Financial planning practice

This audiovisual presentation provides a brief introduction to gathering client data.

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After establishing the client/planner relationship, the financial planner will set about determining the client’s needs, objectives and aspirations. These can be interlinked, but broadly:

A need is a requirement for capital and/or income that the client may have in the event of, say, death or illness to maintain their and/or their dependants’ standard of living;

An objective is the amount of capital and/ or income that the client may require in the future to meet defined expenditure (e.g. providing income in retirement, paying for a child’s wedding, purchasing a house or holiday home etc.);

An aspiration is something that the client would like to achieve in the future, but it is not as firm as an objective. Over time, aspirations may become objectives. An example of an aspiration could be “it would be nice to take a cruise when we retire”.

Even where clients have clear goals in mind, they can sometimes have unrealistic expectations of what can be achieved or misconceptions about one area or another. During the factfinding process the planner may also identify needs that the client was unaware of or had not considered, typically in the area of financial protection. Other needs commonly overlooked include the need to replace a company car on retirement or redundancy, or the additional costs involved in education planning, such as books, uniforms or school trips.

One way of differentiating between objectives and aspirations is to check whether they are SMART – Specific, Measurable, Achievable, Realistic, Timescaled. An objective must be SMART, whereas an aspirat...

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...years or when the children’s education they are funding for will start and finish. The time horizon will impact on the financial plan in a number of ways – it may influence the level of investment risk that is taken, the amount that is set aside regularly or as an initial lump sum as well as the cost of most types of financial protection policies.

Objectives can generally be divided into short, medium and longer-term objectives. What may be a long term objective for one client may be a short term one for another and vice versa, as clients will have different needs and be at different stages in life.

Taking an ‘average’ client in their 30s with a young family, some of their qualitative objectives could be as follows:

Short term objectives

Medium term objectives

Long term objectives

Build up an emergency fund

Pay off high interest debts

Financial protection for family

Extend/Move house 

Save for the children’s education

Save for special family holiday

Save for retirement

Pay off mortgage

Address IHT Liability

With most clients facing budget constraints to one degree or another and often unable to address all of their objectives initially, one or more objectives may need to be sacrificed, scaled back or postponed, although how many and to what extent won’t become clear until after the planner has carried out their full analysis. The next section on prioritisation deals with this in more detail.

What is the difference between a qualitative objective and a quantitative one?

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Most clients will have multiple needs and objectives but will usually not be in a position to address them all at the same time. As such they will need help in prioritising which are the most important and which should be postponed or even sacrificed.

Most clients realise that they may not be able to afford to achieve all of their needs and objectives, so they may need to think about which may be the most important to achieve.

Whilst the prioritisation should be the client’s choice (to ensure that each objective remains the client’s objective), the PIPSI acronym may help.

P rotection

I ncome Protection

P ensions

S avings

I nvestments

 

This is a traditionally established order of importance; however, each client is, of course, individua...

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...nd private education for children

Year off work for a sabbatical

Retire early

Once the essentials have been taken care of, any ‘desirable’ objectives can be planned for in the required order. Whilst this may seem obvious, the natural tendency of most of us is to try and attain short term goals or those most desirable to us at the expense of those that we really should be tackling first. The planner’s task is to make the client aware of what is really most important and the consequences of not addressing these areas. Once the client’s priorities are established then their needs and objectives can be developed in more detail.

What is the acronym that gives you a basic order of priority for financial objectives?

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Advisers should have a broad understanding of the main financial concepts required to analyse and develop a client’s objectives further. Five important concepts are:

Compounding

Discounting

Inflation

Risk

Time Frames

Compounding

Compounding occurs when the returns of an asset are reinvested alongside the original capital. In other words, as well as growth on the capital you get growth on the growth. At the beginning this ‘growth on the growth’ won’t amount to much but as time goes by it will increase the overall return considerably.

This might often be overlooked by a client when they’re considering potential returns, they might believe for example that £100,000 invested over 5 years and growing by 7% would return them £135,000 (£7,000 of growth per annum x 5). The return would in fact be £140,255 (ignoring tax and charges and based on growth being added annually).

The formula for compounding a lump sum is FV= PV (1+r) n , where:

FV = Future Value

PV = Present Value

r = rate of return

n = time period

The effects of compounding when illustrated, particularly over the longer term, can be a great encouragement to save regularly and to start saving early. Obviously the greater the return achieved the greater the impact of compounding.

Discounting

The flip side of the compounding calculation is discounting, which tells you how much you...

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...he case.

Timeframes

Timeframes make a big difference – the longer the timeframe the less the client will need to invest at the outset to achieve a given sum (where the same growth rate is assumed each year). Where the client has a longer term to invest, say 20 years compared to 5, they will need to take less risk in order to achieve their goal as a lower rate of return will be required.

Consider the rate of return that would be required to turn £100,000 into £200,000 over different time periods:

Timeframe

Annual Return required

5 years

10 years

15 years

20 years

14.87%

7.18%

4.73%

3.53%

A longer time frame also compounds the effect of good investment growth. Returns of 6%pa instead of 5% pa might not mean much over 1 or 2 years, but over 30 years the compounded effect could be huge.

The next table shows the effect of a 1% difference in return over longer timeframe on an initial £100,000 investment:

Timeframe

Return @ 5%

Return @ 6%

Difference

1 years

3 years

5 years

10 years

20 years

30 years

105,000

115,763

127,628

162,889

265,330

432,194

106,000

119,102

133,823

179,085

320,714

574,34

+1,000

+3,339

+6,195

+16,196

+55,384

+142,155

What is the real growth rate on an investment where nominal growth is 6% pa and inflation 3.5% pa?

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In order to formulate suitable recommendations for the client, the planner will first need to assess their personal and financial situation. To do this they will have to gather a variety of information, a process which is commonly known as ‘factfinding’. Most firms will have a standard ‘factfind’ or questionnaire document to aid with this, which will have numerous fields where all the relevant information can be gathered including personal and financial information. Some planners will input the data directly onto a computer based factfind, whilst others prefer to complete a paper copy.

Ideally the factfind can be completed in one easy meeting where the client has all the information ready to hand for the planner to record or, even better, the planner may have sent the factfind to the client who has completed it in advance of the meeting. Aside from face to face meetings, factfinding can also be completed over the telephone, by email or via other forms of correspondence. Often however the information required will not be available straight away and some of it may need to come from various sources over a longer time period, for example:

Source

Typical information required

Employer/HR department

Exact details of income, benefits in kind, sick pay, occupational pension arrangement...

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...ument, whether in print or in digital format, will ensure that none of the fundamental questions are missed and also ensures that there is some kind of logical order to the questions and the planner is not flitting back and forward between the same areas.

There is no small measure of skill in obtaining the necessary information and planners will quickly need to gain the trust of the client in order to deal with some of the more sensitive issues that need to be covered. They will also need to be skilled at explaining technical terms or jargon in plain English and in a way that the client will understand. “What if?” questions may also be useful where the client needs to be prompted to think about certain scenarios they have not yet considered, for example “what would happen to you financially if one of you were to lose your job or be unable to work due to illness or accident?”

Open questions will be used when trying to determine general objectives, such as “what are your plans for retirement” whereas closed questions need to be used when trying to determine precise information such as whether or not an employer pays into a pension scheme for them.

What information will the financial planner want to gather from a client’s solicitor?

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Typically, the factfinding process starts with gathering personal information such as:

Name

Address

Phone number(s)

Email address

Date of birth

Marital status

Family and financial dependants

State of health

Smoker status

Residence/domicile for tax

A client’s name and address need to be confirmed through documentary evidence to comply with Anti -Money Laundering regulations and typically a separate form of identity will be required to prove both name and address, for example a passport or driving licence as evidence of name and a recent utility bill or bank statement as evidence of address. Some firms are able to confirm identity via an electronic check, although this will normally be for individual, UK resident clients only.

Email addresses are particularly useful, as corresponding by email will allow a client to answer in their own time and attach documents that the planner may require for information or analysis. Email correspondence can also help to avoid misunderstandings in future as there will be a written record of the email conversation.

Once you move into the area of marital status, family and health it may be useful to explain to the client why this personal information is needed – some clients may have complex famil...

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...state of health as the discount is determined by life expectancy. Clients with health issues may also qualify for an enhanced or impaired annuity.

Whilst most clients will be resident and domiciled in the UK, some may not and this will have considerable tax implications for them. This is particularly true of US citizens who need to declare worldwide income on US tax returns regardless of residence – advising on US citizens is a specialist area and many firms will not take them on due to the complexities involved. Non-UK- domiciled clients will be subject to taxation on the remittance basis (and not UK income tax or CGT) for overseas income and gains if they meet certain criteria, unless the funds are remitted to the UK. Where a spouse is non-UK- domiciled then the normal unlimited spousal exemption for IHT does not apply and is capped at £325,000 (in addition to any available nil rate band). Non domiciled spouses or civil partners can elect to be treated as UK domiciled for IHT purposes in order to avoid the £325,000 limit, however this will also result in them being subject to IHT on their worldwide property (instead of just their UK property).

Why is a client’s marital status particularly relevant for IHT?

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The financial planner will then require details of the client’s:

Income

Employment or Self-Employment

Expenditure

Assets

Liabilities

The planner will need to determine the client’s total income from all sources. As well as the gross figures, their net income after income tax and National Insurance contributions will need to be ascertained. This will help determine the surplus income available to commit to their financial planning needs once their expenditure is taken into account and can also be used as a check to ensure that the client is paying the right level of income tax.

It is also important to differentiate income from different sources, which will be relevant in a number of ways. As an example when planning for retirement, the planner will need to determine the level of ‘UK relevant earnings’ the client has, as the amount of tax relief they can have on their pension contributions is normally restricted to the higher of £3,600 or 100% of UK relevant earnings. The definition of relevant earnings however excludes rental income, investment income and dividend income, all of which might make up part of a client’s total income position.

Clients in employment are likely to have a number of benefits and possibly benefits in kind in addition to their basic salary. Over the course of the next few years, as automatic enrolment is fully implemented, it will be less common to come across clients who are not members of an employer pension scheme. Employed clients may also benefit from a death-in-service benefit, which would typically pay out a multiple of salary on their death. Other common benefits they may be entitled to include Private Medical Insurance, Income Protection, as well as Save As You Earn schemes or Share Incentive Plans which may impact on tax planning. Clients may also receive regular bonuses or commissions which could, for example, be taken into account when applying for a mortgage.

These benefits will need to be taken into account when determining whether the client has any shortfalls in their retirement provision or financial protection needs for example, so it is vital to get accurate information on all of these benefits. In some cases, a client may even need to be advised to opt out of their employer pension scheme to av...

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...rity date

Original investment dates and amounts, withdrawal details : these details are particularly relevant when considering an encashment as they will help the planner calculate any potential liability to tax.

When armed with all the relevant information the planner will want to determine whether the investments are suitable for the client or whether the existing investments need to be amended or even replaced.

When it comes to considering a client’s liabilities, the planner will need details of the type of borrowing, term, interest rate (and whether fixed or variable) and repayment amounts. Clients should be encouraged to request a credit report from one of the major credit rating agencies, especially when considering further borrowing such as a mortgage or remortgage. This will allow the planner to assess their chances of acceptance for certain products and will also flag up any errors or inconsistencies on their credit file.

The most common liability for most people will be a mortgage. Many mortgage deals have certain rates or terms and conditions that run for a few years then revert back to something else, for example a fixed rate of 3.5% for 4 years which then reverts to the standard variable rate. It may be possible for the planner to secure a much better deal for the client where the original terms have expired.

Another liability that the self-employed client may not necessarily bring to the planner’s attention is their income tax and National Insurance bill and possibly VAT. Whilst it would be prudent for the self-employed to put aside a certain portion of their income regularly to cover their bill from the HMRC, it doesn’t always work that way for a number of reasons including cash flow requirements.

Planners may occasionally come across clients with large levels of debt which already are or may become unmanageable for the client. Where other assets or savings are available, clients should be advised to pay off some of this debt, starting with the most expensive borrowing first. Where there is nothing available to reduce the overall level of debt, the client may need to be referred to a professional debt counselling service.

Of which liability might a self-employed client well omit to tell their financial planner?

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Aside from personal and financial information, the planner will need to gather details on:

Protection policies

Wills and trusts

Pensions

Protection policies

The basic details of any protection policies held should be recorded, such as type and level of cover, lives assured, premium amount, whether the premium is reviewable or guaranteed and whether it remains level or is index-linked. It also important to ascertain whether or not the policy is held in trust and if so who the trustees and beneficiaries are as well as the type of trust used. Policies may also be assigned, typically to a mortgage lender and this should also be checked.

As well as the basic details any special features or options should be confirmed in detail. Additional options may include waiver of premium, the option to increase or renew cover or to increase the term. Critical Illness policies can vary considerably in what they cover and a policy booklet may be needed to explain the exact conditions covered and, in particular, the provider’s definitions of each condition covered. These definitions have become more and more restrictive in recent years and older policies may have much more generous criteria, particularly regarding cancer conditions.

Some protection policies will have an investment element and accrue a surrender value on encashment. The policy may or may not be subject to income tax on any chargeable gain depending on whether or not it is a ‘qualifying policy’. As such, it needs to be confirmed whether or not the policy is qualifying and if so whether it is a ‘protected policy’, which is one issued prior to 21 st March 2012. If the policy has been issued after this, different rules will apply.

One final thing worth checking is the smoking status of the client compared to when the policy was taken out. If, for example, the client was a smoker when they took the plan out and have since given up, t...

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...h). It is also useful to check on the funding position of the scheme, particularly where the client is concerned about its financial security.

For DC schemes, the planner will want to know the current fund and transfer values, details of the charges on the plan and any penalties that apply, where the plan is invested and the alternative investment choices available. When analysing a DC scheme, the planner will generally compare it to what is available in the marketplace in case there is something that better meets the client’s needs, particularly where clients hold ‘out of date’ plans – a typical example would be an older plan where the only investment choice is with profits and the bonus rate has consistently been under 1% per annum. They will also want to check whether the existing contract allows flexi-access drawdown or UFPLS.

Another thing to check on DC schemes is whether any guarantees apply – many older plans, particularly Retirement Annuity Contracts (RACs) which were the predecessors of personal pensions, have guaranteed annuity rates attached to them. These rates are generally far superior to annuity rates on the current market as they were devised at a time when annuity rates were much higher. As well as guaranteed annuity rates, some plans have guaranteed minimum growth rates or guarantees that the value of the fund will not fall below the original investment amount. Other plans may benefit from ‘loyalty bonuses’ or discounts. All these types of benefits can be potentially very valuable and are generally no longer available on new pension plans.

State pension benefits should also be taken into consideration and an estimate of the client’s state pension entitlement can be requested from the Department for Work and Pensions using form BR19.

Why should clients be advised to make a will where they have not already done so?

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The financial planner must be able to help clients identify their financial objectives and to develop them into clearly definable and measurable goals...

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...xercised to ensure that only relevant information is gathered, otherwise the factfinding process can become intrusive and even annoying to the client.

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...test will be added to your CPD certificate.