the tax year 2018/19. She made no gains in the same tax year. In the current tax year she sold her holiday flat in Devon, which made
her a profit of £47,600. She had spent £14,000 on renovations,
and it cost her £3,500 in estate agent’s commission to sell it.
Calculate the capital gains tax due for the current tax year
assuming an annual exempt amount of £6,000 and a rate of
18% for gains on residential property.
8) Gain on flat £47,600
Less cost of renovations (£14,000)
Less cost of disposal (commission) (£3,500)
Less carried‑forward loss from 2018/19 (£4,900)
Less annual exempt amount (£6,000)
Taxable gain = £19,200 × 18% = £3,456 capital gains tax
9) Luis sold his house, which has been his main residence since
he bought the house in 2020, and downsized to a one-bedroom
flat, making a gain of £325,000. Is the capital gain made from
this sale eligible for private residence relief?
a) Yes, because the house was Luis’s main residence the
gain from the property’s sale will be eligible for private
residence relief.
b) No, because Luis has not lived in the house long enough to
qualify for private residence relief.
c) We do not have enough information to decide if the gain is
eligible for private residence relief or not.
9) c) In this instance, we do not have enough information to decide if the
gain is eligible for private residence relief. For example, the gain may
not be eligible for private residence relief if:
Luis has spent money renovating the house and is now selling it to
release a profit;
Luis sold some or all of the grounds that originally came with the house
after he sold the house;
any part of the house has been used exclusively for business purposes
while Luis has owned it.
10) A company makes an annual profit of £1.2m. When would the
company’s corporation tax normally be payable?
10) Nine months after the end of the relevant accounting period.
What are the two ways that state benefits affect financial planning?
1) State benefits can affect the need for financial protection. The amount of
additional cover needed by a client can be quantified as the difference
between the level of income or capital required and the level of cover
already existing. Existing provision includes not only any private insurance
that the client already has, but also any state benefits to which they or their
dependants would be entitled.
2) Financial circumstances can affect entitlement to benefits. Certain benefits
are means‑tested – in other words, the amount of benefit is reduced if
the individual’s (or sometimes the household’s) income or savings exceed
specified levels. This might mean, for example, that a financial plan that
increased a person’s income or the value of their assets might be less
attractive than it seemed at first sight, if it also had the effect of reducing
entitlement to, for instance, Universal Credit.
What is universal credit and how is it applied?
Universal Credit is not specifically an ‘in work’ or ‘out of work’ benefit; it is
one benefit for people whatever their employment status. The intention is
that people will not need to keep transferring from one type of benefit to
another as their circumstances change. The structure is intended to be much
simpler than that of the current system, where separate benefits (which often
overlap) are administered by different agencies, with different methods of
means testing.
From April 2013, Universal Credit began to replace the following benefits:
Income Support;
Income‑based Jobseeker’s Allowance;
Income‑related Employment and Support Allowance;
Working Tax Credit and Child Tax Credit;
Housing Benefit.
The amount of Universal Credit awarded to claimants depends on their income
and personal and financial circumstances. There is a basic allowance with
different rates for single claimants and couples (and a lower rate for younger
people), and additional amounts available for those with a disability, caring
responsibilities, housing costs, and children and/or childcare costs.
There is an ‘earnings disregard’, which is based on the claimant’s needs. There is also a maximum cap amount you can receive for specific benefits.
The benefits that remain outside of Universal Credit include:
Carer’s Allowance;
new style Jobseeker’s Allowance and new style Employment and Support
Allowance;
Disability Living Allowance/Personal Independence Payment;
Child Benefit;
Statutory Sick Pay;
Statutory Maternity Pay;
Maternity Allowance;
Attendance Allowance
What are working tax credits?
Working Tax Credit is designed to top up the earnings of employed or
self‑employed people who are on low incomes; this includes those who do not
have children. There are extra amounts for:
working households in which someone has a disability; and
the costs of qualifying childcare.
Working Tax Credit has now been replaced by Universal Credit and new claims
can only be made for those already receiving Child Tax Credit.
What is income support and how is it applied?
Income Support is a tax‑free benefit which was designed to help people aged between 16 and state pension age whose income was below a certain level and who were working less than 16 hours per week (if they had a partner, their
partner must work less than 24 hours per week). It was available to people
with no income at all or it could be used to top up other benefits or part‑time
earnings.
Existing claims continue for those who continue to meet the eligibility
requirements. New claims for Income Support can no longer be made, but
those on low incomes can apply for Universal Credit.
What is job seekers and how was it applied?
Jobseeker’s Allowance (JSA) is a benefit for people who are unemployed or
working less than 16 hours and actively seeking work. There are two forms
of JSA: new style and income‑based. Income‑based JSA is being replaced by
Universal Credit.
People are eligible for new style JSA only if they have paid sufficient Class
1 National Insurance contributions. It is paid at a fixed rate, irrespective of
savings or partner’s earnings, for a maximum of six months. Payments are
made gross but are taxable. Claimants are usually credited with National
Insurance contributions (NICs) for every week that they receive JSA.
How is the support of a mortgage interest loan applied?
Those in receipt of Income Support, Jobseeker’s Allowance, Universal Credit or
Pension Credit can apply for assistance to pay the interest on their mortgage.
Support for Mortgage Interest (SMI) was a pure state benefit until April 2018
but now takes the form of a loan that must be repaid. For eligible claimants, SMI will pay interest on a mortgage up to an upper threshold
(with a lower threshold if a claim is being made for Pension Credit). SMI does not pay for associated mortgage costs, such as the repayment of capital, insurance
premiums or mortgage arrears. Payment is made direct to the mortgage lender at a standard mortgage rate that may be more or less than the actual rate on the mortgage.
The SMI loan is secured on the property by way of a second charge and is
subject to interest. The loan is repaid when the property is sold or ownership
of the property is transferred.
What is a benefits cap?
An often‑voiced complaint about the benefits system is that
people can be better off out of work (by claiming state benefits)
than in work. In response to this, a cap on the maximum weekly
income that can be received from benefits was introduced in
2013. In broad terms, the intention is to limit the maximum
paid to the level of the average UK wage.
The following benefits are subject to the cap.
Employment and
Support Allowance
Income Support
Jobseeker’s
Allowance
Housing Benefit
Maternity
Allowance
Child Benefit
Child Tax Credit
Bereavement
Allowance
Incapacity Benefit
Severe
Disablement
Allowance
Universal Credit
(unless deemed
unfit for work)
Widowed Parent’s
Allowance
What is statutory maternity pay and how is it applied?
Women who become pregnant while employed may receive Statutory Maternity
Pay (SMP) from their employer, providing that:
their average weekly earnings are above a certain threshold;
they have been working for their employer continuously for 26 weeks prior
to their ‘qualifying week’, which is the 15th week before the week in which
their baby is due.
SMP is payable for a maximum of 39 weeks. The earliest it can begin is 11
weeks before the baby is due and the latest is when the baby is born.
There are two rates of SMP: for an initial period, the amount paid is equal
to a percentage of the employee’s average weekly earnings; after that, the
remaining payments are at a standard flat rate or set percentage of the
employee’s average weekly earnings, whichever is the lower.
SMP is taxable and NICs are due on the amount paid.
What is a maternity allowance and how is it applied?
Some women who become pregnant are not able to claim SMP, including those
who are self‑employed or have recently changed jobs or stopped working. They
might be able to claim an alternative benefit called Maternity Allowance. This
is paid by the Department for Work and Pensions (DWP) and not by employers.Maternity Allowance is not a benefit available to all women who become
pregnant; an individual must meet the relevant eligibility criteria in order to
claim.
Maternity Allowance is paid at a lower rate than SMP but it is not subject to
tax or NICs on the amount paid. Like SMP, it is payable for a maximum of 39
weeks. The earliest it can begin is 11 weeks before the baby is due and the
latest is when the baby is born.
What is child benefit and how is it applied?
Child Benefit is a tax‑free benefit available to parents and others who are responsible for bringing up a child. It does not depend on having paid NICs. It is not affected by receipt of any other benefits.
Child Benefit is available for each child under age 16. It can continue up to
and including age 19 if the child is in full‑time education or on an approved
training programme. A higher rate is paid in respect of the eldest child and a
lower rate in respect of every other child.
Child Benefit is means‑tested in the form of an income tax charge if either of a
couple has individual adjusted net annual income over the threshold. If both have adjusted net income above the threshold, it is assessed on the higher of the two incomes. The tax charge is collected through self-assessment and is applied at a rate such that, where adjusted net income reaches a specified level above the threshold, the tax charge equals the Child Benefit paid.
What is child tax credit and how is it applied?
Child Tax Credit is designed to provide financial assistance to people who are
responsible for bringing up children and are on low incomes. A claim may be
made by an individual who is responsible for:
a child aged under 16;
a child under 20 in eligible education or training.
Child Tax Credit is made up of a number of different payments called
‘elements’. How much is received depends on an individual’s income, the
number of children, and whether any of the children are disabled.
Child Tax Credit is being replaced by Universal Credit and is not open to new
claims except for individuals who are already claiming Working Tax Credit.
Jane and John have two young daughters and claim Child Benefit.
John earns £48,000 per year and Jane earns £57,000 per year. If
the threshold is £50,000, they will:
a) become ineligible for Child Benefit, as one of their incomes is
over the threshold.
b) not be liable to an income tax charge as one of their incomes is
still under the threshold.
c) be liable to an income tax charge as one of their incomes is
over the threshold.
d) be entitled to an increased amount of Child Benefit as one of
their incomes is under the threshold.
1) c) Tax is charged through self-assessment for any income above the
threshold, offsetting the amount of Child Benefit received.
What is statutory sick pay and how is it applied?
Statutory Sick Pay (SSP) is paid by employers to employees who are off work
due to sickness or disability for four days or longer, providing their average
weekly earnings are above the level at which Class 1 NICs are payable.
SSP is paid for a maximum number of weeks in any spell of sickness. Spells of
sickness with less than a minimum number of weeks between them count as
one spell. Amounts paid as SSP are liable to income tax and to Class 1 NICs,
just as normal earnings would be.
What is employment and support allowance and how is it applied?
People who are ill or disabled may be able to claim Employment and Support
Allowance (ESA). There are two forms of ESA. For new style ESA, eligibility
depends on a person’s NIC record. New style ESA is not means‑tested and the
payments are taxable. In contrast, income‑based ESA does not depend on NICs
and is means‑tested but not taxable. A key feature of ESA is the work capability assessment, which looks at the
impact that a claimant’s health condition has on their ability to work. As a result of the assessment, people are put in either a work‑related activity
group or a support group. Those in the former group are deemed capable of
working in some capacity and required to take steps to help them move into
employment. For those in the support group, it is recognised that their health
condition severely limits their capacity to work.
Different rates of benefit are payable to the two groups; there is also a lower rate during the initial assessment period.
What is attendance allowance and how is it applied?
Attendance Allowance is a benefit for people who have reached state pension age and need help with personal care as a result of sickness or disability. This
benefit is not means‑tested and it does not depend on NICs.
There are two levels of benefit: a lower rate for people who need help with
personal care by day or by night and a higher rate for those who need help
both by day and by night. Some other state benefits (ie Pension Credit, Housing
Benefit and Council Tax Reduction) are paid at a higher rate if the claimant is also receiving Attendance Allowance.
What is disability living allowance and personal independence payment and how is it applied?
Disability Living Allowance (DLA) is a tax‑free benefit for people who need
help with personal care and/or need help getting around. It is currently
replaced by Personal Independence Payment (PIP) for people aged between
16 and state pension age. People born on or before 8 April 1948 can continue
to claim DLA, but those born after that date will need to apply for PIP or
Attendance Allowance depending on their age.
There are two components to both benefits, and people may be eligible for
either or both:
Care component: this component is for people who need help in carrying
out activities of daily living such as washing, dressing, using the toilet or
cooking a meal.
Mobility component: this component applies if a person has difficulty in
walking or cannot walk at all.
What is a carer’s allowance and how is it applied?
Carer’s Allowance (CA) is a benefit for people who are caring for a sick or
disabled person; they do not have to be a relative of the person they are caring
for in order to qualify.
The right to receive CA does not depend on having paid NICs. It is taxable and
must be declared on tax returns. It is important to be aware that claiming CA can affect the other benefits
the claimant receives, as well as the benefits the person they are caring for
receives.
People in hospital or receiving residential/nursing care. What support do they get and how is it applied?
When people are in hospital, some of the needs normally met by state benefits
or pensions are instead met by the NHS. In general terms, state benefits that were being claimed will continue to be paid when someone goes into hospital.
Which form(s) of Employment and Support Allowance is/are
means‑tested?
a) New style ESA only.
b) Income‑based ESA only.
c) Both new style and income‑based ESA.
d) Neither new style nor income‑based ESA.
2) The correct answer is b). Income‑based ESA is means‑tested; new style ESA
is based on National Insurance contribution record so is not means‑tested.
What support is available for people in retirement?
State pensions are payable from state pension age (SPA). The SPA is subject
to a system of regular reviews based on changes in life expectancy. The basis of the reviews is the principle that people should spend one‑third of their adult life (regarded for these purposes as beginning at age 20) in retirement.
The first review was published in March 2017 and recommended that state
pension age be increased from age 67 to age 68 between 2037 and 2039.
The system of state pension benefits changed from April 2016 with the
introduction of the new state pension. Before this date, state pension provision consisted of a basic state pension with an additional earnings‑related element
for those who were employed. The new state pension has no earnings‑related
element.
Those reaching SPA before 6 April 2016 have their state pension benefits
paid under the system of basic + additional state pensions.
Those reaching SPA on or after 6 April 2016 receive the new state pension, 9
with an adjustment paid to compensate them if they would have been better off under the previous system.
State pensions are designed to provide a basic standard of living in retirement.
The system operates on a pay‑as‑you‑go basis, with National Insurance contributions from the current working population being used to pay pensions
to those entitled to receive them. It is readily apparent that, with the number
of pensioners increasing and the numbers in employment decreasing, there is
little scope for making generous increases to state pensions.
What is the basic state pension and how is it applied?
Originally, the basic state pension was paid only to employed people on their
retirement and was not related to their earnings. It was later extended to
include self‑employed people and others who have made sufficient National Insurance contributions – which means that they have contributed for at least
30 years. Benefits are scaled down for lower contribution rates.
Those who had not made enough NI contributions of their own to qualify for a
full basic state pension might be in receipt of a ‘Category B’ pension based on their spouse or civil partner’s pension entitlement.
What is the additional state pension and how is it applied?
Some employees who reached state pension age before 6 April 2016 are entitled
to an additional state pension, on top of their basic state pension.
The first earnings‑related state pension scheme was the graduated pension
scheme that operated from 1961 until 1975.
It was replaced by the state earnings‑related pension scheme (SERPS), which
came into operation in 1978.
SERPS was itself replaced in 2002 by the state second pension (S2P).
These schemes are now collectively referred to as the ‘additional state pension’.
Unlike the basic state pension, additional state pension was available only
to employed people who paid Class 1 National Insurance contributions.
Self‑employed people could not build entitlement to additional state pension
benefits.
Employed people had the option to ‘contract‑out’ of SERPS/S2P and have the
NICs that would have been used to provide SERPS/S2P reduced or redirected
to an alternative form of pension.
What is pension credit and how is it applied?
Pension Credit is made up of two elements:
Guarantee Credit – this tops up an individual’s weekly
income to a specified minimum amount.
Savings Credit – this is an additional payment for some
people who reached state pension age before 6 April 2016
who have saved some money towards their retirement.
Pension Credit is not taxable.
What is the new state pension and how is it applied?
The complexity of the state pension system led to the introduction of a
simplified state pension for those reaching retirement age on or after 6 April
2016. There is a single level of benefit with no additional earnings‑related
element. Pension benefits are determined by a person’s NIC record. To be
eligible for the maximum pension, an individual needs to have made or been
credited with 35 years’ NICs; those with under 10 years’ NICs are not usually
eligible for any state pension. Carers are credited with NICs.
One of the features of the new state pension is that it is based solely on an
individual’s personal National Insurance record.
What is the triple lock guarantee for benefits?
Once in payment, both the basic state pension and the new
state pension are guaranteed to increase each year by the
higher of:
earnings (measured by the Average Weekly Earnings Index);
inflation (as measured by the Consumer Prices Index); or
2.5 per cent.
This is referred to as the ‘triple lock guarantee’.
A major difference between the basic state pension and the new
state pension is:
a) The basic state pension is paid at a later age than the new state
pension.
b) The new state pension is paid at a later age than the basic state
pension.
c) The new state pension has no facility for an individual to claim
a state pension based on National Insurance contributions paid
by the spouse or civil partner.
d) Lower levels of National Insurance contributions are required
to claim a full new state pension.
3) The correct answer is c). With the basic state pension it is possible to claim
a Category B pension based on the NICs of a spouse or civil partner, but
this is not possible with the new state pension.
1) Why is it important for a financial adviser to have a working
knowledge of state benefits?
1) Financial advisers need to understand what state benefits a person
is entitled to or already claiming in order to give appropriate financial
advice. For instance, when working out the level of life assurance cover
that a family needs, the income that would be available from state benefits
if a family wage earner were to die has to be taken into account.
2) Once Universal Credit is fully implemented, parents who are
eligible for Child Benefit will have to claim Universal Credit
instead. True or false?
2) False. Universal Credit will eventually replace Child Tax Credit, not Child
Benefit.
3) Which of the following is not a feature of new style Jobseeker’s
Allowance?
a) It is only available to claimants who have made National
Insurance contributions.
b) It is only available for claimants who have savings of less
than £6,000.
c) Benefits are taxable.
d) Claimants are credited with NICs.
3) b) New style Jobseeker’s Allowance (JSA) is paid irrespective of savings or
partner’s earnings.
4) James has been working in IT support for 12 years. His current
job is a fixed‑term contract and ends next month. Assuming
James has made NICs throughout his working life, what benefit
is he likely to be able to claim while he is unemployed?
a) Working Tax Credit.
b) Income Support.
c) New style Jobseeker’s Allowance.
d) New style Employment and Support Allowance.
4) c) New style Jobseeker’s Allowance.
5) Aliyah has been working for Abbots Transport for 16 weeks.
She is 24 weeks pregnant. Which of the following state benefits
may she be entitled to?
a) Statutory Maternity Pay.
b) Income Support.
c) Child Tax Credit.
d) Maternity Allowance.
5) d) Maternity Allowance. She is not entitled to Statutory Maternity Pay
because she will not have been with her employer for 26 weeks by her
qualifying week.
6) When is the earliest that Aliyah can begin claiming this benefit?
6) Eleven weeks before the baby is due.
7) Malcolm, who is 42 and self‑employed, has fallen ill and cannot
work. Which benefit might he be entitled to?
a) Disability Living Allowance.
b) Statutory Sick Pay.
c) Employment and Support Allowance.
d) Attendance Allowance.
7) c) Employment and Support Allowance. He cannot claim Statutory Sick Pay because he is self-employed.
8) Lucy earns £52,000 per year and her partner Howard has an
annual salary of £29,000. Let’s say the threshold for Child
Benefit is £50,000. They have three children, one at primary
school and two at secondary school; their eldest son, Ethan, is
18 and studying for three A levels. For how many children are
Lucy and Howard able to claim Child Benefit?
a) Two; they cannot claim for Ethan because he is over 16.
b) All three, because Ethan is still in full‑time education.
c) None, because Lucy earns more than £50,000 a year.
d) None, because their combined household income exceeds
£50,000 per year.
8) b) All three: they will be able to claim for Ethan up until his twentieth
birthday while he remains in approved education.
9) Ian retired in the current tax year at the age of 66. He had made
NICs for 33 years while he was working but he had had a career
break of three years to care for his sick partner. Is Ian eligible
for a full, new state pension?
a) No, because he was not continuously employed throughout
his working life.
b) No, because he retired too early to claim the new state
pension.
c) Yes, because he had paid NICs for more than 30 years.
d) Yes, because he was credited with NICs while he was a
carer.
9) d) Yes. Although 35 years’ NICs are needed to be eligible for the full new
state pension, Ian would have been credited with NICs for the three
years that he was a carer.
10) Lydia is 22 and has just begun a new job on a permanent,
full‑time contract. Her employer will offer her the opportunity
to contract‑out of the state second pension. True or false?
10) False. The state second pension was available only to those who reached
state pension age before 6 April 2016. Lydia’s National Insurance
contributions will build entitlement to the new state pension, which has
no additional earnings‑related element, therefore it is not possible for
Lydia to choose to contract out.
6.1 what are the main investment asset classes?
Property, cash (money held in deposit accounts), fixed interest securities (gilts and corporate bonds), equities(shares), alternative investments(antiques)
6.2 Why do people choose deposit based investments?
Security of capital –
However, inflation could reduce the value of the savings. There is also the risk of
loss of capital if the institution
becomes insolvent.
Convenience – banks and building societies are readily accessible.
What is a basic bank account?
A basic bank account is a simplified current account designed to encourage
people who have not previously had an account to open one. These accounts
are aimed at people (typically those on low income or receiving state benefits)
who might not otherwise be able to open a current account.
Cash can be obtained with
a card from ATMs and in-branch over the counter.
Payments can be made by
direct debit but no cheque books are issued on these accounts and there is no overdraft facility.
What is a packaged current account? (Exam question)
A packaged current account offers the holder a range of ancillary benefits such as breakdown cover, mobile phone
insurance and travel insurance in return for a monthly or annual fee. A packaged current account may also enable the
holder to open other accounts that offer preferential rates of interest.
What protection do depositors have?
(Exam question)
Savings in UK bank and building society accounts are protected
by the FSCS, up to a level of £85,000 per investor per financial
services provider.
Can you remember how interest from savings is taxed?
Interest on deposits is paid gross to all customers, and individuals have to
advise HMRC to deduct tax via their tax code or pay via self‑assessment.
For those on low incomes a starting rate of 0 per cent applies to the first £5,000
of savings income.
The starting-rate band reduces as taxable non‑savings income is received, and the starting rate does not apply at all where income received exceeds an individual’s personal allowance plus the starting‑rate band.
Additionally, there is a personal savings allowance (PSA) for basic‑rate taxpayers
and a lower allowance for higher‑rate taxpayers: savings income falling within
these limits is subject to 0 per cent tax. In calculating eligibility for the PSA, all
of an individual’s income is taken into account in assessing whether they are
a basic‑ or higher‑rate taxpayer.
What are national savings and investments?
National Savings and Investments (NS&I) are a range of saving and investment
products backed by the government.
The risk associated with the products is
very low because the government guarantees the return of capital invested.
What is a cash ISA?
(Exam question)
Individual savings accounts (ISAs) are a form of tax‑free personal savings scheme. One form of ISA is cash (also known as a cash ISA): it is a means of obtaining tax‑free interest on a bank or building society deposit account, subject to certain limits and
regulations.
What are HMRC and offshore accounts?
(Exam question)
Offshore accounts are often perceived as a vehicle to hold
monies that are not declared to the tax authorities. Under
legislation introduced to support implementation of the US
Foreign Account Tax Compliance Act, and effective from 2016,
British Crown dependencies and overseas territories exchange
financial information with HMRC. This includes the names and
financial details of those holding accounts.
What is the redemption date and coupon of gilts?
REDEMPTION DATE
The date on which the government must redeem the gilt by paying back
its original issue value or par value, normally quoted as a nominal £100.
This works in the same way as redeeming an interest‑only mortgage.
COUPON
The interest rate payable on the par value of a gilt. It is a fixed rate, paid
half‑yearly, gross but taxable.
What are index linked gilts?
Index‑linked gilts are gilts where the interest payments and the capital value
move in line with inflation. For the investor, this means that the purchasing power of their capital and interest received remain constant, unlike all other fixed‑interest investments where inflation erodes the purchasing power of
fixed‑interest payments.
A higher‑rate taxpayer buys £100,000 par value of Treasury
5% 2025 at a price of 80.0. how much stock does she pay?
She receives half-yearly interest of £2,500 (ie £5,000 annually),
which represents a yield of 6.25 per cent on her investment of
£80,000.
The interest is paid gross but she must pay tax of 40 per cent
on any interest in excess of her personal savings allowance of
£500.
Later she sells the stock for £90,000. is there capital gains Tax to pay on her gain of £10,000?
(Exam question)
She pays 80000 for her stock
She pays no capital gains tax
How do interest rate movements affect gilt yields?
(Exam question)
Rising interest rates
Robert owns £10,000 of gilts with a coupon of 3 per cent. This
means that he receives £300 per year interest.
He wants to sell the gilts, which have six years to run until their
redemption date. However, interest rates have risen since he
bought them and new six‑year gilts are now being offered with
a coupon of 5 per cent.
Carmen offers to buy Robert’s gilts from him, but she won’t
offer him £10,000 for them because she can buy new six‑year
gilts for £10,000 that gives her a coupon of £500 per year,
instead of the £300 that Robert’s pay.
She offers him in the region of £9,000 for his gilts. The effect
of rising interest rates is that the price on Robert’s gilts has
fallen. Although a price of £9,000 would reflect a return of 3.33
per cent (ie £300 interest on £9,000 invested) in terms of the
income provided by the gilts, it is important to remember that
if Carmen buys the gilts and holds them until redemption she
will also make a capital gain of £1,000 as £10,000 is returned
on redemption.
Falling interest rates
Imagine if, instead of rising, interest rates have fallen and
new 6‑year gilts are only paying a coupon of 2 per cent. An
investment of £10,000 would only return £200 per year,
compared with the £300 per year that Robert’s gilts are paying.
Carmen may therefore pay Robert substantially more than
£10,000, in which case Robert will make a profit (which is
exempt from capital gains tax).
Carmen will need to bear in mind that if she pays more
than £10,000 she will make a loss if she holds the gilts to
redemption.
How do you work out yield and capital gains of a gilt?
CALCULATE
Mark is considering buying gilts and is attracted to 5% Treasury
2025. He finds that this gilt is currently trading at a price of
£130.73. Mark understands that, should he buy this gilt, he will get
income of £5 per year (par value of £100 x 5%) every year to 2025.
He also understands that, should he hold the gilt until redemption
date, he will suffer a loss of £30.73 on each one as only £100 will
be paid on redemption.
To understand whether the income offered is a good rate it is
necessary to calculate the running yield as follows.
Running yield = coupon ÷ price paid
£5 ÷ £130.73 = 3.82%
The 3.82% rate of income looks reasonably attractive, based on
current interest rates, but it should be remembered that if the gilt
is held to redemption it will lose £30.73 of capital value, which
reduces the overall return.
What is a local authority bond?
Like the government (gilts) , local authorities can borrow money by issuing stocks
or bonds, which are fixed‑term, fixed‑interest securities. They are secured on
local authority assets and offer a guaranteed rate of interest, paid half‑yearly.
The bonds are not negotiable and have a fixed return at maturity.
Return of capital on maturity is promised, but these are not quite as secure as gilts since there is no government guarantee.
What is permanent interest bearing shares?
Permanent interest‑bearing shares (PIBS) were once issued by building
societies to raise capital. They pay a fixed rate of interest on a half‑yearly
basis. Interest is paid gross, although it is taxable as savings income according
to the investor’s tax status.
Investors should note that PIBS rank below ordinary accounts in priority of
payment, should a building society become insolvent. As a result, they are
higher risk, because depositors will be paid before shareholders.
If a building society converts to a bank by ‘demutualising’, the PIBS it has issued are converted to perpetual subordinated bonds (PSBs). Perpetual subordinated bonds have similar characteristics to PIBS in that they have no redemption or maturity date and will provide a fixed income stream.
What are corporate bonds?
Generally, a company will seek to finance its activities by using its profits, but
there are situations in which profits, even if retained over many years, will
not be sufficient to meet the company’s requirements and it has to seek other
sources of finance. The two main ways in which a company might seek to raise
additional money are by issuing shares and/or by borrowing. It can, of course,
borrow from banks or other lenders. It can also issue corporate bonds to meet
its long‑term financing needs, or commercial paper if funds are needed over a shorter period.
Corporate bonds are similar to gilts issued by the government. The bond is
issued with the promise to pay a fixed rate of interest until redemption date,
with the loan repaid in full at redemption date. The borrowing is usually over
the longer term, which helps the company to make long‑term business plans.
The bonds can be bought by institutional investors (such as life companies and pension funds) and by private investors.
A bond may be secured or unsecured. If it is secured, a charge is made on
company assets. This means these assets could be taken by the creditor and
sold in the event that the company defaults on interest payments or repayment
at redemption date.
A bond that is backed by security is typically referred to as a debenture. The
security is provided by a charge over company assets. A bond that is not backed by security is generally referred to as loan stock.
Some corporate bonds are convertible, giving the holder the right to convert
the loan into ordinary shares of the issuing company. There is no obligation to do so and if the option is not exercised, the loan continues unchanged.
Interest, rather than dividends, is payable and the company is obliged to
pay the interest promised, whether or not sufficient profit has been made by
the company. Whether the bond is secured or not, the holder is a creditor of
the company so, in the event of the company being wound up, would have
priority over shareholders. If the lending is unsecured, the bondholder ranks
with ordinary creditors.
The risks associated with corporate bonds relate to the viability of the issuing company, its prospects and financial strength. Corporate bonds are riskier than gilts because gilts are backed by the government. Corporate bonds will therefore pay higher rates of interest than similar gilts. A bond that is
unsecured presents a greater level of risk to the investor than one that is
secured.
Why does the fact that corporate bonds are regarded as riskier
than gilts mean that they generally pay higher rates of interest
than similar gilts?
Corporate bonds pay higher rates of interest than similar gilts because of
the relationship between risk and reward – the riskier the investment is
considered to be, the greater the reward the investor expects.
What are Eurobonds?
A Eurobond is a bond issued or traded in a country that uses a currency other
than the one in which the bond is denominated. This means that the bond
operates outside the jurisdiction of the central bank that issues that currency.
Eurobonds are a form of borrowing used by multinational organisations and
governments. For example, a UK company might issue a Eurobond in Germany,
denominating it in US dollars. It is important to note that the term has nothing to do with the euro currency, and the prefix ‘euro’ is used more generally to refer to deposits outside the jurisdiction of the domestic central bank.
Taxation of savings income in relation to bonds , how does it work?
Local authority bonds, corporate bonds, PIBS and Eurobonds pay interest gross
(without deduction of tax).
The interest paid is classed as savings income so would be free of tax if it fell
within an individual’s starting‑rate band for savings income or their personal
savings allowance (see Topic 3, section 3.4.4). If the gross interest, when
added to other savings income, falls outside the starting‑rate band for savings
and exceeds an individual’s personal savings allowance it will be taxed at 20
per cent, 40 per cent or 45 per cent with the actual rate determined by the
individual’s gross income.
What is a structured deposit?
The return from a bank account is generally in the form of interest and linked
to general interest rates. With a structured deposit, the return paid is linked
to the performance of an index measuring the performance of equities, such
as the FTSE 100. The investment is normally arranged over a fixed term, five
years for example.
Unlike a traditional fixed‑rate savings account, the return generated through
a structured deposit is variable because it is linked to the performance of
a particular stock market index or indices. The benefit of using structured
deposits is access to equity‑based returns with a promise that, regardless
of stock market performance, depositors will always get back their initial
investment. This reduction in risk is offset by the lowered potential for reward,
meaning investors probably will not receive the full benefit of any index rise and they will not receive dividend payments. Structured deposits are complex
and are normally purchased via a financial adviser.
6.9 What is ‘alternative finance’?
Alternative finance refers to any form of financial activity or lending that
takes place outside of the traditional banking system. A prime example of
this is crowdfunding. Crowdfunding is a way that individuals, charities and
businesses (including start-ups) can raise money from the public.
Crowdfunding can be donation-based (contributors do not expect anything
in return) or reward-based (contributors expect a reward, for example a free
trial of the product or service being developed). Neither of these types of
crowdfunding are regulated by the FCA.
In contrast, both loan-based crowdfunding (more commonly known as peer-
to-peer [P2P] lending) and investment-based crowdfunding are regulated. Due
to the risks involved, firms are only allowed to promote these to experienced or sophisticated investors, or to ordinary investors who confirm that they will
not invest more than 10% of their net investable assets.
What is P2P lending?
P2P lending involves a saver placing their money with a P2P lender who will
then lend the money out to businesses that are seeking funding. This type of
lending is usually arranged via loan-based crowdfunding platforms.
P2P lending is not a deposit proposition but has a number of elements in
common with deposit‑based savings, notably that funds are aggregated and
distributed, normally for a return, and it is possible to arrange both on an easy
access and fixed‑rate basis over an agreed term. P2P lenders are regulated by
the FCA.
In some cases, returns can be very competitive compared with traditional
deposits but there are more risks. While the lender will perform due diligence
on the businesses to which funds are being lent, there is a risk that loan
repayments might be missed, in which case the returns to the saver would
reduce. Importantly, P2P lenders are not covered by the Financial Services
Compensation Scheme (see Topic 25).
What is investment based crowdfunding?
With investment-based crowdfunding, contributors invest money typically in
exchange for a share of a company or a return on their investment. Investment-
based crowdfunding platforms enable lots of small investors to pool their
funds in one or more start-up companies. On its website, the FCA advises that these investors are very likely to lose their
investment given the significant risk of a start-up company going bust and the
shares becoming worthless.
1) A bank deposit account is a good place to hold a ‘rainy day
fund’. True or false?
True. Deposit accounts allow instant access to funds and they are low risk
because savings are protected by the Financial Services Compensation
Scheme up to a limit of £85,000.
2) What, if any, is the minimum age at which a person can take
out an NS&I Direct Saver?
a) There is no minimum age.
b) 16.
c) 18.
b) 16.
3) Interest on NS&I Income Bonds is tax‑free. True or false?
3) False, interest is paid gross but is taxable.
4) State two reasons why offshore bank accounts might be more
risky than similar UK deposit accounts.
4) If the investment is held in a currency other than sterling, its value might
be affected by adverse exchange rates if it has to be converted to sterling.
Accounts held offshore might not be covered by investor protection
schemes to the same extent as onshore UK investments.
5) In relation to gilts, what is the ‘coupon’?
5) The coupon is the interest rate payable on the par value of a gilt.
6) Jane has invested in short‑dated gilts. According to the UK
Debt Management Office (DMO) definition, this means that:
a) the gilts will have a redemption date within the next seven
years.
b) interest on the gilts will not be paid to her until the end of
the term.
c) the gilts will have a redemption date within the next ten years.
d) she will be unable to access her capital until the end of the
term.
6) a) The gilts will have a redemption date within the next seven years.
7) Rubina is considering buying a gilt, 3% Treasury 2025. The gilt
is currently trading at a price of £107. What is the running yield?
7) The running yield is £3 (coupon) ÷ £107 (price paid) = 2.8%.
Running yield = coupon ÷ price paid
8) The main difference between corporate bonds and gilts is that
corporate bonds:
a) usually pay a variable rate of interest.
b) are usually for larger amounts of money.
c) normally have no specified redemption date.
d) are considered to be higher‑risk investments.
8) d) Corporate bonds are considered to be higher‑risk investments.
9) The main difference between a debenture and other types of
corporate bond is that a debenture:
a) carries the right to vote at the company’s annual general
meeting.
b) is usually secured on the assets of the company.
c) can be converted to ordinary shares of the company.
d) pays a fixed rate of interest.
9) b) A debenture is usually secured on the assets of the company.
10) A Eurobond is the equivalent of a gilt, but issued by a
government within the eurozone. True or false?
10) False. A Eurobond is a bond issued or traded in a country that uses a
currency other than the one in which the bond is denominated, and they
can be issued by large companies, not just governments.
11) Jack opens an account so that his wages can be paid into it. He
can use his account to pay bills such as utilities and rent via
direct debit, and he can use his debit card to make purchases
online and in shops, but he cannot have an overdraft. What
kind of account does Jack have?
a) Packaged account.
b) An interbank account.
c) A basic bank account.
d) A debit account.
11) c) A basic bank account.
What are four factors affecting share prices?
Company profitability, strength of the market sector, strength of the UK and global economy and supply and demand for shares and other investments
How are shares brought and sold?
The London Stock Exchange (LSE). Shares, issued by UK and overseas companies, gilts, corporate bonds and options are all traded on this market. There are two
markets for shares: the main market (for which full listing is required) and the
Alternative Investment Market.
What is the main market for the stock exchange and how is it setup?
To be listed on the main market, companies must conform to the stringent
requirements of the Listing Rules laid down by the Financial Conduct Authority
(FCA).For a full listing, a considerable amount of accurate financial and other
information must be disclosed. In addition:
the applicant company must have been trading for at least three years;
at least 25 per cent of its issued share capital must be in the hands of the
public.
The LSE, like most stock markets, is both a primary and secondary market.
The primary market is where companies and financial organisations can raise finance by selling securities to investors. They will either be coming
to the market for the first time, through the process of ‘going public’ or
‘flotation’, or issuing more shares to the market. The main advantages of
listing include greater ease with which shares can be bought or sold, and
the greater ease with which companies can raise additional funds.
The secondary market is where investors buy and sell existing securities.
It is much bigger than the primary market in terms of the number of
securities traded each day.
What is the alternative investment market?
The Alternative Investment Market (AIM) is mainly intended for new, small
companies with the potential for growth.
In addition to shares companies will enjoy a wider public audience and enhance their profiles by joining the AIM.
Rules for joining the AIM are fewer and less rigorous than those for joining
the official list (the main market) and were designed with smaller companies
in mind.
Name and explain the four shares indices
(Exam question)
It is possible to measure the overall performance of shares by
using one or more of the various indices that are produced.
These include the following:
FTSE 100 Index (commonly known as the Footsie) – this is
an index of the top 100 companies in capitalisation terms;
each company is weighted according to its market value.
FTSE 250 Index – the next 250 companies by market
capitalisation after the FTSE 100.
FTSE 350 Index – the FTSE 100 and FTSE 250 companies
combined.
FTSE All‑Share Index – this is an index of around 600
shares, split into sectors. It measures price movements and
shows a variety of yields and ratios as well as a total return
on the shares.
Explain over the counter trading.
(Exam question)
OTC trading is not very common between individual private
investors, but is common between institutions. They trade
large blocks of securities with little publicity about the price
paid or the company (or companies) whose shares are being
traded. This form of trading is sometimes called ‘dark pools’.
MiFID II introduced stricter requirements for all trading venues
to ensure the fair and orderly functioning of financial markets.
New reporting requirements have increased the amount of
information available and are expected to reduce the use of
dark pools and OTC trading.
Explain the return from shares
Shareholders in a limited liability company do not have a liability for the debts of the company. The company is, legally, a separate entity from its owners and is liable for its own debts. Shareholders do, however, run the risk that the value of their investment in the company could go down; if the company goes into liquidation they could lose their investment altogether.
So, given that those who invest in equities run the risk of potentially losing all
their investment, we might expect that they would also expect to receive higher returns than they could get from investing in deposit‑based investments,
where their capital is protected. It is certainly true that, on average and over
the longer term, equity markets have generally outpaced the returns available on secure deposit‑based investments.
Explain ex dividend shares.
(Exam question)
Dividends are usually paid half‑yearly. Because of the
administration involved in ensuring that all shareholders
receive their dividends on time, the payment process has to
begin some weeks before the dividend dates. A ‘snapshot’
of the list of shareholders is made at that point, and anyone
who purchases shares between then and the dividend date
will not receive the next dividend (which will be paid to the
previous owner of the shares). Once the date has passed when
the administrative process of paying the dividend starts, the
shares are said to be ex‑dividend (or xd). The share price would
normally be expected to fall by approximately the dividend
amount on the day it becomes xd.
Alternatively, a share may be paid cum‑dividend, which means
that it is purchased before it goes xd, and the purchaser
receives the next dividend payment.
How do you calculate EPS, dividend cover and Price/earning ratio?
Earnings per share (EPS) = post‑tax net profit ÷ number of
shares
Dividend cover = how much of company profits are paid as
dividends
P/E ratio = share price ÷ earnings per share
How do you work out taxation of dividend income?
Sophie has taxable earned income of £31,700 and receives dividend
payments of £9,000 in the current tax year.
The tax payable is worked out in a set order of priority:
1) Earned income.
2) Dividend income.
Let’s assume higher‑rate income tax is paid on taxable income
above £37,700, that dividend income is taxed at 8.75% for basic-
rate taxpayers and 33.75% for higher-rate taxpayers, and that the
DA is £1,000.
Sophie’s tax is calculated as follows. (Remember that taxable
income is after the personal allowance has been deducted.)
Her earned taxable income all falls within the basic‑rate tax band
and there is £6,000 of the basic‑rate tax band remaining (£37,700 –
£31,700 = £6,000).
So, the first £6,000 of her dividend income falls in the basic‑rate
tax band. However, the first £1,000 is covered by the DA, so no tax
is payable on that amount.
The remaining £5,000 within the basic‑rate band is taxed at 8.75
per cent = £437.50.
This leaves £3,000 in the higher‑rate tax band, which is taxed at
33.75 per cent = £1,012.50.
The total tax payable on Sophie’s dividend income is £1,450.
Note that the dividend income falling within the basic‑rate band,
even where covered by the DA and not taxed, does use up a portion
of the basic‑rate band. Therefore, in the example, £3,000 is subject
to higher‑rate tax rather than a further £1,000 of Sophie’s dividend
income being taxed at the basic rate.
%
Explain rights issue of shares
to raise further capital by issuing more shares, those shares must first be offered to the existing shareholders. This is done by means of a rights issue offering, for example, one new share per three shares
already held, generally at a discount to the price at which the new shares are
expected to commence trading Shareholders who do not wish to take up this right can sell the right to someone else, in which case the sale proceeds from
selling the rights compensate for any fall in value of their existing shares (due
to the dilution of their holding as a proportion of the total shareholding).
What are script issues for shares?
A scrip issue is an issue
of additional shares, free of charge, to existing shareholders. No additional
capital is raised by this action – it is achieved by transferring reserves into the
company’s share account. The effect is to increase the number of shares and
to reduce the share price proportionately.
What are preference shares?
As with ordinary shares, holders of preference shares are entitled to dividends
payable from the company’s profits. They differ from ordinary shares in
that they are generally paid at a fixed rate, and holders of preference shares
are eligible for any dividend payout ahead of ordinary shareholders. Many
preference shares are cumulative preference shares, which means that if
dividends are not paid, entitlement to dividends is accumulated until such a
time as they can be paid.
Preference shares do not normally carry voting rights, although in some cases
holders may acquire voting rights if their dividends have been delayed.
If a company has to be wound up, there would generally be only a limited
amount of money available to repay debts and shareholders. In this situation, the claims of creditors are repaid in a set order of priority. Shareholders rank
lowest in the order of priority and are therefore most at risk of receiving
nothing at all; however, holders of preference shares have a higher claim than holders of ordinary shares.
Convertible preference shares
Convertibles are securities that carry the right to be converted at some later
date to ordinary shares of the issuing company. Traditionally they were issued as corporate bonds (with a lower rate of interest than conventional corporate
bonds because of the right to convert to equity).
Warrants
Warrants give the holder the right to buy shares at a fixed price at an agreed future date. The attraction is that they give the holder rights at a fraction of the cost of
the shares themselves. At the date when the warrant can be exercised, it will be exercised if the share price is above the price at which the shares can be bought
under the terms of the warrant. If the share price is at or below the terms offered
by the warrant, it will not be worth exercising the warrant and it will lapse.
Please explain 5 benefits of property investment.
Please explain different rules surrounding property for tax.
Please explain alternative ways to get into the property investment market.
Property investment can have benefits, including the following:
Property is a very acceptable form of security for borrowing purposes.
The UK property market is highly developed and operates efficiently and
professionally.On the other hand, there are a number of pitfalls of which inexperienced
investors in particular should be made aware, including the following:
Location is of paramount importance and a badly sited development may
prove a problem.
The property market is affected by overall economic conditions – in times of
recession, letting properties may be difficult and property prices may fall.
Property is a less liquid form of investment than most others.
As with direct investment in shares, direct investment in property can be risky
for the small investor, although buy‑to‑let mortgages (see section 7.6) have made
it easier. For those with smaller amounts of capital and those who wish to spread
the risk, property bonds might be appropriate: the underlying fund is invested in
a range of properties and shares in property companies.
The purchase of property is subject to stamp duty land tax and a premium
applies where the property is not the only one owned.
Income from property, after deduction of allowable expenses, is subject
to income tax. It is treated as non‑savings income for tax purposes. On the
disposal of investment property, any gain is liable to CGT, but any capital
expenditure on enhancement of the property’s value can be offset against
taxable gains.
What are 4 points why property letting is attractive to investors?
What are 6 risks?
Regular and increasing revenue streams to hedge against inflation, easy access to BTL mortgages, well developed market, easy access to ancillary services such as property management services.
Accessing the market can be difficult, as investment costs are high and
there are additional costs associated with arranging a mortgage, legal fees
and stamp duty land tax.
Property is an illiquid investment, meaning that it may be difficult to access
funds if they are required at short notice.
There may be void periods when the property is untenanted, meaning that
income is reduced or ceases.
There is the risk that tenants may damage the property, leading to additional
costs.
Legal fees may be incurred to remove unsatisfactory tenants.
The property will require ongoing management and maintenance; these
services can be outsourced but the costs would reduce overall yield.
Please name three ways that the government has tried to make property less attractive
Tax relief – previously, a BTL landlord could deduct the full cost of
mortgage interest from their BTL income when calculating profits. This
effectively gave tax relief at the landlord’s highest marginal income tax
rate in respect of the interest costs. Tax relief is now limited to a tax credit
at the basic rate only.
Wear and tear – the annual wear‑and‑tear allowance on the cost of
furnishings in the property has been replaced by a furniture replacement
relief that only allows the actual cost of replacing furnishings to be offset
against profits.
Stamp duty land tax – as mentioned in section 7.5, second properties are
now subject to an SDLT surcharge purchase.
Name four advantages of commercial property.
Name three drawbacks.
Commercial property tends to provide reasonably high rental income together
with, in general, steady growth in capital value. The main advantages are:
regular rent reviews, with typically no more than five years between each;
longer leases than for residential property;
more stable and longer‑term tenants;
typically lower initial refurbishment costs.
Drawbacks may include the following:
the higher average value means that spreading the risk is more difficult;
commercial property does not generally show the spectacular growth in
value that can sometimes be achieved in residential property;
if the investment is to be funded by borrowing, interest rates may be higher
than for residential loans.
Name three investigations lenders often carry out before lending for the purchase of commercial property.
quality of the land and property;
reputation of builders, architects and other professionals involved;
suitability of likely tenants.
Outline agriculture property investment?
(Exam question)
A further category of property investment is agricultural
property – farmland. An investor may buy the land and run
the farm themselves to generate income or let out all or some
of the land to a third party, thus providing rental income.
There is the prospect of capital growth but the market for
agricultural land is highly specialised and demand limited;
liquidity is therefore a major concern.
One of the benefits of owning agricultural property is
agricultural relief for inheritance tax. This relief applies to
the land, growing crops and farm buildings. Relief is available
for up to 100 per cent of the inheritance tax liability for
owner‑occupied farms, or 50 per cent where the owner has let
out the land.
Explain what a treasury bill is and how it works.
Explain two ways they differ from gilts.
Who are treasury bills generally for?
Treasury bills are short‑term redeemable securities issued by the Debt
Management Office (DMO) of the Treasury.
Like gilts, they are fundraising instruments used by the UK government, but they differ from gilts in a number
of ways.
Two major differences are:
Treasury bills are short term, normally being issued for a period of 91
days, whereas gilts can be long term or even undated;
Treasury bills are zero‑coupon securities, ie they do not pay interest.
Instead, they are issued at a discount to their face value or par value (the
amount that will be repaid on their redemption date).
As with gilts, Treasury bills are considered to be very low‑risk securities, the
risk of default by the borrower (the UK government) being so low as to be
effectively zero.
For example, a Treasury bill may be issued for £9,850 with a
‘par value’ of £10,000. The investor makes a guaranteed £150 on their £9,850
investment over 91 days, representing just over 6 per cent pa return, with no
risk (£150 ÷ £9,850 x 100 = 1.52% over three months).
Because they are such short‑term securities, changes in market rates of interest
have little impact on the day‑to‑day prices of Treasury bills unless the changes are significantly large.
Throughout their term, Treasury bills can be bought and sold, and there is a
strong secondary market, provided mainly by financial institutions as there
is no centralised marketplace. The
price tends to rise steadily from the
issue price to the redemption value
over the 91‑day period, but prices
can also be affected by significant
interest rate changes, or by supply
and demand.
Treasury bills are purchased in large amounts, and they are not, therefore,
generally of interest to small, private investors. They are held in the main
by large organisations (particularly financial institutions) seeking secure
short‑term investment for cash that is temporarily surplus to requirements.
Explain what a certificate of deposit is.
Certificates of deposits (CDs) are issued by banks and building societies.
They are in effect a receipt to confirm that a deposit has been made with the
institution for a specified period at a fixed rate of interest.
The interest is paid with the return of the capital at the end of the term. Terms are typically three months or six months, although depositors who require a longer term can
often obtain CDs that can be ‘rolled over’ for a further three or six months on
specified terms. The amounts deposited are typically £50,000 or more.
There are significant penalties for withdrawals before the end of the term.
However, because certificates of deposit are bearer securities, they can be
sold to a third party if the depositor needs the funds before the end of the
term.
Banks may also hold CDs issued by other banks, and they can issue and hold
CDs to balance their liquidity positions. For example, a bank would issue CDs
maturing at a time of expected liquidity surplus, and hold CDs maturing at a
time of expected deficit.
Please explain what a commercial paper is. And how it works.
Businesses need to borrow for a variety of purposes. When they need funds
for investment in their longer‑term business plans, they may issue corporate
bonds. When they wish to borrow for working capital purposes, however, they
can issue commercial paper. The transactions are for very large amounts,
with most purchasers being institutions such as pension funds and insurance
companies. Commercial paper can be placed directly with the investors, or
through intermediaries.
The commercial paper market offers cheaper borrowing opportunities for
companies that have good credit ratings, but even companies with lower credit
ratings can issue commercial paper if it is backed by a letter of credit from a
bank that guarantees (for a fee) to make repayment if the issuer defaults.
Direct investment in shares is low risk for individual investors
because, over the long term, equity markets have outpaced
inflation. True or false?
1) False. Direct investment in shares is regarded as high risk because if the
company fails, the entire investment is at risk. It is difficult for most investors
to spread the risk effectively between a large number of companies and sectors.
2) Name three factors that can affect share prices.
2) Factors include company profitability, the strength of the global and UK
economy, the strength of the market sector and the supply of and demand
for shares.
3) What are the implications for the purchaser of buying shares
ex-dividend?
3) They will not be eligible for a dividend payment in the first dividend
distribution following their acquisition of the shares. The previous owner
of the shares will receive this dividend payment.
4) A share with a low P/E ratio is likely to be more expensive than
other shares in the same market sector. True or false?
4) False. A low P/E ratio indicates that the share is not in high demand and it
is likely to be less expensive than other shares.
5) If a company distributes 25 per cent of its profits in the form
of dividends to its shareholders, what would the dividend
cover be?
a) 4.
b) 8.
c) 10.
d) 25.
5) a) 4 – the profit is four times the dividend paid out.
6) What is the difference between a rights issue and a scrip issue?
6) A rights issue involves offering existing shareholders the opportunity to
buy additional shares in order to raise additional capital. A scrip issue
involves issuing additional shares to shareholders free of charge, the
effect being to increase the number of shares in issue and reduce the
share price proportionately; no additional funds are raised.
7) Elliott is considering investing in a buy‑to‑let property. He
thinks this is a good way to achieve a high return. What are the
main drawbacks that Elliott should be aware of?
7) Suitable tenants may be hard to find.
Properties must be in desirable locations (eg good transport links,
access to local amenities, etc).
In times of recession, letting properties may be difficult and property
prices may fall.
Property is less easy to realise than most other forms of investment.
Investment costs tend to be high and can include management fees,
legal charges and stamp duty.
Government measures to discourage BTL have made the tax position
less advantageous.
8) How can a buy‑to‑let investor claim relief for wear and tear on
furniture?
8) They are allowed a furniture replacement relief, which allows the actual
cost of replacing furnishings to be offset against profits.
9) Treasury bills are zero‑coupon securities. What does this
mean?
9) They do not pay interest; instead they are issued at a discount to their par
value.
10) Commercial paper is generally issued for a term of between
three and six months. True or false?
10) False. Commercial paper is generally issued for between 5 and 45 days,
with 30–35 days being typical. Certificates of deposit are generally issued
for between three and six months.
What is the most common amount of days a commercial paper is issued.
Most commercial paper is issued for periods of between 5 and 45 days, with an
average of around 30 to 35 days. Firms that need to retain funds for longer than
this regularly roll over their commercial paper – the advantages of this are:
flexibility; and
the fact that the rate of interest is not fixed for a long period.
Why do collective investments appeal to investors?
The services of a skilled investment manager are obtained at a cost that is
shared among the investors. Individual investors do not need to research
particular companies – nor do they need to understand and deal with the
decision‑making and administrative work arising from events such as
rights issues.
Investment risk can be reduced because the investment manager spreads the fund by investing in a large number of different companies; thus if one
company fails, the investor loses only a small part of their investment,
rather than all of it. This is referred to as ‘diversification’. Such a spread
of investments could not normally be achieved with small investment
amounts.
Fund managers handling investments of millions of pounds can negotiate
reduced dealing costs.
There is a wide choice of investment funds, catering for all investment
strategies, preferences and risk profiles.
Collective investment schemes enable investors to gain exposure to assets
they would not otherwise be able to access due to minimum lot/investment
size (eg corporate bonds)
What is diversification in investments?
(Exam question)
Diversification is an important concept for investors. It
involves creating a portfolio of investments that are spread
across different geographical areas, asset classes and sectors
of the economy. The aim is to spread risk, in the hope that poor performance of one investment will be offset by better performance in another. It is the opposite of ‘putting all your
eggs in one basket’. For example, if you only hold shares in a company that sells sunscreen, you are likely to make more
money in a hot summer. If you only hold shares in a company making umbrellas, you will make more money if it rains. By diversifying to hold shares in both companies, you would have the opportunity to make money whatever the weather.
How are investment characterised?
location, eg UK, Europe, America, Far East;
industry, eg technology, energy;
type of investment, eg shares, gilts, fixed interest, property;
other forms of specialisation, eg recovery stocks, ethical investments.
Many funds are based on more than one categorisation; for example, a UK
equity fund is categorised by both location and type of investment.
A further categorisation is possible:
funds that aim to produce a high level of income (perhaps with modest
capital growth);
those that aim for capital growth at the expense of income; and
those that seek a balance between growth and income.
Funds can also be categorised according to their management style:
Actively managed funds (sometimes referred to simply as ‘managed funds’)
use the services of a fund manager(s) to make decisions on asset selection
and when holdings should be bought or sold.
Passively managed or tracker funds will seek to replicate the performance
of a particular stock market index, such as the FTSE All‑Share. A manager
may be used but it is also possible that asset selection is computerised.
Define managed funds.
(Exam question)
The term ‘managed’ fund can also be used as a marketing term
to describe a fund that is comprised of holdings allocated across some or all of the other funds a company offers. Most
companies offer one or more managed funds – for example, ‘managed growth’ or ‘managed income’. In this context the
manager’s role in a company’s managed fund tends to involve
deciding on the way fund investments should be allocated
between the company’s other funds.
What is a unit trust?
A unit trust is a pooled investment created under trust deed. They can invest a lump sum in the
unit trust, make regular contributions, or a mixture of both.
A unit trust is categorised as an equity trust where the underlying assets
are mainly shares, or as a fixed‑income trust where investment is mainly in
interest‑yielding assets. An equity trust pays a dividend, while a fixed‑income
trust pays interest.
A unit trust is divided into units, with each unit representing a fraction of
the trust’s total assets. It is ‘open‑ended’, so if lots of investors want to buy
units in it, the trust manager can create more units.
Unit trusts may offer the following types of unit:
Accumulation units automatically reinvest any income generated by the
underlying assets. This would suit someone looking for capital growth.
Distribution or income units split off any income received and distribute
it to unit holders. The units may also increase in value in line with the value
of the underlying assets.
The unit trust aims to produce a return by selecting investments that will grow
in value and/or generate income. If this happens, the unit price will increase,
meaning that the investment, when encashed, will be worth more than it was
at outset. A key role of the manager is to select investments that will achieve the trust’s objectives in terms of income and/or growth.
What is a trust?
(Exam question)
In general law, a trust is an arrangement whereby one person
gives assets to another (the trustees) to be looked after in
accordance with a set of rules (specified in the trust deed).
A unit trust is similar in that the trust deed details the investment rules and objectives of the scheme. The investor
effectively gives their money to the trustees who will in turn
allow the fund manager to use it to meet the trust’s objectives.
The trustees will ensure that the manager is fulfilling their
obligations under the trust deed.
How are units priced?
What are the four important prices in relation to unit trust transactions?
To price the fund, the manager will calculate the total value of trust assets,
allowing for an appropriate level of costs, and then divide this by the number of units that have been issued.
On a daily basis, managers calculate the prices at which units may be bought and sold, using a method specified in the trust
deed. Unit prices are directly related to the value of the underlying securities that make up the fund.
There are four important prices in relation to unit trust transactions:
The creation price is the price at which the unit trust manager creates
units.
The offer price is the price at which investors buy units from the managers.
The bid price is the price at which the managers will buy back units from
investors who wish to cash in all, or part, of their unit holding.
The cancellation price is the minimum permitted bid price, taking into
account the full costs of buying and selling. At times when there are both
buyers and sellers of units, the bid price is generally above this minimum
level, since costs are reduced because underlying assets do not need to be
traded.
What is a bid offer spread?
Some unit trusts use bid and offer prices, with the difference between them
(known as the bid–offer spread)
being between 3 per cent and 5 per
cent.
Which is single pricing unit trusts?
(Exam question)
In a single-price system the price is arrived at through
consideration of the net flows of the fund – in other words
whether, on a net basis, more subscriptions are being made
into the fund or whether more redemptions are being taken
from the fund. Where the value of subscriptions is greater than
redemptions, the fund is said to be in net inflow. Similarly,
where redemptions are greater than subscriptions, the fund is
said to be in net outflow.
The net flow of the fund is relevant in determining the single
price because a fund that has a net inflow will need to purchase
assets with the net subscription proceeds and so will be priced
closer to the offer price to reflect the cost of purchasing these
assets. Similarly, where the fund has a net outflow, the single
price will tend towards the bid price to reflect the cost of the
fund selling assets in its portfolio to generate cash, which can
be used to pay redemption proceeds.
In cases where the value of subscriptions and redemptions is
similar and the fund is receiving neither significant inflows
or outflows, the single price will tend towards the mid-price.
Although rare, they may impose an exit charge if units are sold
within, for instance, three or five years of purchase.
What is forward and historic pricing?
(Exam question)
The purchase of units in a unit trust is not an instant process
as application forms need to be completed, sent off or emailed,
and then administered before the investment is made. Units
are generally priced on a forward pricing basis. Under forward
pricing, clients buy or sell in each dealing period at a price
that will be determined at the end of the dealing period. The
prices published in the financial press are therefore only a
guide to investors, who do not know the actual price at which
their deal will be made.
Before forward pricing became standard practice there was a
system of historic pricing: the price of units was determined
by the closing price at the end of the previous dealing period.
Fund managers are still permitted to use historic pricing if they
wish, subject to the proviso that they must switch to forward
pricing if an underlying market in which the trust is invested
has moved by more than 2 per cent in either direction since
the last valuation.
How are units brought and sold? (Trusts)
Unit trust managers are obliged to buy back units when investors wish to sell
them. There is consequently no need for a secondary market in units and they
are not traded on the Stock Exchange. This adds to the appeal as the buying and selling of units is a relatively
simple process.
Units can be bought direct from the managers or through intermediaries. They
can be purchased in writing, by telephone or online: all calls to the managers’ dealing desks are recorded as confirmation that a contract has been established.
Purchasers may receive two important documents from the managers:
The contract note – this specifies the fund, the number of units, the unit
price and the amount paid. It is important because it gives the purchase price, which will be needed for capital gains tax (CGT) purposes when the
units are sold.
The unit certificate – this specifies the fund and the number of units held,
and is the proof of ownership of the units.
In cases where investors subscribe to a unit trust through an intermediary,
their holdings may be confirmed on a non‑certificated basis. Instead, investors
will receive a regular statement outlining the number of units held and their current value from the intermediary (eg a fund supermarket) rather than directly from the unit trust manager.
In order to sell units, the holder signs the form of renunciation on the reverse of the unit certificate and returns it to the managers. If only part of the
holding is to be sold, a new certificate for the remaining units is issued. If the
holding is non‑certificated, the investor may be asked to sign a separate form
of renunciation.
How are units of trust regulated and managed?
In the UK, unit trusts are primarily regulated under the terms of the Financial Services and Markets Act 2000, and must be authorised by the Financial Conduct
Authority (FCA) if marketed to retail investors.
The FCA specifies rules aimed
at reducing the risks associated with unit trusts. The rules require that a unit
trust fund is suitably diversified and specify that the fund cannot borrow an
amount of more than 10 per cent of the fund’s net asset value and, even then,
only for a temporary period.
The trust deed places obligations on both the manager and the trustees. The
manager aims to generate profit for the unit trust provider from the annual
management charge and dealing in units. The trustees’ overall role is to ensure investors are protected and that the manager is complying with the terms of
the trust deed. The role of trustee is usually carried out by an institution such
as a clearing bank or life company.
Manager’s responsibilities
— Managing the trust fund in line with the trust deed
— Valuing the assets of the fund
— Fixing the price of units
— Offering units for sale
— Buying back units from unit holders
Trustees’ responsibilities
— Setting out the trust’s investment directives
— Holding and controlling the trust’s assets
— Ensuring that adequate investor protection procedures are in place
— Approving proposed advertisements and marketing material
— Collecting and distributing income from the trust’s assets
— Issuing unit certificates (if used) to investors
— Supervising the maintenance of the register of unit holders
What are the two types of charges applied to unit trusts?
(Exam question)
The initial charge covers the costs of purchasing fund
assets. The initial charge is typically covered by the bid–
offer spread.
The annual management charge is the fee paid for the use
of the professional investment manager. The charge varies
but is typically between 0.5 per cent and 1.5 per cent of
fund value. Although it is an annual fee, it is commonly
deducted on a monthly or daily basis.
How are units trusts taxed?
Authorised unit trusts fall into two main categories:
If more than 60% of the underlying investments within a unit trust are
cash or fixed-interest securities, such as UK gilts or corporate bonds, the
fund will be classed as a fixed-income or non-equity fund and all income
distributions will be treated as interest payments.
If less than 60% of the underlying investments are cash or fixed-interest
securities, the fund will be classed as an equity fund and all income
distributions will be treated as dividends.
In both cases there is no tax on gains within the fund, meaning that the
investor may be liable to capital gains tax if they make a gain when encashing
the investment.
Equity‑based funds
For equity‑based unit trust funds, the tax treatment is the same as for shares.
Income is paid without deduction of tax. Where an investor’s total dividend in
a tax year is less than the dividend allowance (DA), there is no income tax on
the dividend.
Where dividend income is in excess of the DA, then the income is taxed at
different rates based on which tax band it falls into.
Fixed-income (or non-equity) funds
Interest from a fixed‑income fund is classed as savings income. The income
is paid gross, without deduction of tax. Where the interest is received by a
non‑taxpayer, falls within the starting‑rate band for savings, or falls within the
PSA of a basic‑ or higher‑rate taxpayer, then no tax is payable. Taxpayers who
have used their PSA are taxed on the excess income and are required to declare
the income to HMRC through self‑assessment.
What is the risk of investing in a unit trust?
The legal constitution of a unit trust helps to mitigate risk of fraud because
the trustees have a responsibility to ensure there is proper management.
The risks involved in investing in a unit trust are lower than those for an
individual investing directly into equities on their own behalf because a unit
trust is a pooled investment.
The wide range of
choice means that there are unit trusts to match most investors’ risk profiles.
A cash fund will carry similar risks to a deposit account, while specialist funds
that invest in emerging markets, for instance, are high risk by their very nature.
Overseas funds carry the added risk of currency fluctuations.
Unit trusts provide no guarantee that the initial capital investment will be
returned in full or that a particular level of income will be paid.
What are investment trusts?
Investment trusts are collective investments that are not unitised funds. they are not trusts.
They are public limited companies whose business is investing (in most cases) in
the stocks and shares of other companies. As a company, an investment trust is established under company law and operates as a listed plc; its shares are
listed on the stock exchange. An investment trust, by contrast, must meet FCA requirements
to gain a stock market listing, and it is governed by rules in its memorandum
and articles of association.
As with all companies, shares are sold to investors. The number of shares
available remains constant – the company does not create more just because
investors want them – so an investment trust is said to be ‘closed‑ended’ (in
contrast to the open‑ended nature of unit trusts and OEICs).
How do you invest in a investment trust?
Investing in an investment trust involves purchasing shares in the investment
trust through:
a stockbroker;
a financial adviser; or
direct from the investment trust manager.
Similarly, to cash in the investment, it is necessary to sell these shares, via a
stockbroker or back to the investment trust manager directly.
The shares trade at a single price but dealing fees are added to any purchase
and deducted from any sale. An annual management charge is also payable,
typically between 0.5 per cent and 1.5 per cent.
The share price of an investment trust depends to some extent on the value of
the underlying investments, but not so directly as in the case of a unit trust:
the price can also depend on a number of other factors that affect supply and
demand.
The share price of an
investment trust may be more
or less than the net asset value
(NAV) per share. Where the
share price is less than the
NAV the trust is said to be
trading at a discount, and this
suggests a lack of demand for
the shares. Where the share price is higher than the NAV, the investment trust
is said to trade at a premium, indicating demand for the shares.
How to calculate net asset vale per share?
Total value of the investment fund’s
assets less its liabilities, divided by
the number of shares issued.
Explain the term gearing.
The level of debt as a percentage
of a company’s equity. It is a
way of measuring the extent to
which a company’s operations
are funded by borrowing rather
than by shareholder capital.
Gearing and it’s relation to invesent trusts
Because investment trusts are constituted as companies, they can borrow
money to take advantage of investment opportunities – this is known as gearing. This facility is not open to unit trusts or OEICs, which are only
permitted to borrow money over the short term and against known future cash
inflows.
Gearing enables investment trusts
to enhance the growth potential of a
rising market, but investors should be
aware that it can equally accentuate
losses in a falling market.
The ability
to ‘gear up’ is one of the reasons
why investment trusts are viewed as
being riskier than a similar unit trust
or OEIC. Some investment trusts are
described as being ‘highly geared’ or
‘highly leveraged’, which means they have a high level of borrowing relative
to the assets they hold; the investment trust will be pursuing high returns
but there is the risk of being unable to service interest and/or repayments on
borrowings.
How are investment trusts taxed?
At least 85 per cent of the income received by the fund managers of investment trusts must be distributed as dividends to shareholders. As it is constituted
as a company, an investment trust pays income in the form of dividends. The
taxation situation is the same as that described for equity unit trusts.
As with unit trusts, fund managers are exempt from tax on capital gains.
Investors are potentially liable to CGT on the sale of their investment trust
shares, in the event that their gain, when added to the value of their other gains
realised in a tax year, exceeds the CGT annual exempt amount.
What is a split capital investment trust?
Sometimes known as split‑level trusts or simply as splits, split‑capital
investment trusts are fixed‑term investment trusts offering two or more
different types of share.
The most common forms of share offered are:
income shares – these receive the whole of the income generated by the
portfolio but no capital growth;
capital shares – these receive no income but, when the trust is wound up at
the end of the fixed term, share all the capital growth remaining after fixed
capital requirements have been met.
Most companies will also offer shares with differing balances of income and
growth, so as to meet different investor objective
What is a real estate investment trusts
Real estate investment trusts (REITs) are tax‑efficient property investment
vehicles that allow private investors to invest in property while avoiding
many of the disadvantages of direct property investment. One
particular advantage is that stamp duty reserve tax is charged at 0.5 per cent
on purchase; the rates of stamp duty for direct property purchase are much
higher.
In the UK, REITs pay no cooperation tax on income or growth for the property rental potion of there investments. They have to meet the requirements of reits.
What are the basic 5 requirements of REITS?
R:
• At least 75 per cent of their gross income must be derived from property rent.
• The remainder can come from development or other services but corporation tax is
charged on income and gains made here.
E:
• At least 90 per cent of their profits must be distributed to their shareholders net of basic-rate
tax. Higher- and additional-rate shareholders will have to pay additional income tax.
• Dividends can be paid in cash or as stock dividends (ie the allocation of further shares)
and are taxable at dividend rates.
I:No individual shareholder can hold more than 10 per cent of the shares.
T: Single-property REITs are only allowed in special cases – such as, for example, a shopping
centre with a large number of tenants.
S:They can be held in ISAs, Junior ISAs, Child Trust Funds and self-invested
personal pensions.
Some students find it challenging to get to grips with these
products. To help you, note down at least three ways in which an
investment trust differs from a unit trust.
A unit trust is constituted as a trust; an investment trust is actually a
company.
A unit trust is subject to FCA rules on diversification; an investment
trust is not.
A unit trust issues units to customers and these represent the customers’
holdings of the assets in the pooled fund. An investment trust issues
shares in a fund.
Units must be bought back by the fund manager so no secondary
market is needed; shares in an investment trust must generally be sold
via a stockbroker.
An investment trust can borrow funds to take advantage of investment
opportunities whereas a unit trust cannot.
Unit trusts are open‑ended (ie the unit trust manager can create more
units to meet demand); an investment trust is closed‑ended (ie the
number of shares available is fixed).
A unit trust can be established as an equity trust paying dividends
or a fixed‑interest trust paying interest. As an investment trust is a
company, it only issues shares and pays income as dividends.
What is an OEIC?
An OEIC is an ‘open‑ended investment company’ – a limited liability company
that pools the funds of its investors to buy and sell the shares of other
companies and deal in other investments.
To invest in an OEIC, the investor buys shares in the company; there is no limit
to the number of shares that can be issued, which is why it is described as
‘open‑ended’. The open‑ended nature of an OEIC means that the fund can expand
or contract, depending on whether new shares are being issued in response to
demand, or being redeemed if investors wish to sell. The value of the shares
varies according to the market value of the company’s underlying investments.
An OEIC may be structured as an ‘umbrella’ company that is made up of several
sub‑funds. Different types of share can be made available within each sub‑fund.
OEICs share a number of characteristics with unit trusts and investment trusts.
For instance, as with unit trust and investment trusts, investments can be made by lump sum, regular contribution or a combination of both. One difference
to note, however, is that while both investment trusts and OEICs operate as
companies, an investment trust can borrow money to finance its activities but
an OEIC can only borrow for short‑term purposes.
How are OEICs regulated and managed?
An OEIC is established as a limited liability company under a structural
framework set by HM Treasury (not under trust) under the Open-Ended
Investment Companies Regulation 2001 (as amended) and associated FCA
rules. Unlike an investment trust (unless it is self-managed), OEICs must be
authorised by the FCA; there is a great deal of common ground between the
FCA’s regulations for OEICs and those that apply to unit trusts
The role of overseeing the operation of the company and ensuring that it
complies with the requirements for investor protection is carried out by a
depositary, who is authorised by the FCA. The role of the depositary is similar
to that of the trustee of a unit trust.
An authorised corporate director, whose role is much the same as the manager
of a unit trust, manages the OEIC. The role of the corporate director is to:
manage the investments;
buy and sell OEIC shares as required by investors;
ensure that the share price reflects the underlying net asset value of the
OEIC’s investments.
What is SINGLE PRICING – OEICS?
(Exam question)
The share price of an OEIC is established by dividing the total
value of its assets by the number of shares currently in issue.
This is, essentially, the same approach as that used to establish
the unit price of a unit trust.
In many unit trusts, the units have a different bid and offer
price. Shares in an OEIC are single priced. Some OEICs opt
to use ‘swing pricing’, which is a method through which the
single quoted price of an OEIC ‘swings’ towards a de facto bid
or offer price. The swinging of the price takes account of the
transaction costs the OEIC incurs buying assets when there are
net inflows (ie net subscriptions into the OEIC) or net outflows
(ie net redemptions from the OEIC). The bid price takes account
of the cost of the OEIC selling assets to generate cash to pay
redemptions, whereas the offer price takes account of the cost
of the OEIC buying assets with subscription cash. You might
recall from your reading on unit trusts that some of these now
offer single pricing, too.
What’s are the charges associated with OEIC?
(Exam question)
In addition to the cost of buying the shares, the OEIC will levy:
an initial or buying charge – which is added to the unit
price and is normally in the region of 3 per cent to 5 per
cent of the value of the individual’s investment;
annual management charges based on the value of the
fund – the range of annual management charges is typically
between 0.5 per cent for indexed funds and 1.5 per cent for
more actively managed funds;
a dilution levy – this may be added to the unit price on
purchase of shares or deducted from the price on sale of
shares in situations where there are large flows of funds
into or out of the OEIC.
Other administration costs may also be deducted from the
income that is generated.
How are OEICs taxed?
The tax treatment of UK‑based OEICs is exactly the same as that for unit trusts.
In terms of income, an OEIC will be classified as either fixed‑income or
equity‑based.
If it is fixed‑income, the interest is paid without deduction of tax but is
subject to income tax as savings. There will be a liability to income tax
for basic‑ and higher‑rate taxpayers if total savings income exceeds the
investor’s starting-rate band for savings income (where available) and
personal savings allowance. Additional-rate taxpayers will be liable to
income tax on the full amount paid.
If an OEIC is equity‑based, a dividend is paid, again without deduction of
tax. There will be a further liability for income tax for basic‑, higher‑ and
additional‑rate taxpayers if total dividend income exceeds the investor’s
dividend allowance.
Fund managers are not subject to tax on capital gains, although individual
investors may be liable to pay CGT when their shares in the UK OEIC are
encashed.
How are offshore funds treated for OEIC?
(Exam question)
Where a fund, whether a unit trust or an OEIC, is based
offshore, a UK resident investor will still be liable for taxation
on income and gains.
If the offshore fund reports all the annual income attributable
to an investor, whether the income is distributed or not, it is
referred to as a ‘reporting fund’. The tax treatment is as above:
the investor will be liable for income tax on the income and
CGT on any gain on disposal.
If the offshore fund does not report the attributable income,
it is referred to as a ‘non‑reporting fund’ and the investor will
pay income tax, rather than CGT, on any gain on disposal.
8.4.3 What are the risks of investing in OEICs
The risks associated with investing in an OEIC are similar to those of investing
in a unit trust:
An OEIC is subject to the same FCA rules on diversification and fund
borrowing as apply to unit trusts, and these rules help to reduce risk.
As an OEIC is a pooled investment employing the services of professional
investment managers, the degree of risk is lower than it would be for an
individual investing directly in equities.
Risk is also mitigated by the spread that can be achieved for a relatively
small investment.
There is, however, no guarantee that the value of the original capital investment
will be maintained, nor is there any guarantee as to the level of income that
will be generated.
Make sure you understand the key differences between unit trusts,
investment trusts and OEICs. Create a table like the one below and
fill in the missing information. You will find a completed version
at the back of this book.
What are endowments in relation with life insurance and regular savings
Endowments are a type of investment based on life assurance. They combine
life assurance and regular savings. A lump sum is either paid if the life assured
dies during the term or, if they survive to the end of the term, it is paid at
maturity.
The introduction of schemes such as ISAs has reduced their popularity but
some plans remain in existence.
Endowments vary according to the nature of the underlying investment
structure, and common types are with‑profits and unit‑linked. As long as
premium payments are maintained, with‑profits endowments are comparatively
low risk as they offer the guarantee of at least a minimum value at maturity.
Unit‑linked plans do not carry such a guarantee and the value at maturity
depends on how the underlying investments perform.
What is a friendly society plan?
Friendly societies date from the eighteenth century when they were established
as mutual self‑help organisations. Over time they have evolved, with many
now offering a range of financial services.
A friendly society is able to market a tax‑exempt savings plan, effectively an
endowment with tax benefits, because the friendly society pays no corporation
tax on its investment returns. This can be compared with a conventional
endowment on which the life assurance company would pay corporation tax
on some income and gains within the fund.
As there is preferential tax treatment, the amount that can be saved is limited
to £270 per year (as a lump sum),£25 per month or £75 per quarter. The plan
is set up over an initial ten‑year term and there is no tax upon encashment.
Friendly society plans are often marketed as savings plans that enable parents
and grandparents to save on behalf of their children and grandchildren
What are investment bonds?
Investment bonds are collective investment vehicles based on unitised funds;
although they often appear similar to unit trusts because of their unitised
structure, they are actually very different.
Investment bonds are available from life assurance companies and are set up
as single‑premium, whole‑of‑life assurance policies. An individual who wants to invest does so by paying a single (lump sum) premium to the life company.
If an investment bond is unit‑linked, the investor then receives a policy
document showing that the premium has purchased (at the offer price) a
certain number of units in a chosen fund, and that those units have been
allocated to the policy. To cash in the investment, the policyholder accepts
the surrender value of the policy, which is equal to the value of all the units
allocated, based on the bid price on the day when it is surrendered.
Investment bonds are attractive to investors because of the:
relative ease of investment and surrender;
simplicity of the documentation; and
ease of switching from one fund to another – companies generally permit
switches between their own funds without charging the difference between
bid and offer prices.
The range of available funds is similar to those offered by unit trusts and
investment trusts.
investment a with‑profits
bond is cashed in within a specified period after commencement (typically
five years), the amount received is likely to be less than the value of the units.
In the event of the death of the life assured, the policy ceases and a slightly
enhanced value (often 101 per cent of the bid value on the date of death) is
paid out.
How are investment bonds taxed?
The funds in which the premiums are invested are an insurance company’s
life funds and their tax treatment is different from that of unit trusts. In
particular, they attract internal tax at 20 per cent on capital gains (whereas
unit trust funds are exempt) and this tax is not recoverable by investors even
if they themselves would not pay capital gains tax.
The taxation system for policy proceeds in the hands of the policyholder is
complex. Policies may be qualifying or non-qualifying with tax consequences,
particularly for higher- and additional-rate taxpayers as 20 per cent tax is
deemed to have already been paid within the fund. Investment bonds are
non‑qualifying policies.
Explain:
QUALIFYING AND NON‑QUALIFYING LIFE POLICIES
(Exam question)
Life assurance policies are designated as ‘qualifying’ or
‘non‑qualifying’ policies for tax purposes. The benefit of
a qualifying policy is that there is no tax liability on the
proceeds of the plan on death or maturity; a non‑qualifying
plan may result in a tax liability for higher‑ and additional‑rate
taxpayers. The criteria for qualifying policies is summarised
in Figure 8.5.
What is the key feature of investment bonds that makes them
non‑qualifying policies?
4) To be a qualifying policy for income tax purposes, premiums would have
to be paid annually, half‑yearly, quarterly or monthly over a period of
at least ten years. Investment bonds involve making a single lump sum
payment at the outset. As regular premiums are not made, an investment
bond will be non‑qualifying.
Explain Tax and investment bonds
Broadly speaking, a higher-rate taxpayer will pay an additional 20 per cent
income tax on their gain and an additional-rate taxpayer an extra 25 per cent.
The gain is the surrender value plus any withdrawals previously made that
have not already been taxed, less the original investment.
Top slicing, which enables the gain to be averaged over the term of the policy,
is used to facilitate use of the personal savings allowance (where available).
Top slicing is also used where the gain takes a basic-rate taxpayer into a higher
tax band. Where top slicing results in the gain remaining in the basic-rate tax
band, no further income tax is payable as the liability of a basic-rate taxpayer
is deemed to have been met at source.
Unlike investment trusts and unit trusts, investment bonds do not normally provide
income in the form of dividends or distributions, but it is possible to derive a
form of ‘income’ from them by making small regular withdrawals of capital (ie by
cashing in some of the units allocated to the policy). Investors can withdraw up to
5 per cent of the original investment each year without incurring an immediate tax
liability, regardless of whether the investor is a basic‑, higher‑ or additional‑rate
taxpayer. This 5 per cent allowance can, if not used, be carried forward and
accumulated, up to an amount of 100 per cent of the original investment.
Please see qualifying criteria for tax purposes below:
Explain none mainstream pooled investments
Collective investment schemes may only be sold to the general public in the UK
if they adhere to regulations relating to investment and promotion set out in
the FCA Handbook.
Schemes that do not fulfil the criteria for regulated collective investment
schemes are classified as non‑mainstream pooled investments (NMPIs).
The
FCA Handbook defines an NMPI as:
a unit in an unregulated collective investment scheme (UCIS);
a unit in a qualified investor scheme;
a security issued by a special vehicle, unless an excluded security;
a traded life policy;
rights or interest in any of the investments listed above.
NMPIs may invest in non‑traditional assets. Such investments carry a higher
risk. Also, if the provider is based abroad, an investor may have limited
recourse to the Financial Ombudsman Scheme and the Financial Services
Compensation Scheme. For these reasons, NMPIs are only
considered suitable for a very small group of high‑net‑worth individuals.
The
FCA does not generally permit the marketing of NMPIs to retail customers
What are structured investment products?
The defining characteristic of structured products is that they offer some
protection of the capital invested (up to 100 per cent in some cases), while
enabling investment in underlying assets that have the potential for higher returns but are also higher risk (such as ordinary shares).
8.8.1what are Structured capital‑at‑risk products (SCARPs)?
A SCARP is defined as a product other than a derivative that provides an agreed level of income or growth over a specified investment period and displays the
following characteristics:
a) The customer is exposed to a range of outcomes in respect of the return of
initial capital invested.
b) The return of initial capital invested at the end of the investment period is
linked by a pre‑set formula to the performance of an index, a combination
of indices, a ‘basket’ of selected stocks (typically from an index or indices),
or other factor or combination of factors.
c) If the performance in b) is within specified limits, repayment of initial
capital invested occurs. If it is not, the customer could lose some or all of
the initial capital invested.
8.8.2 what is a Non‑SCARP structured investment product?
A non‑SCARP investment is one that promises to provide a minimum return of
100 per cent of the initial capital invested as long as the issuer(s) of the financial
instrument(s) underlying the product remain(s) solvent. This repayment of
initial capital is not affected by the market risk factors.
8.8.3 what are the risks associated with structured products?
There are a number of risks associated with structured products including:
counterparty risk;
market risk;
inflation risk.
The products are also complex, with terms varying widely between providers.
Before investing in a structured product, an individual should ensure they
understand the risks involved and how the product works, particularly in terms of the returns offered and the conditions that need to apply for specific
returns to be provided.
What are wraps and platforms?
The basic premise of a ‘wrap’ account is that one provider sets up an
internet‑based platform to hold all of the investor’s investments within one
framework, enabling the investor to see all relevant information in one place.
The wrap account allows the investor to analyse and quantify the holdings
according to value, tax treatment and product type.
Wraps are generally offered by independent financial advisers, who levy
charges in addition to any individual fund management charges that apply to the investments held in the framework. Most wraps are able to hold any class of asset or fund on behalf of the investor.
A fund supermarket is designed to provide access to a wide range of funds,
such as OEICS, unit trusts and ISAs, but not investment trusts. The investor
has a ‘general investment account’, which is exposed to the UK tax regime
(apart from any ISAs that are included, as they are tax‑free). The investors pay
a charge for the service: either a flat fee or a percentage of funds held – this is
how the fund supermarket makes its money.
Both wraps and fund supermarkets are often referred to as ‘platforms’,
but they are different. A wrap offers all the same investments as a fund
supermarket, plus a range of other investments, such as investment trusts,
offshore investments and direct equities (shares).
What is sustainable Sustainable finance
The terms ‘sustainable finance’, ‘socially responsible investing’, ‘ethical
investing’ and ‘green investments’ appear frequently in the media and are
often used interchangeably.
In short, sustainable finance is about taking into account environmental, social
and governance (ESG) material factors when making investment decisions. A material factor is one that is likely to affect the profitability of a firm. For
example:
A material environmental factor could be paper recycling for a publishing
house.
Material social factors could relate to how a firm treats its employees. Are
they an inclusive employer? Do they pay a fair salary?
Governance factors relate to how a firm is run. Does it pay its fair share of
taxes? Does it have an ethics code? Is it transparent in its communications?
What are the advantages and disadvantages of sustainable development
What is green washing and sustainable development ?
Exam question
The FCA has concerns that firms are making exaggerated or
misleading sustainability-related claims about their investment
products (known as greenwashing).
CP22/20 introduces a package of measures to clamp down
on this, including sustainable investment labels, disclosure
requirements and restrictions on the use of sustainability-
related terms in product naming and marketing.
How do crypto assets work?
Transactions are recorded using distributed ledger technology (DLT).
Distributed networks eliminate the need for a central authority to check for
invalid transactions. Participants around the world, connected through a peer-
to-peer network, compete to solve complex puzzles to validate transactions.
All verified transactions are recorded on an electronic ledger.
Blockchain is the most widely known DLT network. It comprises transaction
entries called ‘blocks’ that confirm and record users’ transactions. Each block
is cryptographically connected to the previous block in the blockchain through
a ‘hash’ (a digital fingerprint). This creates an auditable trail of the transaction.
Blockchains are generally publicly available and transparent. Transactions are time-stamped on the blockchain and mathematically related to the previous
ones; they are irreversible and impossible to alter.
8.11.2 how do you regulate cryptoassets?
While the FCA has oversight to check that cryptoasset firms have effective
anti-money-laundering (AML) and terrorist financing procedures, generally
cryptoassets are not regulated by the FCA.
The FCA has confirmed that some cryptoassets, such as security tokens, may
fall within its regulatory remit depending on how they are structured.
The UK Cryptoassets Taskforce (CATF) report identified three different
categories of cryptoasset:
Exchange tokens – these are not issued or backed by any central authority
and are intended and designed to be used as a means of exchange. They
tend to be a decentralised tool for buying and selling goods and services
without traditional intermediaries. These tokens are usually outside the
regulatory perimeter.
Utility tokens – these tokens grant holders access to a current or prospective
product or service but do not grant holders rights that are the same as
those granted by specified investments. Although utility tokens are not
specified investments, they might meet the definition of e-money in some
circumstances (as could other tokens). In this case, activities involving
them may be regulated.
Security tokens – these are tokens with specific characteristics that mean
they provide rights and obligations akin to specified investments, like a
share or a debt instrument as set out in the Regulated Activities Order
(RAO). These tokens are within the regulatory perimeter.
(FCA, 2019)
Cryptoassets are considered very high-risk, speculative investments and
the FCA has banned the sale of crypto-derivatives to retail customers due
to concerns surrounding the volatility and valuation of the underlying
cryptoassets.
1) With regard to unit trusts, what does the term ‘open‑ended’ mean?
a) Clients can buy more units.
b) The fund manager can create an unlimited amount of units
according to demand.
c) The fund manager does not need to value the units.
d) There is flexibility in the taxation of units.
1) b) The fund manager can create an unlimited amount of units according
to demand.
2) A unit trust fund’s assets are owned and controlled by the
fund manager. True or false?
2) False. They are owned and controlled by the trustees.
3) Who is responsible for payment of capital gains tax on any
gain realised on the encashment of a unit trust?
a) The unit holder.
b) The trustees.
c) The unit trust company.
d) The fund manager.
3) a) The unit holder.
4) An investment trust is best described as:
a) a unit‑linked, single‑premium whole‑of‑life policy investing
solely in shares.
b) a trust that invests solely in fledgling companies.
c) a company that invests in the shares of other companies.
d) a partnership that invests in gilts.
4) c) A company that invests in the shares of other companies.
5) How can a private individual invest in an investment trust?
a) The investment trust manager creates more units.
b) By purchasing shares of the investment trust company on
the stock exchange.
c) The fund manager issues new shares.
d) By completing an application form for a share account and
submitting it to the investment trust trustees.
5) b) By purchasing shares of the investment trust company on the stock
exchange.
6) What potential benefit does gearing offer to an investment
trust that is not available to a unit trust or OEIC?
6) An investment trust can borrow in order to take advantage of investment
opportunities. Unit trusts and OEICs cannot do this.
7) How are shares in an open‑ended investment company priced?
a) There is a bid and offer price based on the underlying value
of the shares.
b) Shares are based on a historic valuation.
c) There is one price, based on the value of the assets divided
by the number of shares.
d) There is a cancellation price at which all shares are traded.
7) c) There is one price, based on the value of the assets divided by the
number of shares.
8) What rate of tax is deemed to have been deducted from the
investment fund underlying an investment bond?
a) 0 per cent.
b) 10 per cent.
c) 20 per cent.
d) 40 per cent.
8) c) 20 per cent is deemed to have been taken within the investment with a
potential further liability of 20 per cent for higher‑rate taxpayers or 25
per cent for additional‑rate taxpayers.
9) Investment bonds are attractive to investors because
withdrawals are tax‑free. True or false?
9) False. The investor may withdraw up to 5 per cent of the value of the original
investment per annum without paying tax at the time of withdrawal but a
tax liability may arise when the bond matures, on encashment of the bond
or on death of the bondholder.
10) Noah is a higher‑rate taxpayer and is considering a range of
investments. He wants to know which investment, out of unit
trusts, investment trusts or OEICS, would be most likely to
help him meet his objective of achieving capital growth. What
would you advise?
a) A unit trust.
b) An investment trust.
c) An OEIC.
d) Any of the above.
10) d) Noah could choose any of the above. The fact that he is a higher‑rate
taxpayer has no bearing on his decision – they are all taxed in the same
way.
What are the two stages of an investments life what they are taxed?
What are the main taxes that affect investments?
Give an example of a tax wrapper what what does it do?
(Exam question)
TAX WRAPPERS
In considering the different types of investment that can
be held, either directly or indirectly, through collective
investments, the tax treatment is an important factor. Tax can
be charged at two stages in an investment’s life:
while the funds are invested;
when funds are drawn or income is paid out.
The main taxes that affect investments are income tax and
capital gains tax (CGT).
Using a tax wrapper, such as an ISA, changes the way the
investor is taxed on income and gains from the underlying
investment.
What are the five different types of ISA?
A stocks and shares ISA can include:
— shares and corporate bonds issued by companies listed on a recognised
stock exchange anywhere in the world, including Alternative Investment
Market (AIM) shares;
— gilt‑edged securities and similar stocks issued by governments of
countries in the EEA;
— UK‑authorised unit trusts and OEICs;
— UK‑listed investment trusts;
— life assurance policies on the sole life of the ISA investor;
— units in a stakeholder medium‑term investment product;
— shares acquired in the previous 90 days from an all‑employee
savings‑related share option scheme (SAYE).
A cash ISA can include:
— bank and building society deposit accounts;
— units or shares in UK‑authorised unit trusts and OEICs that are
money‑market schemes;
— stakeholder cash deposit products.
An innovative finance ISA involves investing via a peer‑to‑peer (P2P) lender
(P2P lending was discussed in Topic 6).
A Help-to-Buy ISA (now closed for new applications) was to help those
saving for their first UK home by adding a bonus to any savings they make.
A Lifetime ISA can be used to buy a first home
What are the eligibility rules for ISAs?
(Exam question)
ELIGIBILITY RULES FOR ISAS
The minimum age for investing in a stocks and shares ISA,
innovative finance ISA or Lifetime ISA is 18 years (Lifetime
ISAs also have a maximum age of 40); a cash ISA can be
opened by anyone aged 16 or over.
An ISA investor must be generally resident in the UK for tax
purposes.
An ISA can only be held in a single name, ie joint accounts
are not permitted.
What are subscription limits on ISAs and why are they used?
The purpose of granting tax benefits on investments held within an ISA is
to encourage people who might not otherwise have saved funds to do so.
To ensure that the tax benefits meet that objective, there are limits on the
maximum amount that may be saved each tax year. The limit means that those who already have adequate savings cannot benefit further by switching their
savings into ISAs to gain greater tax benefits.
Provided the overall annual subscription limit is not exceeded, an individual
investor can choose to invest the full annual amount into a stocks and shares ISA, or a cash ISA or an innovative finance ISA, or split their investment in any proportion they wish.
What are ADDITIONAL PERMITTED SUBSCRIPTIONS to ISAs?
(Exam question)
On death of an investor on or after 6 April 2018, ISA holdings
are designated as a “continuing account of a deceased investor”
and remain so until the earlier of the:
administration of the estate;
closure of the account; or
third anniversary of the death of the account holder.
While no further funds can be added, the holding continues to
benefit from the tax advantages of an ISA.
An ‘additional permitted subscription’ (APS) allowance applies
when an individual’s spouse or civil partner dies. The purpose
of the APS is to protect the tax benefits around savings held
within an ISA. It allows the surviving spouse/civil partner
to make an additional ISA subscription to the value of the
deceased’s ISA holdings.
The right to make a cash APS applies for three years from the
date that the person died, or 180 days after administration
of the estate is complete, whichever is later. For stocks and
shares, the time limit is simply 180 days after administration
of the estate is complete. The additional subscription can be
made with the manager who held the deceased’s ISA or with
another manager who agrees to accept the subscriptions. Its
value can either be the value of the deceased’s ISA at the date
of their death or at the point the ISA ceased to be a continuing
account of a deceased investor.
9.1.3 explain withdrawals and transfers for ISAs
ISA providers have the option to offer flexibility, allowing funds withdrawn
from a cash or innovative finance ISA, or the cash element of a stocks and shares ISA, to be replenished during a tax year. However, providers are not
obliged to offer this flexibility.
Many ISA providers allow no‑notice withdrawals to be made, although there are
some fixed‑rate cash ISAs that do not permit withdrawals during the fixed‑rate
period.
Funds may be transferred between different types of ISA without contravening
the ISA limits. ISAs can be transferred between providers.
9.1.4 explain Tax reliefs on ISA investments
Investors are exempt from income tax and CGT on their ISA investments.
As a comparison, an investment held in a unit trust is potentially liable to CGT
on encashment. If the unit trust is held within an ISA there is no liability to
CGT.
9.1.5 explain a Help‑to‑Buy ISA
It was designed to help those saving for their first
UK home by adding a bonus to any savings they make.
The scheme was open
to those aged 16 or over, and joint purchasers were able to open individual
accounts that each earn a bonus payment. Anyone who opened an account
by 30 November 2019 will be able to use the funds invested and the bonus
payment towards the purchase of a first home by 1 December 2030.
Account holders could make an initial deposit of up to £1,200. Monthly savings
of between £1 and £200 can be made until 30 November 2029. Each £200 paid
in attracts a bonus payment of £50, subject to the ISA being worth at least
£1,600 when funds are withdrawn for home purchase. The minimum bonus
size is £400 and the maximum £3,000. The bonus is available on purchases of
up to £450,000 in London and £250,000 elsewhere in the UK and is paid when
the home purchase is completed. Savings into a Help‑to‑Buy ISA form part of the annual ISA allowance, rather than being in addition to it.
9.1.6 explain a Lifetime ISA and it’s rules?
A Lifetime ISA was introduced from 6 April 2017, with the aim of encouraging
younger people to save for their first home in the UK, to a value of up to
£450,000, and/or for their retirement. The main rules are as follows:
A Lifetime ISA can be opened by those aged between 18 and 40.
Savings made before the age of 50 attract a bonus of 25 per cent (paid by
the government).
The bonus is paid monthly, which enables interest to be earned on the
bonus.
A maximum of £4,000 may be saved per tax year; there is no monthly
savings limit.
The underlying investment choices are the same as those in the cash and
stocks and shares ISAs.
Savings into a Lifetime ISA form part of the annual ISA allowance, rather
than being in addition to it.
Savings can be used to purchase a first home and/or retained to provide
benefits in retirement from the age of 60.
Savings, including the bonus, can also be withdrawn when the accountholder
is terminally ill.
A 25 per cent penalty is applied if funds are withdrawn for reasons other
than the purchase of a first home, the holder reaching age 60 or the holder
suffering a terminal illness.
An individual may contribute to both a Help‑to‑Buy ISA and a Lifetime ISA,
but the bonus payment from only one of these ISAs can be used towards
the purchase of a first home.
9.2 explain Junior ISAs
Junior ISAs (JISAs) became available in November 2011 when their predecessor
the Child Trust Fund (CTF) scheme closed.
Children cannot have both a JISA and a CTF, but CTFs can be transferred into
JISAs on request. JISAs confer the same tax benefits as an adult ISA. Stocks
and shares and cash JISAs are available, and investment can be made into one
type or split between each. As with other ISAs, there is a maximum annual
investment limit.
Where a child is aged under 16, a JISA can only be opened and managed by
the child’s parent (or another adult with legal responsibility for the child).
An eligible child aged 16 or over can open and manage a JISA on their own
behalf; if a JISA has already been opened for them, they become responsible
for managing it.
Funds cannot be accessed until the child reaches 18; once the child is 18, the
account becomes a conventional adult ISA.
9.3 explain Child Trust Funds
Child Trust Funds (CTFs) are no longer available to new savers, although
existing CTFs can continue to receive subscriptions up to the annual limit.
Alternatively, as already mentioned, a CTF may be transferred into a Junior
ISA (see section 9.2).
A CTF remains in force until the child’s 18th birthday. At this point, no further
contributions can be made but the account keeps its tax-exempt status until
it is closed. A maturing CTF can be transferred into an ISA without affecting
the child’s ISA subscription limit. There is no access to money in the account
before the child’s 18th birthday.
There were three general types of CTF:
deposit‑type savings accounts;
share accounts; and
stakeholder CTF accounts.
Stakeholder CTF accounts invest in a range of company shares, subject to
certain government rules designed to reduce the risk.
The maximum annual charge permitted on a stakeholder CTF is 1.5 per cent.
9.4 explain Venture Capital Trusts and the Enterprise
Investment Scheme
Newly established companies, particularly those not listed on a stock exchange,
can find it difficult to raise the funds they need to grow. To encourage private
investors to provide funds to such companies, the government offers various
schemes that incentivise investment through the award of tax benefits. The
two main types of scheme are Venture Capital Trusts (VCTs) and the Enterprise
Investment Scheme (EIS).
The main difference between the two types of scheme is that a VCT is an
investment in its own right, a collective investment, whereas the EIS is a system
of tax reliefs that an individual company applies for; if a company is eligible
for the EIS an investor in the company can claim the available tax reliefs.
9.4.1 explain Venture Capital Trusts
A Venture Capital Trust (VCT) is a company whose shares are listed (and can
therefore be traded) on the stock exchange; it is run by an investment manager.
The VCT normally spreads the monies raised from investors over a range of
different companies.
Investment into a VCT is normally viewed as high risk, so income tax reliefs
are granted to make the proposition more attractive:
Income tax relief at up to 30 per cent is given on an investment of up to
£200,000 per tax year.
Any dividends paid by the VCT from the £200,000 permitted maximum
investment are tax free.
Any capital gains are exempt from CGT.
A VCT must be approved by HMRC and must meet certain conditions to
gain approval.
9.4.2 Enterprise Investment Scheme
In a similar way to a VCT, the Enterprise Investment Scheme (EIS) is designed to
encourage investment in certain smaller, high risk companies by the provision
of tax relief. The main difference is that whereas a VCT is a listed company
that undertakes the investment on the behalf of the investor, the EIS involves
direct investment in a company that is eligible for the scheme.
As with VCTs, EIS investment is seen as high‑risk so tax reliefs are offered:
Income tax relief at up to 30 per cent is given on an investment of up to
£1,000,000 (£2,000,000 if the amount invested in excess of £1,000,000 is
made in knowledge‑intensive companies) per tax year.
The CGT on any capital gains that are reinvested is deferred.
Capital gains from investment in the EIS are exempt from CGT, provided
that the EIS shares have been held for at least three years.
As with the VCT, there are a number of conditions that must be met for the tax
reliefs to be granted.
There is also the Seed Enterprise Investment Scheme (SEIS), which offers
even higher tax reliefs than the EIS, as it is targeted at raising funds for small
start‑up companies.
1) Stella, aged 24, has invested £4,000 per year into a cash ISA
for the past 3 years. In the current tax year, she received an
inheritance and invested the full subscription limit into her
cash ISA, but now she would like to split the money between
her cash ISA and a stocks and shares ISA. Is she able to do this
in the current tax year?
1) Yes, she can transfer money between different ISAs without contravening
the maximum subscription limit.
2) In what circumstances is an additional permitted subscription
(APS), over and above the usual investment limit, allowed in
respect of an ISA?
2) An APS is allowed for someone who has died: the spouse/civil partner of
the deceased is able to make an additional ISA contribution to the value of
the ISA holdings of the deceased.
3) Following someone’s death, the right to make a cash additional
permitted subscription (APS) lasts for the later of 180 days or
what length of time from the date of death?
a) 6 months.
b) 12 months.
c) 2 years.
d) 3 years.
3) d) The right to make a cash APS lasts for three years from date of death,
or 180 days from grant of administration, whichever is later. For stocks
and shares, the time limit is simply 180 days after administration of
the estate is complete.
4) In the current tax year, Jane invested £10,000 into a stocks and
shares ISA that does not offer a flexible investment facility.
Later in the current tax year, she withdrew £1,760. Given an
annual ISA investment limit of £20,000, how much would Jane
be able to pay into ISAs during the remainder of the current
tax year?
a) £10,000.
b) £12,240.
c) Nil.
d) £20,000.
4) a) The withdrawn amount counts towards Jane’s ISA allowance because
her provider does not offer a flexible investment facility, so she could
invest a further £10,000 (£20,000 less the £10,000 initially invested).
5) The advantage of holding investments in a stocks and shares
ISA, rather than holding collective investments directly, is that
the ISA investment is free of what taxes?
5) Investments held within an ISA are free from income tax and capital gains
tax.
6) Existing Help-to-Buy ISA customers can continue saving up to
£200 per month until:
a) 30 November 2023.
b) 30 November 2025.
c) 30 November 2027.
d) 30 November 2029.
6) d) Customers who owned Help-to-Buy ISAs before 30 November 2019, can
save a maximum of £200 per month until 30 November 2029.
7) What is the purpose of the Lifetime ISA?
7) The Lifetime ISA aims to encourage people to save for the purchase of
their first home and/or for their retirement.
8) An investor can increase their annual ISA investment limit by
taking out a Lifetime ISA, a Help‑to‑Buy ISA and a standard ISA.
True or false?
8) False. The annual investment limits for Lifetime and Help‑to‑Buy ISAs
count towards the overall annual ISA investment limit; they are not in
addition to it.
8) An investor can increase their annual ISA investment limit by
taking out a Lifetime ISA, a Help‑to‑Buy ISA and a standard ISA.
True or false?
8) False. The annual investment limits for Lifetime and Help‑to‑Buy ISAs
count towards the overall annual ISA investment limit; they are not in
addition to it.
9) Aaron, aged 12, has a Child Trust Fund. His mother wants to
open a Junior ISA for him instead, but she is unable to transfer
the Child Trust Fund into a Junior ISA and Aaron cannot hold
both types of account. True or false?
9) False. Aaron’s mother can transfer the Child Trust Fund into a Junior
ISA. However, it is true that Aaron cannot hold both types of account
concurrently.
10) Which type of investment normally represents a higher risk:
an investment trust or a venture capital trust?
10) A Venture Capital Trust would normally represent a higher risk to the
investor than an investment trust because VCTs invest in newly established
companies, which tend to be higher risk.
10.1.1 for pension provision.
How is the threshold income calculated?
How is adjusted income calculated?
Threshold income is calculated through the following steps:
Calculate total net income for the tax year.
Deduct any gross pension contributions that benefited from relief at source
(but excluding any employer contributions).
Deduct any lump sum death benefits from registered pension schemes.
Add any reduction of employed income for pension provision through
salary sacrifice schemes and flexible remuneration arrangements made
after 8 July 2015.
Adjusted income is calculated through the following steps:
Calculate total net income for the tax year.
Add claims made for tax relief on pension savings paid before tax relief
was given.
Add pension savings made to pension schemes where tax relief was given.
Add any tax relief claims on pension savings made to overseas pension
schemes (for non-domicile individuals).
Add employer pension contributions.
Deduct any lump sum death benefits received from registered pension
schemes.
Can you carry forward an annual allowance for pensions and if so how many years?
An individual can carry forward any unused annual allowance from the
previous three tax years to the current tax year.
The unused allowance is
added to the current year’s annual allowance and only if pension contributions
exceed this amount is the annual allowance charge payable.
Name two further allowances for pensions
Two further allowances are important:
Lifetime allowance – if the total value of an individual’s pension benefits
exceeds the lifetime allowance at the point when benefits are taken, there
is a lifetime allowance tax charge. The pension provider will deduct the
tax before any benefits are issued. There are different tax rates charged
depending on how the money is paid out, with lump sums attracting a
higher charge than funds taken as income or withdrawals.
Money purchase annual allowance (MPAA) – this applies where a pension
scheme member draws benefits from their pension using flexi‑access
drawdown income or takes an uncrystallised funds pension lump sum
(UFPLS).
Reading:
In respect of contributions to personal pensions, tax relief is given at source at
the basic rate with any higher‑/additional‑rate relief claimed via an individual’s self‑assessment tax return. Relief at the individual’s highest rate is given at
source on contributions to occupational pensions as any pension contribution
is deducted from gross, pre‑tax, income.
Within a pension fund there is no tax on gains or on savings or dividend
income.
WHAT IS THE ‘MARGINAL RATE’ OF TAX? In terms of pension taxation relief
(Exam question)
A person’s highest marginal rate of tax is the highest rate
that they pay on their income. For example, a person whose
taxable income falls within the higher-rate band would pay 20
per cent on their income up to the basic-rate threshold and 40
per cent on any income that lies above that. As they only pay
higher‑rate income tax on part of their earnings, they would
only receive tax relief at the highest rate (40 per cent) on that
amount of their pension contributions (eg if £5,000 of income
was within the higher-rate band, then £5,000 of pension
contributions would be eligible for an additional 20 per cent
tax relief). Any contribution in excess of that amount would
receive tax relief at the basic rate.
Explain Collective defined-contribution pension schemes
There is a demand for a third type of scheme, which can provide more
predictability for scheme members than defined contribution, without the
cost volatility for employers associated with defined benefit. The Pension
Schemes Act 2021 provides a framework for the UK’s operation and regulation
of collective money-purchase schemes (commonly known as collective
defined‑contribution pensions). The new collective defined-contribution
(CDC) pension will see both the employer and employee pay into a joint fund,
with pensions paid out from this shared pot. The benefits of the new scheme include that it offers predictable costs for the employer and is more resilient
against economic shocks. The Royal Mail and Communication Workers Union
will be the UK’s first CDC scheme and a case study will be done on how UK
workers receive the new scheme and how successful these schemes can be in
practice.
Explain Topping up defined-benefit schemes
As people are now living longer and spending a longer period in retirement,
employers are finding defined‑benefit schemes increasingly expensive to
run. As a result, many are reducing their commitment and transferring
responsibility for pension provision to individuals. Many people may therefore
wish to supplement their retirement income by contributing more to their
occupational schemes, or contributing to private arrangements.
The following
are tax‑efficient pension arrangements:
additional voluntary contributions (AVCs);
free‑standing additional voluntary contributions (FSAVCs);
personal/stakeholder pension plans.
AVCs and FSAVCs are available to employees who are members of occupational
schemes. Personal/stakeholder pensions are generally available to anyone
under the age of 75.
Funds do not pay tax on income or gains.
10.2.1 explain Additional voluntary contributions to pensions
AVCs are additional contributions to an occupational scheme. Sometimes,
such contributions purchase additional years’ service in a final salary scheme.
However, most AVCs operate as defined-contribution arrangements and the
employee will only have a limited choice of funds.
The employer will usually cover some or all of the administration and fund
management costs. Contributions to AVCs are deducted from gross salary and
the employee therefore receives full tax relief at the same time.
10.2.2 explain Free‑standing additional voluntary contributions for pensions
As an alternative to an AVC, an individual might choose to contribute to an
FSAVCs defined-contribution fund provided by a separate pension provider.
FSAVCs are available from a range of financial institutions, including insurance
companies, banks and building societies.
Contributions to FSAVCs are made from taxed income. Tax relief at the basic
rate of 20 per cent is claimed by the pension provider and added to the
individual’s pension fund. Higher‑ and additional‑rate taxpayers need to claim
additional relief separately through their income tax self‑assessment. Up until 2006, FSAVCs were potentially attractive to employees who wished
to keep their financial arrangements independent from their employer and
because they offer a wider range of investment funds than AVCs. Their drawback
is that they tend to be more expensive than AVCs because the employer is not
bearing the costs. Once personal/stakeholder pensions became available to all
employees in April 2006, FSAVCs became much less popular.
10.2.3 explain the background to Workplace pensions and how the government tried to make more people have them ect
Successive UK governments have been concerned that people are not saving
enough for retirement. In 2009, for example, only 50 per cent of UK employees
were members of their employer’s pension scheme, and not all employers
offered a pension scheme. Workplace pensions and auto‑enrolment, introduced
in 2012, are an attempt to address this problem.
Under auto‑enrolment, employers must enrol ‘eligible’ workers in a qualifying
workplace pension and contribute a specified minimum amount to the scheme.
Many existing occupational pensions already qualified as a suitable pension
scheme for this purpose; those employers who did not have a scheme already
could set one up, or enrol their employees in the National Employment Savings
Trust (Nest).
Explain NEST pensions
(Exam question)
NEST
As an alternative to setting up or using their own pension
scheme, employers can meet their obligations by enrolling
their employees in Nest.
Nest is a trust‑based occupational pension scheme established
to support workplace pension provisions; it can be used by an
employer either alongside or instead of its own occupational
pension scheme.
Nest offers a range of investment funds from which the
member can choose, and there are default fund selections for
members who do not wish to make their own choice. Charges
are capped. Benefits can be taken from age 55 and must be
taken no later than age 75.
What is the criteria for auto-enrolment in pensions?
The criteria for auto‑enrolment are that the employee:
is not already in a pension at work;
is aged 22 or over;
is under state pension age;
earns more than £10,000;
works in the UK.
Reading
An employee can choose to opt out of the scheme, but only after they have
automatically been made a member.
A minimum of 8 per cent of an employee’s earnings have to be paid into the
scheme, made up of an employer contribution of 3 per cent, an employee
contribution of 4 per cent and tax relief of 1 per cent.
How to calculate direct benefits pensions?
He then worked for ten years at Brooks Bakery until his retirement
and paid into their 1/60th scheme. His final salary with Brooks was
£25,000.
10/60ths of £25,000 = 10/60 x £25,000 = £4,166.67
Pat has been employed by Telephonics plc for just over 35 years
and has been a member of the company’s 1/60th pension scheme
for the whole of that period. His salary is now £81,000 and he is
due to retire next month. What will his pension entitlement be?
a) £54,000.
b) £28,350.
c) £47,250.
d) £81,000.
2) c) £47,250 (35 ÷ 60 × £81,000). Answer a) is not correct because £54,000
represents 40/60ths of his final salary, which is what Pat could have
earned under the scheme had he worked for Telephonics for 40 years, not
35. Answer b) is not correct because £28,350 represents 35 per cent of his
final salary, not 35/60ths. Answer d) is not correct because, although he
can pay in to his pension a maximum of 100 per cent of his UK earnings,
his pensionable service does not justify that level of pension.
10.3 explain What is a personal pension is
All forms of non‑occupational pensions are arranged on a defined‑contribution
basis. Personal pensions are individual arrangements provided by financial
services companies such as life assurance companies, banks and building
societies. Contributions receive basic‑rate tax relief at source, even for
non‑taxpayers. A higher‑ or additional‑rate taxpayer needs to claim additional
relief separately through self‑assessment.
10.3.1explain What is a group personal pension?
Providing an occupational pension is expensive and may be unaffordable for
a small or medium‑sized employer that lacks the financial resources to set
up and run a scheme. An alternative is to arrange a group personal pension: a collection of individual personal pension plans all administered by an
insurance company on behalf of a single employer.
The arrangement is very much the same as each employee arranging a personal
pension individually with access to the insurance company’s range of pension
funds. Each member has their own plan, which they can take with them if
they leave the employer. However, as there are a number of members, the
insurance company normally offers a discount on the set‑up and management
charges, meaning each employee gets better value than setting up a scheme
on an individual basis. It is also possible that the employer will enter into a
‘direct pay’ arrangement whereby they collect pension contributions from each
employee’s gross salary and pay them over in bulk to the pension provider.
10.3.2 What is a self‑invested personal pension (SIPP)?
A SIPP is a personal pension arrangement that gives access to a wider range of
investment options than would be available through a conventional personal
pension. For example, it may be possible to hold a direct shareholding or
commercial property within a SIPP. While access to a wide range of investments
is permitted, a SIPP will also allow a scheme member to use the provider’s
range of conventional pension funds.
A SIPP may appeal to someone who has the confidence to make their own
investment decisions.
Explain what a stakeholder pensions is
The stakeholder pension has been available since 6 April 2001 and is a type
of personal pension. The government’s aim in introducing it was to encourage
more individuals to contribute to their own pension arrangement, particularly
those at lower earnings levels, who traditionally did not have pension provision
and relied on the state pension.
Stakeholder pensions were designed to be simple, low‑cost options. Key
standards that a product must meet in order to be designated a stakeholder
pension are as follows:
Charges cannot exceed 1.5 per cent of the fund value per annum for the
first ten years of the term and cannot exceed 1 per cent after that time.
Entry and exit charges are not permitted.
The minimum contribution required cannot be more than £20.
The restriction on the level of charges meant that advisers generally found
it uneconomic to give advice on stakeholder pensions. To overcome the
lack of access to advice, the government prepared a set of decision‑making
flowcharts, known as decision trees, which people can use to determine
whether stakeholder pensions are appropriate to their own circumstances.
It was partly because of the failure of stakeholder pensions to achieve a
large‑scale take‑up that auto‑enrolment into qualifying workplace pensions
was introduced in 2012.
What are the two phases of retirement planning?
Retirement planning has two phases:
an accumulation phase when savings are made into a pension to build up
a fund;
a decumulation phase when benefits are drawn.
The way in which pension contributions are invested during the accumulation
phase very much depends on the type of scheme.
What are the two phases of retirement planning?
Retirement planning has two phases:
an accumulation phase when savings are made into a pension to build up
a fund;
a decumulation phase when benefits are drawn.
The way in which pension contributions are invested during the accumulation
phase very much depends on the type of scheme.
10.4.1 explain Defined‑benefit pension schemes
In respect of a defined‑benefit scheme there is, generally, a pension fund
operated by or on behalf of the employer into which contributions are paid.
Investment decisions are taken at scheme level, with the objective being
to ensure that the scheme can continue to pay pension benefits already in
payment and the benefits of current members who will reach retirement age/
draw benefits in future. The scheme will usually be invested in a mixture
of equities, gilts, corporate bonds and cash; individual members are unable
to make decisions on how their contributions are invested but have the
reassurance of the promise of a certain level of pension benefits.
10.4.2 explain Defined‑contribution pension schemes
Within defined‑contribution arrangements, the scheme member has much
more choice and control over how their contributions are invested. The
pension provider usually offers a wide range of investment funds from which
the member can select, and pension benefits depend, in part, on the value of
the fund when benefits are taken.
When an individual is many years from taking benefits they may choose
investment funds aimed at maximising growth, such as equity funds; as retirement approaches the preference may be for lower‑risk funds such as
cash or fixed interest. The member is able to choose a mix of funds to meet
their needs, objectives and circumstances.
If the pension is an individual arrangement, such as a personal pension, a
financial adviser can guide on fund choice. Where a defined‑contribution
pension is an occupational scheme there may be a more limited range of funds
to choose from, with the employer selecting what they believe to be the most
suitable funds.
Explain PUBLIC SECTOR/PUBLIC SERVICE SCHEMES
(Exam question)
These schemes are operated by the government and most of
them are ‘unfunded’. There is no pension fund as such and
contributions form part of general government revenues. The
schemes do provide a promise in terms of pension benefits
and this is provided by the government out of its funds.
10.5 How can benefits be taken from a pension?
Up to 25%
tax-free
Annuity
Uncrystallised
funds pension
lump sum
Flexi-access
drawdown
10.5.1explain Annuity purchase
Annuity purchase involves the payment of a lump sum from the pension fund
in exchange for an income.
The benefit of an annuity is certainty: the annuity provider promises a
guaranteed rate of income – an annuity rate – based on the annuitant’s
circumstances. It is not necessary to buy the annuity from the company used
during the accumulation phase: pension providers must inform their clients
that they can ‘shop around’ for the most appropriate benefits structures and/
or higher annuity rates. This is known as the open‑market option.
Once an annuity has been purchased, investment risk is removed but there is
no longer any prospect of further investment growth.
10.5.2explain Flexi‑access drawdown for DC pension
Flexi‑access drawdown (FAD) involves drawing the pension fund, after any
PCLS has been taken, and reinvesting it into a fund to provide income. The
fund remains invested so there is potential for further growth but there is also
the risk that the fund value might fall and, consequently, income levels may
not be maintained.
The withdrawals can be structured however the member wishes: as smaller,
regular payments to provide an income, or as larger, perhaps one‑off payments.
As any payment beyond the PCLS is taxable, care must be taken not to trigger
a large tax charge.
10.5.3 explain a Uncrystallised funds pension
lump sum
Opting for a UFPLS means the pension fund remains invested. Unlike FAD,
none of the fund is drawn or reinvested and no PCLS is drawn. The member is
able to use their pension fund to draw a series of lump sum payments to meet
their income/capital needs.
10.5.4 explain The money purchase annual allowance
Pensions are almost unique as an investment because of the tax relief they offer on
contributions: tax relief that is provided to encourage people to save for retirement.
With the ability to draw sums from a defined‑contribution (ie money‑purchase)
pension via FAD or UFPLS, there is a risk that those who already have adequate
retirement income draw funds and then reinvest them into a defined-contribution
pension to benefit from tax relief, effectively getting two lots of tax relief.
To limit the extent to which people can do this, a lower annual allowance applies
once an individual has started to access their funds via FAD income or UFPLS.
Instead of being able to receive tax relief on pension contributions up to the full
annual allowance, they have an MPAA. The MPAA only applies to contributions
to defined‑contribution schemes: a member can still pay up to the full annual
allowance into a defined‑benefit pension scheme (although that total is reduced
by the amount of any contribution into a defined‑contribution scheme).
Explain the CAPPED AND FLEXIBLE DRAWDOWN for pensions
(Exam question)
Capped drawdown was an option for those who reached pension
age before 6 April 2015. Income benefits were drawn direct from
a designated drawdown fund, with an upper limit (ie a cap), on
the amount that could be drawn. Capped drawdown is no longer
available for those reaching minimum pension age, but those
already using a capped drawdown arrangement can add further
pension funds. Alternatively, they can convert to FAD.
Flexible drawdown was another option available until 6 April
2015. This form of drawdown allowed unlimited withdrawals. All
flexible drawdown arrangements have been converted to FAD.
10.6 explain Death benefits for pensions
Pensions can provide a range of benefits when a member dies, with the options
available depending on the type of scheme and whether death occurred before
or after retirement. When seeking to understand the nature of death benefits
provided, it is always important to check the scheme rules.
10.6.1 explain Defined‑benefit schemes and the affects of death
If a member dies before retirement age, referred to as death in service, a lump
sum death benefit is usually available. This can be a multiple of earnings
or a fixed sum. Additionally, there might be a spouse’s and/or dependant’s
pension, paid from the scheme to the spouse, civil partner or dependants of
the deceased. This can be a proportion of the member’s pension rights. On death after retirement, a defined‑benefit scheme may:
continue to pay the pension income for a period of time, a ‘guaranteed
period’; or
pay a spouse’s/dependant’s pension as a proportion of the pension that
was being paid to the member.
10.6.2 explain the affects of death on Defined‑contribution schemes
On death before crystallisation, the pension fund can be used to provide
income and/or lump sum benefits.
On death after retirement, there are a range of ways in which a
defined‑contribution scheme will be able to provide benefits to the spouse/
civil partner or dependants of the deceased:
continuing scheme pension;
lifetime annuity continuing for an agreed period post‑death;
lifetime annuity paying an annuity protection lump sum – this would be the
balance of the funds used to buy the annuity as compared with how much
had already been paid out as income at date of death; or
continuing drawdown income.
10.7 explain pension scams
While pensions confer a number of tax benefits, there are limitations in terms
of the benefits not being accessible until age 55 and only 25 per cent of the
fund value being available as a tax‑free PCLS. The large sums of money invested
in pensions have proved attractive to criminals who attempt to ‘scam’ people
out of their pensions.
An approach will often be made via a cold call or text message on the pretext
of an offer to transfer the pension to a scheme that will enable all funds to be
drawn immediately as a tax‑free lump sum. The reality is that no such type of
scheme exists and the intention is to take control of the pension.
Pensions are by no means the only area in which attempts will be made to
scam people out of money. Criminals are also active in promoting investment
schemes that promise high rates of return, the sale of shares that in reality
do not exist and in taking fees to arrange consumer credit which is never
provided.
An adviser’s role is to be aware of such schemes and to advise a customer
considering one to be mindful of the potential risk. The general rule is that, if
it looks too good to be true, it probably is.
Explain PENSIONS DASHBOARDS
(Exam question)
PENSIONS DASHBOARDS
The government is working to introduce pensions dashboards
that will allow consumers to see the current value of their
pensions, administrative details about their pots, and their
estimated income in retirement, all in one place for all pensions
that are not yet being paid. This will include their state pension
entitlement, workplace pensions and personal pensions from
all providers. The aim is to make it easier for people to plan
for their retirement and ensure they have enough money to
support them in later life.
The implementation date of pensions dashboards has suffered
several setbacks, so you should keep an eye on developments
in this area.
1) Marta is 37 and pays 3 per cent of her salary into a pension
scheme each month. The benefit that she will receive at
retirement depends solely on the investment performance of
the fund. Marta’s pension scheme is:
a) a defined‑benefit personal pension.
b) a final‑salary occupational pension.
c) a defined‑benefit occupational pension.
d) a defined‑contribution occupational or personal pension.
1) d) Marta’s scheme is a defined‑contribution scheme, which could be
either an occupational or a personal pension.
11.3 what are the WHOLE‑OF‑LIFE ASSURANCE POLICIES?
What is the fixed term, death benefit, surrender value, tax treatment of benefits of level term assurance, non profit whole life, decreasing term assurance, with profit whole of life,unit linked whole of life, increasing term insurance, convertible terms assurance, low cost whole life, renewable term assurance, fixed whole life, family income benefit and universal whole life?
13.4 what areMortgage interest rate options?
A distinction can be made between the way a lender charges interest to the
mortgage account and the different interest rate options that can be applied
to the mortgage.
For both repayment and interest‑only mortgages, there is a variety of ways in
which interest can be charged to the mortgage account. For instance, some
lenders charge interest on an annual basis, some on a monthly basis, and
some on a daily basis. It is the lender who decides how interest is charged,
and this can vary between different mortgage products with the same lender.
Lenders will generally offer a range of different interest rate options or
‘mortgage products’ such as fixed or variable rates, and the ability to defer
interest or take an interest payment ‘holiday’.
14.4 Understanding plans and objectives for clients
Completing the first two sections of the factfind – the personal and family
details and the financial situation – involves gathering hard facts, ie about
tangible items and people. The client’s plans and objectives tend to be more
intangible; here the aim is to find out “why?”, “how?” or “do you feel that?”;
in other words, to discover the client’s feelings about what they have, what
they want and where they want to go from a financial point of view. These are
known as soft facts.
Figure 14.3 summarises the soft facts that the adviser needs to establish for
each area.
Knowing the client’s feelings about their situation, their aspirations for the
future and their existing arrangements will help build understanding in a
number of ways:
Discovering the reasons behind the client’s existing arrangements may in
turn indicate the client’s level of understanding of their finances.
Determining the level of the client’s interest in their situation will indicate
their motivation to improve their situation and the likelihood of their
taking action.
Ascertaining the client’s views on a number of possible alternative solutions
will help in constructing acceptable recommendations.
To find out how a person feels about improving their financial situation, the
adviser needs to ask questions like these:
14.6 Identifying needs and objectives of the client
Clients often have a range of financial needs, even when they approach an
adviser with one particular need in mind. To give the most appropriate advice,
advisers must be aware of the broad range of needs that clients might have –
and must be able to recognise those needs even where clients themselves are
not aware of them.Every client is different but, in general terms, an adviser should first seek to ensure
that there is adequate protection of their lifestyle in the event of death or illness.
Retirement planning would then be the next priority as it is effectively protecting
income for a time when a person either does not want to or is no longer capable
of working. Once the client’s current and future positions are protected, attention
can then be made to enhancements through savings and investment planning.
In seeking to assess any of these areas, an adviser should look for examples
of typical things that clients either do wrong or fail to do at all. This might
include the following:
A young family, with little or no savings, relying solely on mortgage
protection cover as their only form of life assurance. It would repay the
mortgage but is not designed to meet the ongoing costs of running the
house and bringing up the family.
A low level of life assurance premiums being paid, suggesting that cover
might need to be increased for the required protection to be adequate.
Unnecessarily large amounts being held on deposit in bank and building
society accounts over the long term and so not gaining access to better
returns available elsewhere.
Substantial taxable savings/dividend income, in excess of allowances,
being received by an individual who pays higher‑rate income tax.
A non‑taxpayer holding investments where tax is taken while funds are
invested and where the tax deducted cannot be reclaimed.
A client with many small holdings of shares over a wide range of companies,
causing administration and monitoring difficulties.
A married couple owning most of their assets in an individual’s sole name
and paying more tax as a result.
A client not making any pension contributions, or making only very small
pension contributions as a percentage of total earnings, which will mean
being dependent upon state benefits unless action is taken.
People who have not made a valid will, whose assets on death may, therefore,
not be distributed as desired.
The adviser’s role is to define the client’s needs and objectives accurately,
to enable the client to see the key issues facing them and to recommend and
discuss a priority order for action.
Where are the high standards for the FCA applied?
18.1 What are regulated activities and investments in firms and individuals?
Any financial services business that carries out a regulated activity in the UK
must be authorised, unless they are exempt. Firms have to apply to the FCA
(or, if dual regulated, to the PRA) for authorisation.
The FCA describes two categories of regulated investment:
securities (such as shares, debentures and gilts); and
contractually based investments (including life policies, personal pensions,
options and futures).
24.4.2 Markets in Financial Instruments Directive (MiFID)
The Markets in Financial Instruments Directive (MiFID) applies to firms that
provide services to clients in relation to tradeable financial instruments, which
include shares, bonds, units in a collective investment, and derivatives. Life
assurance, pensions and mortgages are outside the scope of MiFID.
In the UK, MiFID became effective from November 2007. It is a key element of
the EU Financial Services Action Plan and aims to harmonise the regulation of
investment services across the EU. MiFID has the main objectives of increasing
both competition and consumer protection by setting requirements in three
main areas:
conduct of business;
organisation;
market transparency.
MiFID distinguishes between core and non-core activities: core activities are
“investment services and activities” and non-core activities are “ancillary
services”. Where a firm performs both core and non-core activities, MiFID
applies to both aspects of its activities. A firm that only performs non-core
activities is not subject to MiFID.
MiFID includes the principle of an EU ‘passport’, meaning that a firm subject
to MiFID has the right to operate throughout the EEA on the basis of a single
authorisation in its home state. The aim of the directive is to make cross-border
activity easier to conduct by imposing a single set of rules across the EEA.
The FCA, as the body responsible for the securities industry in the UK, has
written MiFID into its Handbook. Firms affected include securities and futures
firms, banks conducting securities business, recognised investment exchanges
and alternative trading systems. The types of investment activity covered by
MiFID are summarised in Figure 24.3.
Given that MiFID does not apply where a business only carries out ‘non-core
activities’, UK firms are exempt from MiFID if they do not hold client money
and do not advise on or arrange complex investments such as derivatives.
However, any firm making use of the exemption in respect of ‘non-core’
activities will not be able to engage in cross-border business on the basis of
home state authorisation.
MiFID II
The European Commission launched proposals for reform in 2010. These were
intended to improve the functioning of financial markets in light of what was
learned from the financial crisis, improve investor protection and tackle some
of the issues that were missed in the original MiFID.
MiFID II represents a comprehensive set of reforms covering eight main
areas (see Figure 24.4). The legislation was published in June 2014 and has
applied within EU member states since 3 January 2018. The onshore UK
MiFID framework commenced at the end of the Brexit transition period on 31
December 2020.
25.3.2 Key requirements
The FCA places a significant emphasis on the fair treatment of customers,
and the rules and guidance on complaint handling aim to ensure that
complainants are dealt with promptly and fairly. Firms must have appropriate
and effective complaints‑handling procedures and make consumers aware
of these procedures – this is normally done through the client agreement or
initial disclosure document.
When a complaint is received, a firm must take the steps summarised in Figure
Payment services providers must give a full response to a complaint within
15 days. This can be extended to 35 days in exceptional circumstances, with a
holding letter sent in the interim.
Firms are also required to:
report to the FCA on their complaints‑handling on a six‑monthly basis;
investigate the root cause of complaints and take action to prevent the
recurrence of similar issues in future.
The FCA requires financial services firms to appoint an individual at the
firm, or in the same group as the firm, to be responsible for oversight of the
firm’s compliance with the complaints rules. The individual appointed must
be carrying out a governing function. Firms are not required to notify the
individual’s name to the FCA or FOS but are expected to do so promptly on
request.
25.4 What is the role of the Financial Ombudsman
Service?
A customer who is dissatisfied with the actions of a firm must first complain to
the firm itself, as explained in section 25.3. If the customer is still not satisfied
once the firm’s internal complaints processes have been completed, they can
take their complaint to the Financial Ombudsman Service (FOS). Certain types
of pension and aspects of pension arrangements are dealt with by the Pensions
Ombudsman (see section 25.5).
The FOS attempts to resolve complaints at the earliest possible stage and
by whatever means appear to be most appropriate, including mediation or
investigation. The process for investigation is outlined in Figure 25.4.
The FOS will determine a complaint by reference to what is, in its opinion, fair
and reasonable in all the circumstances of the case, taking into account: the relevant:
— law and regulations;
— regulators’ rules, guidance and standards;
— codes of practice; and
where appropriate, what they consider to have been good industry practice
at the relevant time.
