Financial planning practice

This audiovisual presentation looks briefly at current cash flow statements of income and expenditure.

(Each audiovisual opens in a new window)

Taxation will generally overlap into and form part of other individual areas for analysis, as it is an integral part of most areas of financial planning.

As the chapter progresses, we will see how taxation issues are considered when analysing the investment and retirement situation of the client as well as their estate planning position. We ha...

Shortened demo course. See details at foot of page.

...t and various IHT exemptions and reliefs

Opportunities to spread ownership between spouses/ partners to make holdings more tax efficient

Managing taxable gains, perhaps by spreading capital gains across tax years or optimising the point of taxation for investments such as offshore bonds

Tax consequences of any encashments or switches.

There are many risks to the client for the financial planner to consider, which could all have a significant impact on the client’s overall financial plan. At this stage of the process, the planner’s job is to identify the key risks, analyse any existing provision the client may have in place and determine whether any shortfalls exist.

The main risks to consider are as follows:

Death

Illness or disability (that leads to incapacity and loss of earnings or long term care)

Losing job/ business failing/significant drop in income (or increase in expenditure)

Risk to home (and contents)

Divorce (or separation)

Living longer than expected (and running out of resources)

Investment Risk – this is covered in detail in chapter 2.2

Generally speaking insurance is the best solution for those risks that would have a significant impact on the client and/ or their family but are less likely to happen, such as the premature death of either parent (or both) in a family.

For risks that are relatively probable and/or likely to occur frequently, insurance might not be the answer and it may be possible to manage these risks in other ways. Investment risk, for example, could be managed by diversifying asset classes and fund managers/ providers, whilst building up a ‘rainy day’ fund can protect against smaller emergencies such as having to replace or repair a car unexpectedly.

Life/ Health cover

The vast majority of clients with financial  dependants will have some sort of need in this area  and the planner will need to determine who is dependent on the client(s) and for how long. The client’s health and smoking status may have an effect on their insurability, as well as any hazardous jobs they have (such as those that involve working at heights) or dangerous pastimes (such as flying helicopters) and so should also be considered at this stage.

Dependency position - John & Tessa Smythe

John and Tessa have two daughters, Dina (8) and Joanna (6), who they expect to be financially dependent on them until they leave university.

John

Tessa

Age

40

39

Dependant 1 (and term of dependency)

Tessa (lifetime)

Dina (13 yrs)

Dependant 2 (and term of dependency)

Dina (13 yrs)

Joanna (15 yrs)

Dependant 3 (and term of dependency)

Joanna (15 yrs)

-

Insurability issues

Enjoys scuba  diving

Smoker

John and Tessa’s only dependants are their immediate family members, however other clients may have different dependants, such as elderly relatives, adult children or grandchildren.

John’s income would be sufficient to cover his own short and long term needs if Tessa were to pass away, as we will see shortly, so he does not consider himself to be financially dependent on Tessa.

Quantifying the need – life cover

The next step is to quantify the amount of capital and income that would be needed if the clients died, as well as the length of time cover would be needed for. This should be split between:

Example

Capital needs

Repaying the outstanding mortgage

Short term income needs

Providing for costs of children whilst financially dependent

Long term income needs

Providing income for surviving spouse for their lifetime

Any existing provision should then be analysed and compared against current needs and objectives, in order to determine whether any shortfalls exist. When summarising existing cover, planners should note the following:

Who is covered (lives assured)and basis of cover (SL, LoA, JLFD or JLLS)

Amount of cover

Whether cover is level, decreasing or increasing/ index-linked

Term of cover

Premium

If the plan is in trust or assigned

Any special features (waiver of premium, renewable cover, exclusions etc)

John & Tessa Smythe – analysis of life cover situation

John and Tessa have total monthly expenditure of £2,520. In the event of either of them passing away, they would like the mortgage to be cleared. The mortgage is on a repayment basis with an outstanding balance of £105,000 and 15 years remaining. They have no other liabilities.

Their planner ascertains that their long term income requirements would be £875 per month (for Tessa if John died) and £1,075 per month (for John if Tessa died). This assumes that the mortgage would be cleared and is based on their current expenditure, less:

Cost of the monthly mortgage payments

Cost of the mortgage protection policy

Costs relating specifically to the children (which will be an additional short term requirement)

Costs relating specifically to the other spouse.

Tessa

John

Current expenditure

£2,520

£2,520

Less: Children costs

(£700)

(£700)

Mortgage

(£510)

(£510)

Mortgage protection policy

(£35)

(£35)

Directly related to spouse

(£400)

(£200)

Personal expenses/long term income need

£875

£1,075

Needs analysis

Tessa gave up work when Dina was born and would not return to work if John died. Tessa feels that she would need some help around the house though if she were on her own.

John earns a salary of £44,000 and would continue to work in the event of Tessa’s death and would need to pay for extra childcare and domestic help.

John plans to work until State pension age and in the event of Tessa’s death, his pension provision at retirement is projected to be sufficient to meet his living costs. In the event of John’s death, Tessa would be able to meet her living costs from a combination of the State pension and the widow’s pension from John’s employer scheme. John and Tessa’s long term needs therefore run until age 68 - the age they will start receiving the State pension.

Tessa

John

Capital needs

Clear mortgage

£105,000

£105,000

Funeral expenses

£3,000

£3,000

Top up to Emergency fund

£5,000

£5,000

Less Bereavement Support Payment (lump sum)

(£3,500)

(£3,500)

Total

£109,500

£109,500

Long term needs

Monthly £

Monthly £

Personal expenses

£875

£1,075

Less continuing income

-

(£2,666)

Less widows pension from John’s employer scheme

(£480)

-

Total need

£395 pm

n/a

Short term needs

Children

£700

£700

Extra childcare

-

£650

Domestic help

£100

£250

Less child benefit

(£149)

(£149)

Less Bereavement Support Payments (18 months)

(£350)

(£350)

Total needs

£301 pm

£1,101 pm

If John continued to earn a salary of £2,666 per month (net), this would be sufficient to cover both his short and long term income needs, which total £2,176 per month for the first 18 months (£1,075 + £1,101), increasing to £2,526 per month when the Bereavement Support Payments cease

Tessa on the other hand would initially have a total income shortfall of £8,352 per annum (£395pm + £301pm) x 12)) for first 18 months until the Bereavement Support Payments ceased

this shortfall would increase by £350 per month / £4,200 a year to £12,552 a year when the Bereavement Support Payments cease, and this shortfall would continue for the remainder of the period of the children’s dependency (15 years until they are both financially independent, so for the remaining 13.5 years)

The shortfall would reduce again to Tessa’s personal expenses only, which is £4,740 per annum (£395 pm), for the 14 years following the children’s dependency, and until State pension age is reached

Both John and Tessa would have a capital need of £109,500 should the other pass away, although part of this will decrease in line with the mortgage whilst they are both alive

John & Tessa’s Existing provision

Life Assured

Type

Amount

Indexed/

Level/

Decreasing

Remaining Term

Premium

Beneficiary

John

Note 1

Death in service

£126,000

Level

28 years

Employer

In trust (for family)

John

Note 2

Spouse’s pension

£5,760 pa

Indexed

For life

Employer

Tessa

John & Tessa

Note 3

Term Assurance

£89,000

Decreasing

10 years

£35 pm

None <...

Shortened demo course. See details at foot of page.

...und;21,000 pa

Increasing

28 years

Employer*

John

Additional Feature/Notes - Payable after 6 months waiting period

*where the employer meets the premium, the benefit will be paid through the company payroll and therefore subject to tax and National Insurance. The net benefit in this instance would be around £17,500 pa

Income Protection

When quantifying the need for income protection, the amount of cover required will generally be the current level of expenditure less:

Reductions in expenditure due to being unable to work, i.e. travel to work

State benefits

Income from any existing policies

Income from any other sources

Some account should be made for potential additional expenses, such as private care or medication costs, taxis etc

Critical Illness

When quantifying the need for critical illness, cover will generally be required to provide capital for:

Clearing the mortgage and any other liabilities

Adaptations to home, car etc

Other expenses incurred (i.e. nursing care)

Generating an income – for example where there is no income protection in place

Once the sums for the above have been determined they should be added together and any existing cover should then be deducted to determine whether a shortfall exists

When analysing a client’s existing critical illness policy, the planner should look at the illnesses covered and their definitions. Definitions have become stricter in recent years, particularly where cancer is concerned, and so some older policies may have much more generous definitions than would be available in the marketplace today. This may make existing cover more valuable and outweigh any potential savings in costs that might be achieved by replacing a policy.

Loss of pension benefits

Anyone suffering an illness and being unable to work long term could suffer a serious reduction in their pension fund. Part of a lump sum payout from a critical illness policy, or the income from an income protection policy, could be used to provide an alternative fund. It could for example, feed contributions of £2,880 per annum into a pension scheme and/or invest in an ISA.

Private Medical Insurance (PMI)

An objective for some clients may be to have medical treatment privately, if it was ever required, rather than through the NHS. The main reasons for this are to avoid NHS waiting times and make use of the facilities of a private hospital. For clients with dependants, PMI is of less importance than life, critical illness or income protection cover, although it may still be a very important objective to them personally. The vast majority of clients will require insurance to provide this treatment if it was ever required, rather than trying to fund it out of their own resources.

The cost and quality of cover can vary widely and there are big differences between a budget PMI plan and a fully comprehensive one. Budget policies will typically exclude certain treatments or consultant fees that might be available on more comprehensive plans. Outpatient cover, if available, will normally be subject to a maximum annual limit.

When quantifying the need for PMI, the planner should determine which areas are important to the client and then make sure cover is tailored accordingly. The main areas to consider are:

Outpatient cover - do they want cover that offers a full refund for treatment in all areas or are they happy with cover limits in one or more areas, i.e. psychiatric treatment?

Underwriting basis – do they want the option for moratorium underwriting? Cover on this basis will be cheaper, however any conditions that have existed in the last few years will not be covered (initially at least)

Policy Excess - what level of excess would the client be willing to pay (if any)?

Hospital choice – the hospitals where treatment is available can vary widely from policy to policy. Some clients may want to have treatment at a particular hospital

Alternative medicine – many policies do not cover alternative treatments, such as treatments from chiropractors, osteopaths or homeopaths. This may or may not be something that the clients wishes to avail of.

Cancer cover - this may well be the most important element of PMI for many people. The levels and types of treatment differ widely and it should be ascertained just how comprehensive a level of cancer cover the client requires, i.e. do they want a policy that would provide them with stem cell or bone marrow transplants, biological and/or hormonal drug therapy? Or would they be content with cover that only provides for radiotherapy or chemotherapy?

Once the client’s preferences have been established the planner can then research the market for a suitable plan, although in truth PMI is a specialist area and many financial planners choose to outsource this part of a client’s planning to a specialist. If the client has existing cover, which is often through their employer, the terms and conditions of the cover should be analysed and compared against the client’s specific needs and objectives. Many policies will allow spouses and children to be added as well, although this can increase the cost substantially.

Premiums on most PMI policies tend to increase fairly significantly each year and many older clients can find that PMI can become unaffordable and/or uneconomic.

Other areas of protection

Home insurance: Most client’s main asset is their home and planners should ensure that their clients have adequate protection in the event of damage to their home, for example by fire or bad weather. Home insurance will cover this, whilst the contents can also be insured, which can protect a client’s belongings against damage, theft or loss.

Redundancy cover: Clients can go some way to protecting against the financial effects of being made redundant, by having a large emergency fund for example. They might also have a flexible mortgage, which would allow them to suspend or reduce their monthly payments for a time if necessary. Redundancy cover may also be combined with other short term cover within a single policy, for example ASU policies which protect against accident, sickness and unemployment.

Long term care

Clients may be worried about the costs of long term care should they ever require it in the future and may want to try and plan for such an eventuality. Currently local authorities might pay for all, some or none of the costs, as the amount the individual is expected to contribute is means tested. The means test will take into account capital and income and in some circumstances the client’s home may be included as capital.

In the past it was possible to take out a ‘pre funded’ long term care plan, which would pay for care in your own home or a residential home. Whilst these plans disappeared from the market for a long time they may start to re-emerge. When analysing any existing plans financial planners should consider the criteria for when the client is eligible for a payout, the level of cover, current premium and any premium review periods. There may also be some restrictions on the plan, for example some plans will only pay out after age 65.

The main alternative options to consider for those trying to plan for long term care costs, would be:

Downsizing – many clients may be prepared to move to a smaller home and use any capital profit to pay for care costs, should the need ever arise. Where residential care is required the home may be sold to fund the care costs.

Equity Release – clients could plan to release equity from their home in future to pay for care costs

Using capital or other assets to pay for care costs or purchase an immediate needs annuity

Many people transfer ownership of the family home or other assets into their children’s or someone else’s name, to try and prevent having to make a large contribution to care costs or sell the family home in the future. Capital might also be invested in investment bonds, which are typically disregarded from the means test. There is no guarantee that such strategies will work however as they may be considered as ‘deliberate deprivation of assets’ by the local authority and included in the means test calculation anyway, even though the actions the client may have taken means the asset is no longer accessible by them.

Much like Private Medical Insurance, Long Term Care is a specialist area and many planners will outsource advice in this area to a specialist care–fees adviser, such as a member of the Society of Later Life Advisers (SOLLA).

Broadly speaking clients invest for either growth or income (or a mixture of both), however their underlying objectives can be very varied. Some clients invest simply to try and outperform cash and/or inflation, with no specific target in mind, although more commonly clients tend to have a target sum or income that they wish to achieve to meet one or more particular objectives. They could be trying to build up a capital sum to pay for school fees, a holiday or house deposit. Or, they could be investing to produce a target income, for example to supplement their income in retirement.

When analysing and evaluating a client’s existing investments, financial planners will look at:

Allowances/ reliefs/ exemptions/ tax efficiency: Is the client making use of their available allowances, reliefs and exemptions? For example, their annual ISA allowance or CGT annual exempt amount. Are there large future capital gains/income tax bills accruing? Could the investments beheld more tax efficiently or should a different tax wrapper be considered? Could ownership be switched to a spouse or partner paying tax at a lower rate?

Portfolio vs Risk Profile: Does the portfolio match the client’s agreed risk profile for their objective? Has the level of volatility been higher than expected? Is the asset allocation (still) suitable for the client’s risk profile and capacity for loss?

Diversification: Are the client’s investments sufficiently diversified or are they too heavily concentrated in a particular asset class/sector/fund?

Suitability for meeting objective: Is the portfolio properly designed to meet the client’s objective(s)? For example, is it geared towards generating a regular, sustainable income for a client requiring regular income or is it more of a long term capital growth portfolio? Is the portfolio sufficiently flexible that it can accommodate changes to the client’s circumstances or objectives or changes to legislation?

Performance and progress against target: have the specific holdings and the portfolio as a whole under/ overperformed against the agreed benchmark(s)? How has this affected the likelihood of the client achieving their objective(s)?

Charges: Are the charges reasonable? Have they increased recently?

Penalties: Do any of the holdings have exit penalties or market value reductions (in the case of with profit funds) If so when do they expire? For with profit funds are there any MVR free dates?

Fund changes: Has the fund manager changed? Often funds are chosen on, to some degree at least, the strength of its manager. Has there been a change in the fund’s objectives/ parameters? With Profits investments - How ‘healthy’ is the fund?  What is the likelihood of bonus rates increasing/decreasing?

Guarantees/ Additional benefits: Do any of the funds have any form of guarantee (i.e. a guarantee that the investor will get back at least their original capital or a guaranteed minimum growth rate) or a special benefit (i.e. loyalty bonus, discount )

Liquidity: Are there any liquidity issues with the current holdings? Some investments can be difficult to sell 

Ethical preferences: Are there any areas that the client does not wish to invest in for ethical reasons, such as arms, tobacco etc. How do their investments conform with these wishes?

The analysis points above assume a predominantly actively managed portfolio. As we saw in the audiovisual presentation however, there are alternative factors to analyse when evaluating passive investments. Rather than performance against a benchmark and the importance of the fund manager and his investment style, the performance of passive investments is largely measured in terms of tracking error. Costs should also be much lower. There should not be any issues around liquidity or guarantees either.

Third party research

Many financial planners (or their teams) do not have time to meet fund managers and carry out in depth due diligence on the vast range of funds and investments available to them. As such some planners choose to outsource the investment function altogether, for example by using discretionary fund managers, whilst others make use of third party research to complement their investment process. This could be through the use of fund ratings agencies such as FE fundinfo, Morningstar, Square Mile and S&P Global. 

Where third party research is used and a fund loses its rating from a particular agency, this could be a cause for concern when analysing a client’s portfolio.

Asset Allocation

Asset allocation is a strategy that aims to balance risk and reward by dividing an investment portfolio between a number of different asset classes, such as equities, bonds, property or cash, or between a number of different sectors within a particular asset class. The strategy is based on the principle that the individual asset classes or sectors may behave differently in various market conditions, for example when equities are falling, bonds might be going up.

Ideally this should provide a portfolio with greater protection against market volatility, although it does not always work out that way.

The percentage that should be held in each asset class or sector will depend on the agreed risk profile for the investor. Generally speaking the higher up on the risk ladder you are then the more you will have in equities and vice versa. Many firms adopt third party asset allocation ‘models’ for use with their clients, some of which may be linked to a risk profiling tool. Where the firm have the required resources and expertise, asset allocation models can be designed in house.

When considering how the client’s investments compare against their risk profile, the primary indicator is usually how their current asset allocation stacks up against the ‘model’ for their agreed level of risk. Where there has been a significant change in the market, the overall asset allocation can become skewed. A rally in the markets for example could lead to the equity component of the portfolio becoming much higher, in percentage terms, than originally intended. Such imbalances can be avoided via regular ‘rebalancing’, which is simply the process of buying and selling holdings to realign the asset allocation back to its target levels.

There are many different formats financial planners use to analyse investments for their clients. The example below outlines one method, with the first table looking at the portfolio overall and the second table analysing the specific underlying investments and funds.

Example Analysis – Denis Brown

Denis wants to use his investments to purchase his dream holiday home in Spain in 10 years time. He has no further capital to invest. His financial planner has calculated that he will need overall growth of 7.2% per annum to achieve his goal, taking into account charges, tax, inflation etc. His attitude to risk has been assessed as ‘Moderate to High’. Both Denis and his financial planner are firm believers in an ‘active’ style of fund management, which relies on fund managers’ ability to consistently outperform the market.

Asset Class

ISAs

Collectives

Investment Bonds

Total (£)

Total (%)

Model asset allocation

+/- vs model

Cash

£0

£0

£0

0

0

5.0%

-5.0%

UK equities

£34,000

£7,920

-

£41,920

35.53%

40.0%

-4.47%

Overseas equities

-

£16,080

-

£16,080

13.63%

30.0%

-16.37%

Total equities

£34,000

£24,000

£0

£58,000

49.16%

70%

-20.84%

UK fixed interest

-

-

£18,000

£18,000

15.25%

12.5%

+2.75%

Overseas fixed interest

-

-

-

-

-

5.0%

-5.0%

Total fixed interest

£0

£0

£18,000

£18,000

15.25%

17.5%

-2.25%

Property

-

-

£42,000

£42,000

35.59%

2.5%

+33.09%

Other

-

-

-

5.0%

-5.0%

alternatives

Total Alternatives

£0

£0

£42,000

£42,000

35.59%

7.5%

+28.09%

TOTAL

£34,000

£24,000

£60,000

£118,000

100%

100%

Wrapper cost

0.25%

0.25%

n/a

Cost of underlying funds

1.75%

1.20%

1.00%

Adviser charges

0.50%

0.50%

0.50%

Total cost

2.50%

1.95%

1.50%

1.88%

ISA

1 yr growth

3 yrs growth

5 yrs growth

Historic yield

Volatility

OCF

Current Value

Penalties

Wizard UK Equity

1.42%

45.18%

78.62%

0.79%

9.10

1.88%

£18,000

n/a

Wizard UK Opportunities

-6.43%

47.23%

71.22%

0.75%

15.56

1.60%

£16,000

n/a

Overall

-2.28%

45.87%

75.14%

0.77%

12.14

1.75%

£34,000

n/a

Benchmark

1.03%

36.18%

60.98%

-

10.51

-

-

-

Other Points:

ISA allowance unused for the current tax year

Collectives

1 yr growth

3 yrs growth

5 yrs growth

Historic yield

Volatility

OCF

Current Value

Penalties

Wizard Global Growth

2.45%

25.92%

51.43%

0.02%

8.31

1.20%

£24,000

n/a

Benchmark

1.14%

24.03%

40.32%

-

7.96

-

-

-

Other Points:

Original Investment/ Book Cost £15,000

CGT annual exempt amount unused for the current tax year

Investment Bond 1

1 yr growth

3 yrs growth

5 yrs growth

Historic yield

Volatility

OCF

Current Value

Penalties

Wizard UK Property

15.02%

21.68%

50.41%

-

2.08

1.00%

£42,000

None

Benchmark

12.59%

17.42%

37.42%

-

1.67

-

-

-

Investment Bond 2

1 yr growth

3 yrs growth

5 yrs growth

Historic yield

Volatility

OCF

Current Value

Penalties

Wizard Fixed Interest

3.74%

6.89%

19.74%

-

4.01

1.00%

£18,000

£360

Benchmark

4.35%

11.89%

24.66%

-

3.70

-

-

-

Other Points

Chargeable gains of £6,000 and £2,000 respectively on these (onshore) bonds  if surrendered.

Denis is a higher rate taxpayer so the gains would be taxed.

NB: OCF = ongoing charges figure

Analysis:

Denis has not currently used his CGT annual exempt amount and has not used his ISA allowance for the last couple of tax years, including the current one

With no new capital to invest, Denis could consider encashing his investment bonds and reinvesting the proceeds into his ISA and Collectives portfolios, where he can make use of these allowances, if overall it would be more tax-efficient

His second investment bond does however have an ‘early surrender’ penalty, which will gradually reduce over the next 2 years. There are also  chargeable gains to consider. These downsides would have to be weighed against any tax advantages that might be achieved through the alternative tax wrappers

Denis made these investments through his previous financial planner, who has now retired. The previous planner had recommended that Denis should hold around half of his portfolio in property originally, although this has since fallen to the current level of just under 36%

Denis’s new planner has assessed his risk profile as ‘Moderate to High Risk’ and the model asset allocation for this profile would have just 2.5% in Property. There is a huge differential here

UK Equity exposure is not far off the model, however Overseas Equities exposure is much lower than the target holding

Total Fixed Interest is slightly high compared to the model, whilst all of the current holding is UK based with no overseas fixed interest

There is no cash holding in the current portfolio and no alternative assets, for example absolute return funds

A rebalancing exercise would be required to bring the portfolio in line with the target asset allocation and would involve selling most of the Property holdings and a small amount of UK Fixed Interest. The proceeds would be reinvested into the asset classes where exposure is currently too low, i.e. Overseas Equities, UK Equities, Overseas Fixed Interest, Cash and Alternative Assets

The rebalancing exercise would have to take into account other factors, such as taxation, switch fees etc

Overall the weighted performance of all Denis’s investments over 12 months is 5.77%, which is below the target growth level of 7.2%. Denis’s planner hopes that a change to a more appropriate asset allocation will help increase returns

The overall cost of the ISA seems quite high. In addition the Wizard UK Opportunities fund has substantially underperformed the benchmark over  the 1 year period, and at the same time the volatility of the fund has been much higher than the sector average

Also within the ISA, the manager of the Wizard UK Equity fund is due to retire within the next 12 months and pass over management of the fund to his deputy. Much of the steady performance of the fund has been credited to the current manager. An overall rethink of the ISA may be required given all of these issues

The Wizard UK Fixed Interest fund has consistently underperformed its benchmark. There would be no chargeable gain triggered by switching funds within the investment bond

Denis holds five funds in total and all of these are from the same investment house, with the same manager managing two of them. This lack of diversification would be cause for concern

This could be addressed at the same time as the rebalancing exercise and potential change of wrapper, by spreading the portfolio between a number of different investment houses and fund managers, although the investment bonds have quite a restrictive investment choice

Clients may intend to use pension plans and/ or other assets to fund their retirement. A lifetime cash flow analysis, such as in the example for Steven and Audrey in chapter 3.1, can be a good way of comparing projected income from all assets against target income in retirement and determining whether a shortfall exists.

Most commonly, a client’s main provision for retirement will be a defined contribution pension scheme and/or defined benefit scheme, alongside their State pension. When analysing a client’s defined contribution scheme(s), the vast majority of the analysis will be the same as that we looked at for investments, given that these pension plans are essentially just another type of investment wrapper with its own particular rules (in particular re taxation). So the areas the financial planner will want to consider will be:

Do the underlying investments match the client’s agreed risk profile for this objective?

Are the charges on the plan reasonable?

How has the plan performed? How has any under/ overperformance affected progress against the client’s target fund?

Has the client made use of their annual allowance? Do they have any carry forward available? Planners will need to confirm the pension input period on the scheme(s) if carry forward is being considered

Do any of the plans have any protection against the lifetime allowance?

Is the portfolio well diversified?

Are there any issues with any of the underlying funds? i.e. change of fund manager, fund mergers, liquidity issues

Are there any valuable guarantees or other benefits? Some older plans, such as retirement annuity contracts, may ha...

Shortened demo course. See details at foot of page.

... shortfall

She could consider using other assets to fund her retirement – Grace is divorced and lives alone in a valuable four-bedroom property. The mortgage is due to be paid off by the time she retires. Grace could consider downsizing to a smaller property and putting any profit towards her retirement. Alternatively she could consider equity release, although 67 is quite a young age for this

She could try and source alternative income in retirement – Grace could consider freelance or other part-time work in retirement, although this will depend on her health

She could defer her retirement date – Grace could carry on working past 67 (and saving for retirement) and give her money purchase plans longer to grow. Deferring her State pension and her defined benefit pension (according to the scheme rules) would increase the level of starting pensions.

She could increase the level of risk she takes with her money purchase pensions – increasing the level of risk taken, in theory, increases the potential for higher returns. This should probably be considered as a last resort and as Grace gets closer to retirement this option would likely be ruled out altogether, as the funds would have less time recover any losses.

She could simply accept a lower level of income in retirement – Grace could adjust her preferred lifestyle in retirement, so that she could get by on a lower income.

The choice of strategy will depend on what the client feels most comfortable with and will form part of the recommendation stage (Step 4 of the 6 Step process). A mix of more than one of the strategies may be the preferred route.

The summary of the client’s estate planning position should include:

Current value of assets and liabilities

History of gifts made (going back 14 years)

Details of any future gifts planned

Details of current wills (including bequests to exempt parties, such as charities)

Details of any existing trusts/powers of attorney

Details of any existing provision, for example whole of life insurance or pension death benefits (for couples)

Domicile of client (and spouse)

Details of any exemptions being utilised, for example gifts being made out of normal expenditure, annual £3,000 exemptions etc

For widowed clients, details of whether any of their late spouse’s nil rate band was unused. If so, the unused percentage can then be claimed by the executors on the client’s own death, which will increase their  nil rate band proportionately

Details of whether any assets qualify for any reliefs or exemptions, such as Business Relief or Agricultural Relief

Once the above information has been analysed, the planner should then be able to determine the extent of any Inheritance Tax liability and how this compares with the client’s objectives in this area.

NB: For simplicity the figures in the examples below are in nominal terms, with no allowance for inflation or investment growth etc.

Example Analysis – Philip and Fiona

Philip (65) and Fiona (63) are married and both retired. They have wills that leave everything to each other on the first death, whilst on the second death, everything is split equally between their two nephews. They have made no gifts and have no future gifts planned. They do not make use of their annual IHT exemptions and have no powers of attorney in place, however they do have a joint-life second death whole of life plan in place, with a (level) sum assured of £100,000, which is written under a discretionary trust with their children as named beneficiaries. They are both UK resident and domiciled and their objective in this area is to provide funds for any IHT liability their beneficiaries would face.

Their estate planning position is relatively simple and the position on second death would be as follows:

  

Philip

Fiona

Joint

Main Residence

£450,000

Personal belongings

£20,000

£15,000

£10,000

Cash/cash type assets

£180,000

£95,000

£45,000

Investments

£185,000

£40,000

£320,000

TOTAL

£385,000

£150,000

£825,000

Less liabilities

-

-

-

Taxable Estate on second death*

£1,360,000

Less 2 x Nil Rate bands

(£650,000)

Amount subject to IHT

£710,000

IHT @ 40%

£284,000

*as Philip and Fiona leave everything to each other on first death (transfers between spouses are IHT exempt), there would be no IHT liability on first death. The nil rate band of the first to pass away would be unused and available for claim by the executors of the second to die, in addition to their own.

Philip and Fiona’s current provision is insufficient to meet their objective of providing for any IHT liability their beneficiaries would face

The whole of life policy would only provide £100,000 towards the IHT bill, leaving a shortfall of £184,000. The existing policy has no inflation protection and the sum assured will remain level. The shortfall is therefore likely to increase in ...

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Value

Main Residence

£380,000

Farmland*

£450,000

Personal belongings

£50,000

Cash/cash type assets

£115,000

Investments

£105,000

TOTAL

£1,100,000

*Muriel’s financial planner has confirmed with her accountant that the farmland would qualify for Agricultural Relief at 100%

When Muriel’s husband passed away he only used 30% of his nil rate band (£255,000 in 2003/04)

The nil rate band available on Muriel’s death would therefore be £552,500 (£325,000 x 170%)

Whilst the gift to her eldest son remains in the estate however, £50,000 of the nil rate band would be utilised, reducing the remaining available NRB to £502,500

The farmland would also be exempt, which would reduce the value of the estate significantly

Ignoring the RNRB, the amount subject to IHT (at 40%) would be £147,500, giving an IHT liability of £59,000

However, Muriel’s estate also benefits from the residence nil rate band (RNRB) which reduces her taxable estate by £175,000, and in future years could eliminate her IHT liability altogether, although this will depend on any growth in the value of her assets. At any rate Muriel’s cash looks to be sufficient going forward

Should the farmland cease to qualify for Agricultural Relief for any reason however, then this would jeopardise Muriel’s objectives

The importance of making or updating wills

Financial planners often come across clients without a valid will. Anyone dying without having made a will or with a will that is invalid, will see their estate distributed according to the rules of intestacy. As such, clients should always be advised to make wills and to ensure that they are up to date and valid, so that their specific wishes are carried out when they pass away. Many clients will not be aware that existing wills become invalid on marriage/remarriage and clients in this position will need to make new ones.

By way of example, in England and Wales the rules of intestacy would see the surviving spouse/ civil partner receive the whole estate if there were no children. Where there are children, all the personal chattels plus the first £270,000 (plus interest from date of death to distribution) goes to the surviving spouse and half of the remaining estate. The other half is split between the remaining children, although they can’t access their share until 18. For unmarried couples, the surviving partner would end up with nothing. (NB: There are different rules for those living in Scotland and Northern Ireland).

Non domiciled spouses

Whilst UK domiciled spouses can pass their whole estate to each other, free from Inheritance Tax, the situation is different where one or other is non UK domiciled. Only an amount equivalent to the nil rate band in force can be passed free of IHT to a non-domiciled spouse – this would limit the total amount that can be passed free of IHT in such a scenario to £650,000, i.e. £325,000 of a nil rate band plus the non-domiciled allowance of £325,000.

Clients in this position, with estates over £650,000 and who want to leave more than this to their non-domiciled spouse, could consider whether the non-domiciled spouse should elect to be treated as UK domiciled – this would allow them to benefit from the unlimited spousal exemption, however any non-UK assets would then be included in their estate on death.

In this chapter we have looked at how financial planners analyse a client’s ...

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...lop and present the financial plan, which will be covered in chapters 4.1 and 4.2.

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