UK Financial Services, regulations and ethics

In this chapter, we introduce the concept of financial needs in the future including retirement planning, long term care, saving and investing and estate and tax planning.

Introduction

Many people fail to consider their retirement planning until it is too late to make adequate preparations, despite wanting to maintain the same if not better standard of living. Very few members of occupational pension schemes retire on maximum benefits (many receive only 20% - 30% of pre-retirement earnings) and for many othe...

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...or example, there is a financially dependent spouse.

Previous and current arrangements

Need to deduct any existing provision from the total income required at retirement to find out the additional funding required.

State provision

Need to include within pension provision needs the:

Basic State Pension/Single tier state pension

Top up schemes e.g. S2P, SERPS, Graduated Pension Benefits

Any current personal pension arrangements

The State Pension is examined in more detail in a later chapter.

Listed below are the main sources of recognised pension provision that a client may have. Needless to say, most forms of savings and investment could be practically applied towards retirement and these alternatives may provide some flexibility to the client in exchange for them not losing out on some of the specific tax and benefit advantages offered under registered pension arrangements and State benefits.

State

Funded by National Insurance Contributions

Individual & Occupational

HMRC rules determine:

Amounts that can be contributed

Tax relief available

How tax relief is given

Additional benefits that can be included

Death before retirement benefits

Age at which benefits can be taken

Format that benefits can be taken in

Individual pensions and some occupational pension schemes are contribution led.

Occupational

Rules determined by pensions legislation and policed by HMRC

Areas covered by rules are broadly similar to individual pensions

Some occupational schemes are benefit led, i.e. maximum pension benefits are determined at retirement by certain limits set by the scheme (althou...

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...oyer must re-enrol the individual every three years. For those earning less than £10,000 but more than £6,240 in the 2026/27 tax year, automatic enrolment is not essential, but the individual can ask to be enrolled. If they do become enrolled, the employer must make contributions for them.

Both employers and employees must make contributions to the scheme and from April 2019, the minimum contribution is 8% including tax relief, with a minimum of 3% paid by the employer. The employer can if they choose to pay the full 8%, with contributions in the 2026/27 tax year paid on earnings in excess of £6,240.

To help employers meet their obligations under automatic enrolment, the Government introduced the National Employment Savings Trust (NEST), a pension scheme that complies with the automatic enrolment rules and can be used by any employer who did not previously have a pension scheme that met the requirements to be classed as a qualifying pension scheme. A qualifying scheme is one which meets the minimum requirements in terms of contributions for defined contribution schemes and benefits for defined benefit schemes.

ISAs can be used to provide a fund free of tax

The Lifetime ISA launched in April 2017 is available to those aged over 18 and under 40. A Government bonus of 25% is paid on the amount in...

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... and the income element is paid net of 20% tax. Higher and additional rate taxpayers will have an additional liability through their self-assessment tax returns for 20% and 25% respectively

Introduction

The constant developments in medical science have led to an increasing number of elderly people surviving illnesses that would previously have resulted in their death. However, this increased longevity frequently results in a need for long term care. They may be able to have this provided through additional support in their homes but for many this requires them to move into residential nursing homes. As the cost of full-time nursing care is high and constantly rising, many elderly people look to take out long term care insurance (LTCI) and are seeking advice in this area.

Providing advice in this area can be highly complex as there are many factors to take into account, such as the interaction of any insured arrangement with State benefits. The regulator therefore views this area as ‘high risk’ and those providing advice in this area are required to have specialist training and obtain qualifications specific to this area.

FCA definitions

The FCA definition of long term care insurance is as follows:

“Long term care insurance is a long term insurance contract:

(a) Which provides or is intended to provide benefits that are payable or provided if the policyholder’s health deteriorates to the extent that he cannot live independently without assistance and that is not expected to change; and

(b) Other benefits that are capable of being paid for periodically for all or part of the period that the policyholder cannot live without assistance

Where ‘benefits’ are services, accomm...

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...s determined following an assessment by the local Integrated Care Board (ICB).

Where the cost of care is privately funded, an individual who has reached their State pension age can claim Attendance Allowance. This is a tax free and non-means tested benefit. Individuals under State pension age may qualify for Personal Independence Payment (PIP).

If a claimant applies for local authority payment of their care costs the local authority will undertake a financial assessment to check the claimant’s ability to pay the fees out of their capital assets and/or income. Local authorities have a duty to:

Assess someone’s care needs following a request

Determine by means test or financial assessment whether the local authority should fully or partially fund the care required

Determine maximum fee levels

Care needs to be taken if an individual transfers an asset out of their name to someone else. Where the local authority can prove that a transfer was done deliberately to reduce the individual’s capital that would otherwise be means tested, the local authority can treat the individual as having ‘notional capital’ to the value of the asset disposed of. There is no time limit with regards to when transfers are made; therefore, local authorities can look back further than just the period immediately preceding the assessment. Deliberate deprivation of assets is illegal and the local authority could claim back the cost of care fees plus all the legal costs through the courts, which could end up being very expensive.

Introduction

Most clients wishing to build up funds for future use are likely to want the value of their funds to grow quickly but may not be prepared to let the value fall, two objectives that conflict with each other. The amount that will ultimately be achieved will be affected by the amount of risk a client is willing to take and it is vitally important that they are aware of and understand the risks involved in different types of savings and investments products.

Regular savings is the term used when a client is regularly putting aside small amounts of money aiming to achieve a larger lump sum in the future. Where a larger sum of money has either been accumulated over time or arisen as a result of an inheritance or windfall and is being placed into a product to either continue to grow or maintain its value, it is referred to as lump sum investment.

Before starting to save or invest, everyone should have an emergency fund of immediately accessible cash at around three to six months’ monthly expenditure. The reason why someone is saving will influence the timescale and the products which might be suitable to achieve the goal. Short-term savings covers a period of up to five years, medium-term from five to 15 years and long-term more...

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...cise the option—since buying the asset in the open market would be cheaper. In that case, the buyer would let the option expire and lose only the premium paid.

Derivatives are typically used by professional investment managers to manage risk in large portfolios and are not commonly used by individual private investors.

Investors can choose to invest in any asset class, each carrying different levels of risk. Diversification—spreading investments across various assets—can help reduce (though not eliminate) these risks, as it avoids relying too heavily on a single investment.

Investment can be made directly into each class, with each having different levels of risk or the risks can be reduced by diversifying across the asset classes – not putting all your eggs in one basket.

Alternatively, investors can invest into the asset classes through collective or pooled investments. With these products, the money of all investors is placed into a chosen fund (a large range are available to meet different objectives and risk profiles) and professionally invested by a fund manager.

There are also tax wrappers – ISAs and pensions – where the investments are held in an environment where no tax is paid on the growth.

Collective investments (otherwise known as pooled investments) are schemes that cost-effectively allow individuals to contribute relatively small sums either through regular savings or lump sum investment. The amounts saved by th...

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...example of this is a tracker fund which will aim to track the movements of a particular index, for example, the FTSE 100.

We shall now go on to consider some of the more popular types of collective scheme in the next sections.

Unit trusts are collective investment schemes set up under trust deeds. They are run by both trustees, who have the responsibility of holding investments and overseeing the operation of the trusts, and managers, who are responsible for the day-to-day management of investment assets within the trust. We will explain the detailed roles of the trustee and manager later on.

As pooled investments, they allow investors to participate in a mix of stocks and shares with other investors, thus benefiting from diversification even though they may only have relatively small amounts to invest.

Unit trusts create ‘units’, each of which is an identical proportion of the total assets of the trust. Most often, the assets of the trust will comprise mainly share or bond holdings. Where further funds are placed into unit trusts, new units can be created thus increasing the overall net asset value of the unit trust. This is why these schemes are termed as open ended. When investors wish to redeem units they are bought back by the unit trust manager (who may use these in place of creating new units for new investors).

There are two main types of unit that can be ...

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...Pricing and charging of unit trusts

The valuation of a unit trust is dependent upon the values of the underlying assets within the fund adjusted for charges.

Bid/offer spread

If the company is using a dual pricing system, then two prices are quoted:

The buying price (offer price) is the price at which units are offered for sale to the investor

The selling price (the bid price) is the price at which the fund managers buy back the units, and this is usually 4-5% below the buying price

The difference between the buying and selling prices is the bid-offer spread. Managers may elect to convert to a single price system.

Annual management charge

There is also an annual management charge in the region of 0.5%–1% per year, but this will vary with the underlying assets and any special function that the fund might offer (e.g. monthly distribution payments). This is normally deducted from the trust’s annual income but is charged to capital is some circumstances. Discretionary portfolio managers may make two levels of charges – one to pay the manager of the underlying assets and one to cover the over portfolio management service.

Open ended investment companies (OEICs) are similar to unit trusts in that they are a diversified collective investment scheme. They are otherwise known as investment companies with variable capital (ICVCs).

Their legal structure is that of a limited liability company constituted by an instrument of incorporation and managed to maximise investment returns for investors.

Investors’ interest in the fund is in the form of shares (rather than units). The fund is open ended so that issues to and redemptions by investors are met with corresponding increases and decreases to the company’s share capital and assets. Investors purchase shares in OEICs in t...

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... will then apply to both purchasers and sellers of shares within the OEIC. Where appropriate, any entry (initial) and exit charges are shown separately, which can be up to 5%. OEIC managers can use a dual pricing system (like unit trusts) if they wish.

Annual management charges vary, typically between 0.75% and 1%.

Dealing and management

Very similar to unit trust dealing. The ACD will issue a contract note for each trade and may also issue a share certificate.

Taxation of OEICs

OEICs are taxed in the same way as unit trusts, capital gains on disposal are liable to CGT and income is subject to income tax, either as dividend or savings income.

Offshore f...

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...porate.

Investment trusts are a type of collective investment scheme where many investors pool small amounts of investment resources together in order to achieve greater diversification. The name investment trust (ITs) is slightly misleading in that these collective investment schemes are not trusts, and are actually structured as listed limited companies that invest in other companies.

Investors have the right to vote at AGMs, receive a share of profits in the form of dividends and receive a share of the investment trust’s capital on wind-up

As a...

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...e an investment trust can borrow money and partly because the share price doesn’t necessarily reflect the underlying net assets value of investments.

The shares are subject to dealing costs and an underlying management charge of between 0.75% and 1%.

Taxation

Dividend income is subject to income tax in the same way as an equity based unit trust

Gains on disposal are subject to capital gains tax

Investment trusts can be held within an ISA wrapper, in which case all income and capital gains made by the investor will be tax free

Individual Savings Accounts (ISAs) are not investments themselves but, rather, a flexible, tax-efficient savings wrapper within which a wide range of savings and investment products can be held virtually tax free. There are many ISA providers offering tax-efficient savings through a wide range of investments products.

Investors can subscribe to a:

Stocks and Shares ISA – which includes equities, unit trusts, OEICs, investment trusts, life assurance, gilts and corporate bonds

Cash ISA – which includes National Savings & Investment products, bank and bu...

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...and those who already had a Child Trust Fund could continue saving into their CTF or transfer the funds from the Child Trust Fund to a JISA. In the current tax year up to £9,000 can be invested and can be split between a cash or stocks and shares JISA, but funds cannot be withdrawn until the child reaches age 18. Contributions can be made by parents, grandparents, other family members and friends.

Lifetime ISA

Lifetime ISAs became available in April 2017 for those aged between 18 and 40. They provide a tax advantageous way of saving for a house purchase or retirement.

Open-ended life insurance funds are run by life insurance companies and can be accessed through their life and pension products. They are designed to produce medium to long term capital growth but can provide an income through encashment of units in the fund. The underlying investment fund is broken down into identical units (unit linking), and the investment made by a client purchases a number of units in the fund. The units have two prices - an offer price at which the units are bought and a lower bid price at which the units are sold. The difference between the two is known as the bid-offer spread and is, in effect, a charge.

There are a variety of funds available to investors to meet different needs and risk profiles, which normally include general equity funds investing in a variety of shares across a range of sectors, property funds, cash or guaranteed funds, distribution funds, managed funds and protected equity funds. Whichever fund is chosen, the investor is exposing themselves to the risks associated with the underlying investments and the value of the inv...

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...estor will buy units at the offer price and sell at the bid price

Some funds will apply 100% or more of the investment towards purchase of units (though still with a bid-offer spread) and others may apply a lower allocation. Often this depends upon the amount invested

Penalties may be applied to certain funds on surrender, either because of the length of time the investment has been held, or because of adverse market conditions

An annual management charge will be applied to the fund. This can commonly be around 0.75% to 1.00% of the fund value with unitised funds

Volatility

The level of volatility of respective funds will vary considerably from very low for units within a cash fund to very high if held within a specialist equity fund

Volatility in terms of fund value will also be affected by any charges that may apply to the fund on encashment

Access

As mentioned earlier, accessibility to funds will not usually be a problem but could result in some kind of early surrender penalty being applied if the investment is only held for a short term

There are a number of circumstances where a tax charge could arise as a result of a “chargeable event” taking place. These are:

Death resulting in payment of policy proceeds

Assignment for ...

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...reason that higher rate and additional rate taxpayers do not pay tax at the higher or additional rates of 40% or 45% is that account is taken of the tax taken at a rate of 20% within the life fund itself.

Life assurance based investments offer access to a range of funds:

Equity – invests in a wide range of shares

International equity – UK and overseas shares

European (equity)

Ethical – shares in companies that have been selected on the basis of their ethical credentials

North American (equity)

Asian (equity)

Fixed interest – gilts and high quality corporate bonds

Index linked gilt

Property – commercial and industrial property

Money markets – short term money market instruments

Managed – offering a mixture of different asset cl...

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...ll flexibility of a unit-linked policy with the smoothing effects of with profits. There are two variations on this theme - variable price units and fixed price units. With variable price units, the price increases daily at a rate set in advance and once set is guaranteed not to fall. With fixed price units the price stays constant but a bonus declared annually in advance as a percentage increase in the number of units is added daily and these extra added units cannot be removed.

The following bonds are structured (unless otherwise stated) as non-qualifying single premium life assurance policies.

Guaranteed growth bonds

These bonds are issued in limited issues (or “tranches”) to coincide with current market conditions. They grow at a fixed rate of “interest” as notified from outset and will typically run for terms of between two and five years.

The investor receives a guaranteed return at maturity including the original investment. Gains at maturity will be subject to the usual tax rules for this structure of policy and therefore higher rate taxpayers will incur a tax liability from the resulting chargeable event.

Assuming that they are held to maturity they are relatively low risk bu...

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... and difficult to liquidate.

Funds categorised by risk

Low risk - with-profits funds, gilt funds, fixed interest funds, index-linked funds.

Low to medium risk – managed funds, UK equity income funds, manager of managers, fund of funds and absolute return funds.

Medium risk – managed funds, manager of managers, fund of funds, absolute return funds, UK equity funds, property funds.

Medium to high risk – UK smaller companies funds, European funds, US funds

High risk – European smaller companies funds, US smaller companies funds, Japanese funds, emerging markets funds and technology funds.

An endowment policy is a type of life insurance contract that involves paying regular premiums over a set period—commonly 10, 15, or 25 years. The policy pays out either when it reaches maturity or earlier if the policyholder passes away. These plans combine life insurance coverage with an investment component and were historically used to repay interest-only mortgages.

To ensure that policy proceeds are is exempt from ...

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...t growth on a with-profits policy is achieved by the addition of bonuses. Two types of bonus may be paid, an annual ‘reversionary’ bonus and a final ‘terminal’ bonus, on maturity or death. However, new sales of with-profits endowments have all but disappeared, and the popularity of unit-linked versions has also declined significantly in recent years, even though many existing policies are still active.

Collective investments allow investors to invest across the full range of asset classes by lump sums or regular savings and benefit from professional fund management and achieve income, grow...

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...sing income. Unit trusts and OEICs can product a variable and potentially increasing income. Investment trusts can product higher rates of income from assets purchased at a discount.

Platforms allow a range of different investment to be held and dealt wit...

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...lient’s portfolio easily and can provide a more efficient service.

Conventional investing focuses on generating financial returns through investing in companies that are expected to perform well. While environmental, social and governance (ESG) factors may be considered in the investment process, the focus will be on financial returns, rather than social or environmental impacts. <...

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...iculture

When making socially responsible investment choices in addition to the normal investment considerations, investors need to be aware that they may have less choice of funds and therefore less diversification, possible higher charges and greater or lesser volatility than non-sustainable equivalent options.

In this section we briefly identify the factors that are taken into account when assessing a client’s need to address estate planning and the considerations necessary to advise clients on mitigating their tax liabilities.

Objective of estate planning

Inheritance tax (IHT) is paid on death and on the value of some transfers of property made during an individual’s lifetime. For those who are long-term resident in the UK IHT is payable on the value of their worldwide assets. For individuals who are not long-term UK resident, IHT on the value of their assets in the UK.

The value of an individual’s estate can be reduced by them making gifts of assets during their lifetime. These could fall under one of the available ...

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...which means deliberately failing to provide full and accurate details to the relevant tax authorities and which is illegal.

Advisers need to be aware of the tax implications of any recommendations they make and can help clients avoid tax by following some simple processes mainly:

Use available exemptions

Use available allowances and claim reliefs

Pay attention to timing of transactions

Pay maximums into pensions and ISAs

Think about tax consequences before making a transaction

Complete tax returns on time and accurately

Pay tax on time

Do not recommend schemes you do not understand yourself

Keep planning flexible in case of changes in legislation

Undertake regular reviews of a client’s tax position