Financial services, regulation and ethics

In this...

Shortened demo course. See details at foot of page.

...hose needs.

The process of providing financial advice is never an exact science or a ‘one size fits all’ approach, as each client’s circumstances and needs are differe...

Shortened demo course. See details at foot of page.

...ity. These are budgeting, managing debt, borrowing, protection, retirement planning, savings and investment, estate planning and tax planning.

The first stage in any financial planning scenario is the consideration given to the client's available budget. Those individuals who know how their money is spent will always be in greater control of their finances and are more likely to be living within their means, with sufficient money to meet regular monthly outgoings and occasional expenditure such as presents and household repairs.

Carrying out a budgeting exercise with a client will identify the difference between income and expenditur...

Shortened demo course. See details at foot of page.

...he time periods for which they are required.

Where a client’s available funds are limited, it is more prudent to recommend a partial solution that is affordable and will remain in force rather than a complete solution that is unaffordable and will be cancelled within a short period.

Budgeting exercises are most important for those relying on investment income, which is likely to fluctuate.

Explain what is meant by the term ‘disposable income’.

Answer : Purchase course for answer

Before an adviser gives any advice in relation to new products, it is important for them to establish the level of debt that a client has. While considering a client’s available budget, the adviser needs to ensure that all existing commitments can be maintained after any new products are sold.

Establishing the amount of money that a client has coming in and going out is the essential first step in managing debt. Expenditure should be considered under three headings:

Essential spending – housing, insurance, utilities

Everyday spending – food, cleaning, travel

Non-essential spending – clothing, entertainment, holidays

If it appears that a client has little lef...

Shortened demo course. See details at foot of page.

...ing much more over the extended new loan period. There may also be penalties applied when repaying loans earlier than stated in the terms of the agreement.

Where the situation is spiralling, clients should be encouraged to continue tackling the situation. Various agencies are available to assist, including Citizens Advice, National Debtline, Payplan, and the StepChange Debt Charity. In extreme situations, a client may have to consider bankruptcy or an individual voluntary arrangement, but these both involve legal proceedings and should be regarded as the last possible option.

Explain two things that a client could do to reduce their monthly spending.

Answer : Purchase course for answer

Clients often need to raise extra short-term funds, for example to finance home repairs or improvements or to pay for holidays. This can be done using unsecured short term loans from banks or building societies or, alternatively, by borrowing further amounts from an existing lender who has already advanced them a loan (mortgage) secured against their main residence. They could also raise the required funds by re-mortgaging with another lender.

Constantly borrowing on a short-term basis, or borrowing significant amounts on credit ...

Shortened demo course. See details at foot of page.

...ed on the borrower’s property, they run the risk of negative equity or losing their home completely if repayments are not maintained.

If clients have loans or other forms of credit outstanding but hold large cash reserves at the same time, the adviser should ask why it is that the client does not consider repaying some of the debt with their cash reserves, which would give them a higher level of monthly disposable income.

State the potential disadvantage of long-term secured borrowing.

Answer : Purchase course for answer

Protection is normally considered to be the top priority when it comes to financial planning. Though many individuals can earn enough while they are working to assist them through periods of financial difficulty, an early death or disability can radically change the financial position in both the short and long term. It is, therefore, advisable that all clients consider protecting against the financial consequences of death, accident and long-term or critical illness, because the financial consequences of any of these events would be felt immediately.

There are many factors that will influence a client’s protection needs. The major ones are:

Age

Dependents

Income

Financial liabilities

Employment status

Existing cover

We will examine each of these separately, but it is important to realise that all the above factors are interdependent and that they all impact on the cost, terms and availability of any protection products recommended.

Age

A client’s age is a major factor in determining any protection needs they might have. Children are normally the responsibility of, and provided for by, their parents and so they do not usually have any protection needs of their own. As children become financially independent – usually in the late teens or early twenties – certain protection needs become apparent, such as the need to protect their income in case they cannot work.

Between the mid-twenties and mid-forties, protection needs are likely to be at their highest as individuals marry and start their own families. The death or serious illness of a breadwinner is likely to cause financial hardship for the surviving spouse and children; protection may be needed to replace lost income or to provide a large capital sum. With a growing family - and the associated need for a larger home - the amount of protection required will be at its highest. However, these clients may not always have sufficient financial resources available to meet the cost of arranging a full suite of protection products for the desired amount and type of protection.

By the time a client reaches their mid-forties, their children are becoming independent and the amount of cover required may reduce. This allows parents to focus on thei...

Shortened demo course. See details at foot of page.

... commitments

Shared financial goals – buying a house

One or both may work – need to protect income in case of illness

Need to provide capital sum on death if mortgage/loans/maintain standard of living

Starting a family

Need money to meet families needs

May be one partner at home caring for family/one income may cease

Carer returns to work/income restored

Childcare costs/education/university considerations

Capacity to earn increases/investments start to increase

Life cover imperative/may have Death In Service benefit

Need to protect income of earner and provision to pay for care if the non-worker suffers illness

Family with older children

Capacity to earn reduced

Need to protect for consequences of death or illness decreases

Priority is to save for retirement/clear debts

May still be supporting adult children

May have investments to rely on

Other objectives (holidays/hobbies) being realised

Post-family/pre-retirement

Children independent/completed education

Need to protect against financial consequences of death/illness mostly disappears

But health may not be as good

Children (should) no longer be a drain on finances

Retirement

Desire to maintain standard of living/maintain health

Need approx. 2/3 of pre-retirement income to achieve this

May have low pension and little or some capital, or they may have sufficient pension and substantial capital

Divorce and relationship breakdown

A single parent may have to live on less money than they are used to

Have to protect themselves and income in the event of death or illness

Partner may be obliged to pay maintenance

(Which will impact on the payer’s goals too)

Split of assets/shared pensions

Note

These time periods and descriptions are, of course, generic and many families no longer conform to these conventional stereotypes. Events will always happen that are unexpected, e.g. divorces, which can radically alter the concerns and needs at any stage in life, and ongoing reviews should always be a major part of the overall process of identifying and addressing needs.

Explain why income protection policies usually limit the maximum amount of benefits available.

Answer : Purchase course for answer

After considering protection needs, the next area of priority is retirement planning. If early death does not occur, clients will eventually reach retirement and provisions need to be made to ensure that the standard of living achieved during their working life is maintained when they stop working.

An individual’s retirement needs depend upon a number of factors:

Age

The first factor is age, with the two most important questions being:

How old is the client?

At what age do they want to retire?

These factors determine how urgent it is to make adequate provision for retirement and what priority this should have over other needs. The difference between a client’s current age and their preferred retirement age gives the time period available for building up savings. Pension arrangements started earlier will cost less because they will have a longer pe...

Shortened demo course. See details at foot of page.

...ion provision. The level of income required in retirement is also likely to be much higher where the client has a financially dependent spouse.

Previous and current arrangements

The fourth factor is the client’s previous and current arrangements. Any existing provision – either from previous employers or personal pension policies - needs to be deducted from the total income required at retirement to establish the additional amount of funding required. Calculations should also factor in the amount of State pension provision the client will be entitled to, including the new State pension and the Basic State Pension with any available top-up schemes (S2P, SERPS, or the Graduated Pension Benefit).

Why should inflation be factored into the calculations when considering the amount of income that a client wants in retirement?

Answer : Purchase course for answer

It is strongly recommended that all clients pay off any expensive debts, protect their family, have a retirement plan and have an amount of money behind them to cope with any unexpected emergencies before looking at savings and investments. But after protection and retirement needs have been examined, the adviser can move on to the ‘nice to have’ area of savings and investments.

Most clients have a desire to generate specific or non-specific sums of money for anticipated or wanted future events and needs. Some of this can be achieved through regular savings and some from investing existing lump sums for growth.

‘Savings’ generally refers to regularly putting to one side small amounts of money, with the objectives tending to revolve around expensive items such as the future purchase of a house, car or holiday or the funding of school fees or weddings

‘Investment’ tends to relate to maintaining the value of the money invested in real terms, taking account of inflation, or to achieving real growth above the rate of inflation.

Fur...

Shortened demo course. See details at foot of page.

...s; the psychological aspect to consider is whether they can cope with fluctuations in value to achieve their long-term goals.

For each savings plan or investment, it is necessary to establish a timescale for when the funds will be required. Before embarking on any longer-term plans, all clients should have a readily accessible emergency fund equivalent to approximately three to six months’ income.

Beyond that:

‘Short-term investment’ covers periods up to 5 years and includes provision for home deposits, cars and holidays

‘Medium-term investment’ covers periods from 5 to 15 years and includes provision for school fees, dream holidays or large luxury purchases

‘Long-term investment’ is for periods of over 15 years and most often includes saving for income in retirement, either through a pension or other product. In each case, it is essential that the chosen product fits with the desired timescale

Explain what is meant by the term ‘market risk’ and how it can be reduced.

Answer : Purchase course for answer

After addressing the immediate, future and ‘nice-to-have’ financial need areas, the adviser can then move on to the more generic aspects of the financial advice process that may not be applicable to all clients.

Inheritance tax is potentially payable by everyone considered to be a permanent resident of the UK -even if they do not actually live here -and is chargeable on their worldwide assets. A charge can arise when an asset is gifted to another during an individual’s lifetime or from their estate on their death.

Everyone has a stated amount available to them, known as the nil rate band, on which no inheritance tax is charged. Any amount above this will be charged at the current rate of 40% if passed to anyone other than a surviving spou...

Shortened demo course. See details at foot of page.

...used percentage of her husband’s nil rate band – in this case, an uplift of 100%. If Mr Jackson had used some of his nil rate band, the unused proportion could have been transferred to Mrs Jackson. This will mean that a considerably smaller amount of tax will be due.

As a part of the financial planning process, advisers should establish the potential inheritance tax liability on a client’s estate and continue to review this regularly as a client’s wealth and estate value fluctuates. The aim of effective inheritance tax planning will always be to pass on as much wealth as possible to beneficiaries of the client’s choice, free of any tax liability.

When can an inheritance tax charge arise?

Answer : Purchase course for answer

Although estate planning may not be important or necessary for all clients, saving tax in general is important to everyone.

The amount or rate of tax a client pays will impact on their disposable income, the returns they receive from any savings or investment products, and their overall financial situation.

The UK tax system is complex, and advisers need to have an in-depth understanding of the various taxes to ensure that their advice is appropriate to the client’s current and potential future tax position. This is a fundamental...

Shortened demo course. See details at foot of page.

...a very attractive annuity on offer

Think about tax consequences before making a transaction

Complete tax returns accurately and on time

Pay tax on time

Avoid recommending schemes you do not understand yourself

Keep planning flexible in case of changes in legislation

Undertake regular reviews of a client’s tax position

Don’t persuade a client to do something against their nature just to gain a tax advantage

Explain the difference between tax avoidance and tax evasion.

Answer : Purchase course for answer

In the previous sections, we identified the main areas of financial advice that a customer may require, and the factors that would influence the amo...

Shortened demo course. See details at foot of page.

...t, the purpose that product serves and the justifications for the recommendations will differ depending on their individual circumstances and needs.

We previously highlighted the importance of considering the repayment of debts before providing advice on any other products. One of the largest debts that anyone will have over their lifetime is their mortgage, and it is therefore essential to ensure that this debt will not only be repaid in full on death, but also that the payments can be maintained in the event of accident or illness preventing the mortgage holder from working.

A mortgage is the term often used for a loan to purchase a property, although it can also relate to a commercial loan. The mortgage itself is the security offered in exchange for the loan though in using the term, most people are referring to a residential home loan. Most lenders will only lend for property purchase on the strength of a legal mortgage and this is created by way of a legal charge. The legal charge is a deed which states that the property has been charged with the debt (the loan) as security for the lender, and this remains in place until the loan is fully repaid.

A mortgage can be arranged as a capital and interest repayment arrangement or as an interest only arrangement. With a capital and interest repayment arrangement, the monthly repayments to the lender consist of both capital and the interest. In the early years, most of the monthly repayment will be interest but, as time goes on, increasing amounts of capital are repaid. Throughout the term, the amount of the monthly repayment will be the same, assuming no change in interest rates. With an interest only arrangement, the borrower is only paying interest to the lender during the mortgage term. At the end of the mortgage term, the full amount of the original capital borrowed will have to be repaid. Many people use a form of savings plan to build up the capital for this.

There are advantages and disadvantages to both methods. A capital and interest mortgage is more expensive, but the borrower knows that at the end of the mortgage they will have repaid the mortgage loan in full and, provided there are no other loans secured against their home, they will then own the property outright. With an interest only mortgage, it is possible that the savings product may have built up a fund in excess of what is required to repay the outstanding capital, leaving a surplus for the borrower to use as they wish. However, while this is the cheaper option, there is no guarantee that the mortgage will be repaid at the end of the term, and a shortfall could even be possible.

Types of mortgages

Both types of loan can be set up in a number of ways, explained below:

Capped – for an initial period, usually two or three years, the lender guarantees not to increase the interest rate that applies to the mortgage above a...

Shortened demo course. See details at foot of page.

...ess the tenants fall under the FCA definition of ‘family’ or the borrower’s circumstances mean that the transaction falls under the Mortgage Credit Directive definition of a Consumer Buy to Let, or CBTL). There is therefore less protection for clients if problems arise.

Business buy to let

This is where borrowers enter into a contract to purchase a property with the intention of engaging in commercial enterprise. For example, where a borrower buys a property with the intention of renting it out neither he nor his immediate family intend to occupy it. Although most mortgages are now regulated, this type is not. There is therefore less protection for clients if problems arise.

Consumer buy to let

This is a regulated buy to let proposition, defined as one which is not entered into by the borrower predominantly for the purposes of business carried on by the borrower. This type of situation arises where, for example, a borrower moves out of his mortgaged property to live elsewhere temporarily for work and does not wish to sell, or where an individual inherits a property and needs to let it out, or where an individual intends to occupy the property themselves in some capacity.

Loans

There are two main types of loan: unstructured and structured.

Unstructured

Mortgages and loans on commercial property are unstructured, which means that it is possible to increase loan repayments to reduce the outstanding capital and the interest. Normally, these loans can be repaid at any time without penalty, which also saves on the interest element. Some personal loans and overdrafts also fall into this category. The interest rate applied to the loan varies in line with the risk of default and is usually related to the bank or mortgage base rate. 1% above the base rate indicates that the borrower is low risk, while 4% above indicates a realistic chance of default.

Structured

These loans tend to be for smaller purchases, for example, furniture or cars. This type of loan has a fixed rate of interest, which is paid over the term of the loan, and a fixed repayment structure. On this basis, even if the base interest rates alter, the loan repayments remain the same. One disadvantage is that it falls into the higher risk category and will, therefore, be more expensive than an unstructured loan. It is important to check the Annual Percentage Rate (APR) as there can be a large discrepancy between the nominal and actual rates of interest. Where a structured loan is repaid early there is likely to be a penalty charge to ensure that the lender receives the fixed profit it has factored into the terms of the loan.

State an advantage and disadvantage of an interest only mortgage.

Answer : Purchase course for answer

In this section we will examine the main types of life assurance policy, which are designed to provide financial protection for the life assured and/or their dependants.

Term assurance

A term assurance policy pays a lump sum (or series of lump sums), known as the sum assured , in the event of the death of the life assured within a specified term. The client selects the term for which they require the protection and the sum assured that they require. These arrangements generally have no savings element, so if the policyholder cancels the policy during its term or if the life assured survives to the end of the term, there will be no payout from the life company.

Premiums are generally quite cheap in relation to the amount of cover provided, but premium costs are higher for longer term policies and as the proposed life assured gets older. Premiums are reduced significantly if the life assured is a non-smoker. Premiums are normally paid monthly or annually.

On a death claim, the sum assured can either be paid to the estate of the life assured, or it could automatically pass to someone else, for example, if it was placed into a trust or if it was set up as a ‘ life of another ’ policy (this is where the life assured is not the same person as the individual setting up the contract).

There are a number of types of term assurance policy to suit different protection needs:

Level term assurance

A level term assurance provides a level sum assured and fixed premiums throughout the term of the contract. This is a cheap way of providing protection for families or businesses, but has the disadvantage that once established the term of the policy cannot be extended if the client’s needs change.

It can also be used in connection with an interest only mortgage.

Increasing term assurance

An increasing term assurance policy allows the original sum assured to be increased at set points during its term, or provides the policyholder with the option to do so without having to provide any further evidence of their health. The increase may be a set percentage, or linked to the increase in the Retail Prices Index. As the sum assured increases, so does the premium. These policies allow the clients the opportunity to ensure that the sum assured keeps pace with inflation over the term, but has the disadvantage that the term of the policy cannot be increased.

Renewable term

A renewable term assurance allows the client to take out a policy for an initial short period of time (e.g five years) and then, at the end of that period, to renew the policy for the same term without providing any further evidence of their health.

These policies tend to have an expiry date of age 60 or 65. Although the premiums will start at a low level, they will increase at each renewal as the the client is older each time and the risks of death have increased.

Convertible term

A convertible term assurance allows the client to convert the original term assurance policy into an endowment or whole of life policy with the same sum assured before the end of the original term. This can be a valuable option if the client feels that they will need to have more savings than protection at some point in the future, or that they will require the protection for their entire life rather than for a stated time period.

Decreasing term (life cover or family income benefit)

A decreasing term assurance is designed to provide a sum assured that decreases over the term, although the premiums still remain level. Premiums are lower than with a level term assurance policy because the amount of protection provided is constantly reducing as the years pass. These policies are often used as protection for capital and interest repayment mortgages or as a family income benefit policy where, on the death of the life assured, a series of annual lump sum payments will be made to his surviving family over the remainder of the term. For example, Mr Ross sets up a family income benefit policy with a sum assured of £12,000 per year for a 15 year term. If Mr Ross dies after 2 years, the life assurance company will pay out £12,000 per year for the remaining 13 years of the term. If he were to die after 8...

Shortened demo course. See details at foot of page.

...ge loan, to meet the costs of house alterations, to provide for specialist treatment and care or to allow for a stress-free recuperation period. There is no specified maximum level of benefit that can be arranged, although it will be largely constrained by what the individual can afford.

These policies are available as stand-alone contracts, or critical illness can be incorporated as an additional benefit under a term, whole of life or endowment policy. As the chances of becoming seriously ill are much greater than actually dying, the premiums for these policies tend to be high, although the benefits are paid tax-free. Where there is no life cover associated with the critical illness cover, the insurers normally require the assured to survive diagnosis by between 14 to 30 days.

Reviewable critical illness

The fact that medical advances continue to prolong life after many serious conditions, the cost of providing critical illness cover with a guaranteed premium continues to rise. To assist in making the cover more affordable, reviewable policies are starting to emerge. These tend to have premiums that are lower by 15% to 55% compared with premiums for guaranteed policies but they are reviewed every 5 to 10 years. The premium after the review is based on prevailing morbidity rates and take account of advances in medical science – the new premium does not take into account any changes in the policyholder’s health.

Private medical insurance (PMI)

Although every UK resident is entitled to free health care from the NHS, many people choose to buy health insurance so that they can choose the type of care they will receive on illness. Like all insurance policies, the cover available varies - from those that will pay the costs of treatment and surgery only, to those which extend to out-patient treatments involving consultants and specialists.

The cover can be purchased with full medical underwriting, where the premium is calculated depending on the answers given to the medical history questions, or on a moratorium basis, where no health questions are asked but any health conditions suffered in the previous five years will automatically be excluded.

Typically, the policies will not cover:

Treatments already needed when the application is made

Pre-existing conditions

Treatment of chronic conditions

Out-patient and routine treatments

Routine pregnancy, HIV/AIDS, mental health conditions and elective treatments (for example cosmetic surgery)

Long term care insurance (LTC)

As clients get older, they may wish to consider putting in place policies to assist with the cost of long term care. Such arrangements can provide funds to help fund care in the individual’s own home or help towards the cost of moving into permanent care facilities. Some help may be available from the State, but it is important to ensure that the costs can be met without depletion of the individual’s savings or investments. There are two types of policy available:

Immediate care policies  

They are purchased when the care is actually needed. The policy is purchased with a lump sum and then pays out a regular income, which pays for the cost of the care. The costs vary depending on the age of the individual, the amount of income needed, whether the income is to increase annually in line with inflation, and the individual’s state of health. Applicants may have to undergo a medical examination to fully assess their potential requirements.

Pre-funded policies

They are purchased at any age, in advance or anticipation of needing long term care. The applicant is effectively taking out an insurance policy that will pay out a regular income if and when they need to pay for the costs of care. These are no longer sold because they are too expensive for providers to maintain, but some clients may have bought policies of this type in the past.

Any firm advising and selling long-term care insurance (LTCI) must be regulated and will be subject to an enhanced regime where additional professional qualifications are required.

Explain the two types of bonus that are paid on a with-profits whole of life assurance policy.

Answer : Purchase course for answer

In this section, we will look at the retirement planning options available to meet the need for an income in retirement.

State Pension

The basic State pension is now only payable to those who reached State retirement age before 6 April 2016. The amount an individual receives is determined by the number of years for which they have made National Insurance contributions over their own working life. The current rate of basic State pension is up to £156.20 per week (2023/24), this amount being payable after 30 qualifying years.

Retirement after 6 April 2016

The new State pension, which took effect from 6 April 2016, is paid at a flat rate and is currently paid at a maximum of £203.85 per week (2023/24). This maximum is achieved after 35 years of NIC credits (increased from 30 years for the basic State pension), and a proportionate pension is paid if the individual achieves less than this. A minimum of 10 years’ contributions is required for any entitlement to the new State pension.

Some employed individuals may also have additional amounts of pension paid from their membership of one of a number of earnings-related State pension schemes that have been available over the years, detailed in the State benefits section later.

However, regardless of which State scheme(s) an individual is entitled to and how many elements are involved, the actual amount received - even for maximum pension entitlement – is very low when compared to average earnings, and sole dependence on the State for income in retirement leaves many elderly people living in poverty. For these reasons many individuals choose – and are actively encouraged and incentivised by the government - to make additional personal provisions.

Occupational pension schemes

Individuals in employment are frequently offered the opportunity to become part of a pension scheme provided by their employer. This can be either a:

Final salary scheme otherwise called a defined benefit scheme, or a

Money purchase scheme otherwise called a defined contribution scheme

These schemes can either be fully funded by the employer or set up so that both employer and employee contribute to the scheme. These schemes, along with individual pension arrangements, are collectively referred to as registered pension schemes.

Final salary (defined benefit) schemes

These schemes are also known as ‘defined benefit’ schemes, where the members are provided with a pension related to their earnings. Early schemes provided a pension equivalent to a specified fraction (e.g. 1/80 th ) of the member’s final salary for each year of pension...

Shortened demo course. See details at foot of page.

...variety of different products. Most forms of savings and investment products could practically be used towards saving for retirement. However, although these alternatives may provide greater flexibility to the client, they do not benefit from the same tax advantages as registered pension schemes and so the individual may lose out.

When considering the amount of income that a client needs or wants in retirement, and how much they need to save into their pensions to achieve that figure, inflation must be taken into account. The adviser will project figures forward using inflation assumptions to ascertain how much will be needed at retirement to ensure that the current standard of living can be adequately maintained, taking account of the increasing cost of living during the period of saving, and the estimated purchasing power of the savings at retirement.

Other ways to fund retirement

ISAs grow free of income tax and capital gains tax and are a popular vehicle for saving for retirement, despite the lack of tax relief. Pensions are IHT friendly, which ISAs are not unless they are invested in the AIM market and held for at least two years at death. ISAs are particularly beneficial for basic rate taxpayers, who would not benefit from higher rate relief anyway, and for non-taxpayers who would otherwise pay non-reclaimable income tax on dividend income.

Pension holders sometimes choose to buy a purchase life annuity with the tax-free lump sum (pension commencement lump sum, or PCLS) from their pension fund. The income from this type of annuity is made up of part capital and part interest, and only the interest part is taxed -  just the same as if the annuity was bought using non-pension money. Contrast this with a compulsory purchase annuity (sometimes called a lifetime annuity) which is bought with the taxable part of a pension fund. In this case, all of the income it produces is taxable.

Purchase life annuities is a competitive market and the interests rates reflect this. The market for compulsory purchase annuities is captive, and rates are lower.

Members of defined contribution pensions schemes who do not want to buy an annuity - or just not yet -  can take their PCLS and then enter the remaining fund into flexi-access drawdown, which allows the withdrawal of ad-hoc income or lump sums taxable as earned income. Alternatively the member can take one or a series of uncrystallised funds pension lump sums (UFPLS), 25% of each one is tax-free and the remainder is taxable as earned income.

List the three tax advantages from investing in a registered pension scheme.

Answer : Purchase course for answer

The range of products available to meet a client’s savings and investment needs is broad and varied, and from a continually increasing number of providers. However, they are all variations and combinations of the different asset classes available.

All investments are based on one or a combination of types of asset, and the four mains asset classes are:

Cash

Fixed interest

Shares/equities

Property

Deposit-based savings accounts

The funds placed into these products are not actually invested but used by the institution to lend to other institutions and individuals as secured and unsecured loans. These borrowers are charged interest on these loans. In return for depositing the funds, the account holder is paid a proportion of this interest, which increases the value of their deposit.

The rates of interest paid to the depositor will be less than those charged to those borrowing, and this can be at either a fixed or variable rate, depending on the type of account held. Higher rates are often paid if the depositor is prepared to give notice before withdrawing funds. Interest will be added to the deposited funds at different times on different...

Shortened demo course. See details at foot of page.

...urself with these products at the NS&I website at www.nsandi.com.

Taxation

Interest from bank and building society accounts is paid gross. There is a Personal Savings Allowance of £1,000pa available to non and basic rate taxpayers, and £500 for higher rate taxpayers, and interest that falls in the PSA is not taxed. Additional rate taxpayers do not have a PSA. Those with non-savings taxable income less than £5,000 can benefit from up to £5,000 of interest taxed at 0% as this fall in a ‘starting rate for savings income’.

Uses of deposit-based products

Deposit based products play an important part in any savings/investment portfolio. They are an ideal home for emergency funds and short-term savings for periods up to five years, where the capital will remain preserved and an element of growth obtained. As a part of a larger investment portfolio, they can be utilised to provide an element of guaranteed income and capital security over the medium to longer term.

It is also quite sensible for an investor to keep enough available on deposit to be able to take advantage of new investment opportunities as they arise.

Investing is for the longer term, usually putting money in funds in some way linked to the investment markets. Investors are exposed to a degree of risk, but they balance the short-term losses against longer term gains. This is for money individual don’t need immediately. Investments can provide capital growth, income or both.

Fixed interest investments

Fixed interest products include gilts and corporate bonds, and other names for this type of investment include debt securities, and loan stock. These products are effectively loans made by the investor for a fixed term and for a fixed rate of return.

The loans can be made to the Government, companies or local authorities. They can also be loans to building societies (PIBS) and to companies.

Gilts

A gilt is a loan to the Government, whereas bonds are loans to companies.

Gilts and bonds have a ‘nominal value’, which is the amount borrowed that will be returned to the holder of the bond at maturity. However, as they have a fixed redemption value and a fixed term and a fixed rate of interest, their value varies as investors speculate as to future interest rates.

For example, gilts are normally issued in nominal units of £100. The name of the gilt provides the information about it; for example, 5% Treasury Stock 2028 tells us that the gilt is being issued by the Treasury, it will pay a return of 5% interest per year on the nominal amount (£100) and will be repaid at the ‘redemption date’ in 2028. If an investor purchased £1,000 of 5% Treasury 2028, they would receive 5% interest per year on their £1,000 investment and in 2028, the invested capital of £1,000 would be returned in full.

If the coupon paid on a gilt is higher than the interest rates generally available elsewhere in the market, investors (buyers) may be prepared to pay more than £100 for each £100 of nominal value. This is called being ‘above par’. Conversely, if the interest rates generally available elsewhere in the market are higher than the coupon paid on a gilt, investors (buyers) will pay less than £100 for each £100 of nominal value. This is described as being ‘below par’.

Although the nominal yield figure stated in the gilt’s name states the amount of interest that will be paid each year, the real return is the rate of return for the investor and will depend on how much the investor paid for it. The ‘running yield’ demonstrates this, and is calculated as:

Coupon/Price paid x 100%

If Mrs Matthews pays £105 today for 6% Treasury 2028, the real return she will be receiving is:

6/105 x 100% = 5.7%

This real rate of 5.7% is relatively high in the current marketplace, so Mrs ...

Shortened demo course. See details at foot of page.

... advisers will recommend them for direct inclusion in any investment portfolio, although they will construct their recommendations around any shares an investor already holds. They may, however, form a larger part of longer-term investments through funds held in unit trusts/OEICs and ISAs. This gives the potential for increasing income over time as companies become more successful and real capital growth through the value of shares increasing above the rates of inflation.

Property

Property is often considered as an alternative investment in its own right, through direct property purchases, but it can also be purchased indirectly through funds available within unit trusts/OEICs and ISAs.

Direct property holdings can be in either residential or commercial property. Residential property can provide rental income as well as an increase in capital value. Commercial property is generally purchased for rental purposes as the capital value will be influenced by such factors as location, the expansion or contraction of the local community, planning regulations and the supply and demand in the area. Commercial property is also more expensive to purchase and therefore less attractive to private investors.

Consideration also needs to be given to the fact that it may not be possible to turn the investment into cash at the time required if prospective buyers are not readily available. Although property prices are less volatile than equities, it is not a risk-free investment. The risks associated with direct investment into property include interest rates rising, problems with tenants, expensive structural repairs, lack of liquidity.

Having examined the different assets classes that are available for investment, either singularly or in combination with different products, we will move on to consider the actual products available to meet the savings and investment needs of clients.

When we looked at the different asset classes above, we saw how individuals seeking to save or invest can do so by investing directly into them and, in some cases, make significant gains. However, this can require:

Specialist knowledge

Significant amounts of time to monitor the markets and identify the best times to buy and sell

Large amounts of immediately available capital, making this option unviable for many smaller investors

Many insurance and investment companies now offer collective investments, which give professional expertise and management, along with a choice of funds investing in different mixes of the asset classes. This affords the investor an element of protection against loss while offering a greater potential for higher returns.

Income and capital gains from property are taxable unless held within a tax wrapper, such as an ISA or pension.

Collective or ‘pooled’ investments are schemes that allow individuals to contribute relatively small sums, either through regular savings or lump sum investment. The amounts saved by the individual are pooled together with those of other individuals to create a much larger fund. There is a range of funds available from which the investor will choose one or more that meets their objectives for income or growth and is within the amount of risk they are prepared to accept.

Types of funds

The types of funds available under collective or ‘pooled’ investments include:

Managed fund

This is a popular default fund for investors who do not necessarily wish to concentrate on any specific investment area, perhaps due to a lack of investment expertise. It will typically combine investment in UK equities, fixed interest funds, cash and property. Managers will hold and alter specific weightings of each asset type to create the most favourable returns. The balance of investments held in these fund types provides some exposure to capital risk but, through appropriate diversification of assets, managers attempt to limit exposure. This ‘risk management’ approach does not usually produce very spectacular returns.

Cash fund

This type of fund invests in money market, cash-based securities. It is normally used as a ‘safe haven’ for investors during periods when stock markets are poorly performing, as an interim measure when switching between higher risk funds or when the investor is close to withdrawing funds and wishes to ‘crystallise’ any gains already made.

Gilt and fixed interest fund

This fund invests in UK gilts, overseas government bonds and UK corporate bonds. As we saw earlier, the returns from these areas will be steady but not large.  This type of fund is generally considered low risk.

Equity fund

The equity fund invests in UK equities; which ones will depend on the fund manager’s view at any given time. It may be heavily weighted in either larger listed shares or those of smaller companies. These funds are higher risk and performance will very much be based on appropriate stock picking by the fund manager. Generally, this type of fund is considered as medium to high risk.

Overseas equity and international fund

This invests in shares that may secure a high level of earnings from overseas as well as international companies. As we saw earlier, risks could arise not only from the performance of the companies included in the fund, but also from fluctuations in exchange rate values. This type of fund is generally considered high risk.

Property fund

This fund invests predominantly in commercial buildings. These will be split between office, industrial and retail units. The investment manager will take a view at any one time as to which sectors are likely to perform, in order to decide upon the appropriate mix of each. In adverse market conditions, withdrawals from these funds can be delayed for a period of time (‘suspended’) in order to ensure that remaining investors are not unduly penalised by people wishing to surrender. This is because property is illiquid and if such a condition was not imposed, buildings may have to be sold at below market rates to produce cash quickly enough to pay off policyholders wishing to surrender. Generally, funds of this nature are considered medium to high risk.

Distribution fund

Usually with investment bond funds, income and capital gains tend to be reinvested to provide capital appreciation. Withdrawals (by regular encashment) could therefore be from either income or capital gains achieved within the fund. With distribution funds, income generated by the fund (whether from gilts, corporate bonds, shares or property rental) is kept in a separate sub-fund and distributed to bondholders regularly. Thus, the values of the underlying investments are not affected by the investor’s need to withdraw ‘income’. Usually, any income not distributed to the planholder will then be reinvested to provide further units. The ‘income’ withdrawals, however, will still be tr...

Shortened demo course. See details at foot of page.

... is paid at higher rates than capital gains tax. (There is no capital gains tax on gains from investment bonds). Although a higher rate taxpayer can benefit greatly from the 5% allowance when making withdrawals during the term of the bond, they may be liable for tax at 20% on the final gain. Other forms of collective investment may allow them to have a liability for capital gains tax on any gain, which is not only paid at a lower rate than income tax but also benefits from the annual exemption which reduces the actual amount taxable.

Investment tax wrappers

An ISA is not a product in its own right, but a tax wrapper around a savings or investment product. Investors can invest in two different types of ISAs in any tax year - a cash ISA and a stocks and shares ISA. The ISAs can be with the same or different providers.

The stocks and shares ISA is normally considered a longer-term investment and is likely to consist of individual shares, bonds or collective funds.

There is no income tax or capital gains tax on the growth within an ISA, so it is particularly suitable for higher rate and additional rate taxpayers.

Individual Savings Accounts (ISAs)

OEICs, investment trusts, unit trusts, individual shares and fixed-interest investments are all eligible to be held within an ISA wrapper, giving them favourable tax treatment. Shares received from approved share schemes for employees can also be transferred into an ISA wrapper with no liability for tax arising.

To hold a stocks and shares ISA, an investor must be aged 18 and resident in the UK. There is an annual maximum permitted investment of £20,000 per year (2023/24). It is possible for an individual to withdraw money from their cash ISA and replace it in the same year without it counting towards their annual ISA subscription limits, but not all providers allow this much flexibility.

Child Trust Funds and Junior ISAs

Individuals born between 1 September 2002 and 3 January 2011 were eligible for a Child Trust Fund, which is no longer available. CTFs were available in 3 types: a cash account, a stocks and shares account and a stakeholder account. They were started off with a Government voucher of £250 once the child was registered for Child benefit.

Junior ISAs are available to anyone born before 1 September 2002 or after January 2011. There is no Government bonus. There is no restriction as to how contributions may be split between cash and shares. The investment limit for 2023/24 is £9,000, and existing CTFs can be transferred into Junior ISAs.

The Lifetime ISA

This has been available since April 2017 to individuals between the ages of 18 and 40 as a means of saving for their first home or for retirement. The annual contribution limit is £4,000, to which the Government will add a 25% bonus (£1,000). £1,000 will be added for every £4,000 contributed before the saver’s 50th birthday.

The saving can be used as deposit for the individual’s first home (up to £450,000) anywhere in the UK. Those with a Help to Buy ISA (which are no longer available to new investors)can transfer their savings into a Lifetime ISA or continue to save in both (although they can only use the bonus to buy one house).

If the saver chooses to save for their retirement instead, they will be able to take out all of their Lifetime ISA funds, including the Government bonus, after their 60th birthday. If they wish to withdraw before then and they are not using the money to buy their first house, they will lose all of the Government bonus and pay a 5% penalty.

Platforms

A platform is a proprietary system that provides investors with access to a selection of collective investments, effectively allows investments to be held and dealt more conveniently. Among the products that can be held on a platform are ISAs, OEICs, offshore bonds and pensions. They offer the facility to switch between holdings from different investment companies quickly and relatively cheaply. Investors an also aggregate holdings from different companies on the same system

List advantages of collective investments.

Answer : Purchase course for answer

Derivatives

A derivative is not an investment in its own right but one which obtains its value from the underlying product to which it is linked. They are highly volatile investments, but they can produce exceptional returns if purchased at the right times. A derivative is a rig...

Shortened demo course. See details at foot of page.

...ed rate and interval, and some or all of the capital returned at maturity)

A derivative (a financial instrument linked to the value of something else such a stock market index, or the price of an asset like gold. This part provides the potential growth on the structured product

The estate of an individual may become liable for inheritance tax on their death. Some individuals may also incur an IHT liability as a result of gifts of assets made during their lifetime. To mitigate the liability, policies can be taken out to provide the funds to pay the tax when it falls due.

The IHT Nil Rate Band (NRB) is £325,000 per individual for 2023/24 and any unused proportion of this may be transferred to a surviving spouse on death (married or civil partnership). A new dedicated main residence relief was introduced in April 2017 – the Residenc...

Shortened demo course. See details at foot of page.

...y the tax due and will receive the full amount of the estate that has been left to them.

Where a whole of life policy is being used, it is advisable to consider a policy with built in increasing cover, or to carry out regular reviews to ensure that the sum assured is still sufficient to cover the increase in the estate’s value resulting from inflation.

Explain the benefits of placing a policy which is intended to meet an inheritance tax liability into a trust for the intended beneficiaries of the policyholder’s estate.

Answer : Purchase course for answer

In the previous sections, we examined the products available to meet the range of financial needs that an individual may have. In some instances, we highlighted how the sums assured or the benefits payable would take into account any State benefits that the individual may also be entitled to. In this section, we will examine the main State benefits available, including how they are funded, who they are available to and how the amounts available to different individuals are calculated.

State benefits are funded through the National Insurance contributions (NICs) paid by the employed, self-employed and employers; they are effectively a further tax. They are not paid by individuals under the age of 16, even though they may be working and have earnings, nor are they paid by those over State pension age. However, if an individual over State retirement age is still working, their employer will have to continue making contributions.

NICs are paid to Her Majesty’s Revenue and Customs (HMRC) and these are then passed on to the Department of Work and Pensions (DWP), who administer all State benefits.

The system of social security benefits provides financial support for people who are:

Unemployed and looking for work

On a low income

Bringing up children

Retired

Caring for someone

Unable to work due to sickness

Disabled

The range of State benefits available is extensive and in this section we will examine only the most commonly claimed benefits. Full details of all benefits is available directly from the DWP or from Post Offices.

Some State benefits are only paid to claimants who have paid sufficient National Insurance contributions (NIC) to qualify, while others are paid regardless of the individual’s NIC contribution record. Some benefits are means-tested on income and others means-tested on the amount of savings or capital an individual may have. Some benefits are taxed while other benefits are not.

These factors can have a significant influence on the level of private provisions needed when undertaking any financial planning advice, so we will also highlight the factors that need to be considered.

You can see the current rates for these benefits on the DWP website www.gov.uk.

The Benefit Cap

The Benefit Cap was introduced as part of the Welfare Reform Bill, which received royal assent on 8 March 2012. From April 2013, a ‘cap’ has been placed on the total amount of benefit that working-age people can receive. This cap aims to ensure that households where no one is in employment do not receive more in benefits than the average earnings of working households.

The cap applies to the total amount of benefits a household can receive from:

Bereavement Allowance (if received before 6 April 2017)

Child Benefit

Child Tax Credit

Employment and Support Allowance (unless you receive the support component)

Housing Benefit

Incapacity Benefit

Income Support

Jobseeker’s Allowance

Maternity Allowance

Severe Disablement Allowance

Universal Credit (unless deemed unfit for work following a capability assessment)

Widowed Parent’s Allowance or Pension

The level of the cap is:

£384.62 per week for single parents whose children live with them (£442.31 in London)

£257.69 per week for single adults with no children or whose children do not live with them (£296.35 in London)

The cap does not apply to those who qualify for working tax credit, gets universal credit or receives any of the following:

Disability Living Allowance

A...

Shortened demo course. See details at foot of page.

... State Earnings Related Pension Scheme (SERPS)

The State Second Pension (S2P)

State Pension Credit

The amount of basic or new State Pension paid to an individual depends on the number of ‘qualifying’ years the person builds up, prior to reaching State pension age. A qualifying year is a tax year where the person has paid, or is deemed to have paid, sufficient NICs. The achievement of sufficient NICs will generally be Class 1 NICs for employees, Classes 2 and 4 for the self-employed and Class 3 for voluntary contributions. Class 3 NICs are usually paid to those who want to build up more qualifying years.

The basic State Pension and new State pension are not means-tested in payment. They are paid gross and are subject to income tax when added to any other income the recipient receives in that tax year. It is possible to defer taking the State Pension, which will allow the person the ability to get a larger pension when they do later take their benefit.

Previous earnings-related State pension schemes

Some employed individuals may also have additional amounts of pension paid from their membership of one of a number of earnings-related State pension schemes that have been available over the years, such as graduated pension scheme, SERPS or S2P. These additional elements are also only available to those who retired before 6 April 2016, and only to those who were employed, as opposed to being self-employed (i.e. they paid Class 1 NICs):

The State Graduated Pension was introduced in 1959 and benefits built up until 1975. Each year, earnings above a stated level gave an entitlement to an additional pension on retirement. Initially, there was no inflation proofing of the pension earned, so today these benefits are worth only a few pounds each year

In April 1978, the State Earnings Related Pension Scheme (SERPS) was introduced. The original aim was that the final pension was to be based on an individual’s best 20 years’ earnings (in a specified band), revalued in line with growth in National Average Earnings, giving a maximum pension of 25% of band earnings

From April 2002, changes were made to SERPS with the introduction of a new scheme called the State Second Pension (S2P), which focused more on low paid workers. This allowed them to build up a better pension than would have been possible through SERPS. At its introduction, those earning under the Lower Earning Threshold would receive a pension of twice what they would have received under SERPS

All earnings-related elements had a maximum level of earnings above which no additional benefits built up. High earners, even those receiving a full State pension, will therefore find that the total State pension they receive will be a much smaller proportion of their earnings.

Those who retire after 6 April 2016 but who have a record of second pension contributions will be paid ‘protected payments’ if their entitlement under the old system works out higher than under the new system (taking account of any periods when the individual was contracted out, and the corresponding entitlement they will receive from the provider concerned). This is referred to as their ‘starting amount’.

State Pension Credit

It is paid to people who retire on a modest income, to ensure they have a minimum stated level, and is therefore means-tested. This benefit is not usually available to those who retired on or after 6 April 2016.

List the State benefits paid to those unable to work through illness or disability.

Answer : Purchase course for answer

This revision test (opens in a new window) has 30 questions...

Shortened demo course. See details at foot of page.

...udy time 7 hours

12 standard multiple choice questions in the R01 exam