Financial planning practice

This audiovisual presentation looks briefly at an overview of an example investment process.

(Each audiovisual opens in a new window)

Despite the wide range of different client objectives and situations financial planners will come across, there are some general rules of thumb that tend to apply across the board:

Costs: Clients will want to keep costs down and get as much value for money as possible

Risk: Clients will generally want to take as little risk as they need to in order to meet their objectives

Tax: Clients will want to minimise tax and pay no more than necessary, which makes the choice of tax wrapper for each objective so important

Flexibility: Most clients will want as much flexibility and access to their funds as possible, although this may necessarily have to be restricted in some circumstances to meet client objectives (for example gifts into trust as part of an estate planning strategy)

The lifetime or contingent cash flow analyses will have highlighted any shortfalls that need to be addressed, for example gaps in retirement provision or financial protection. The planner will then have determined the cost of plugging these gaps – where the client has surplus income available, the planner will have to advise on how the surplus can best be used, especially where it is insufficient to meet all the clients’ targets and objectives in full (which is often the case). Alternatively, expenditure could be cut and/or ways found to increase income in order to provide the funds required, or objectives may need to be adjusted.

Short term savings/emergency funds

All clients should ideally have some readily accessible cash to cover emergencies such as loss of income due to illness/disability, redundancy and un...

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...e of any inheritance the clients had planned to leave their beneficiaries.

The two main types of equity release scheme available are lifetime mortgages and home reversion schemes .

Lifetime mortgages : Usually a lump sum is provided at outset, with the interest accruing on the outstanding balance until repayment, which will either be when the client passes away or moves into a care home. With interest rolling up on a compound basis, the outstanding balance can increase very quickly. With this in mind, those considering equity release should look for a negative equity guarantee, where the outstanding loan can never exceed the value of the property.

The older the client the more they will be able to borrow, as their life expectancy will be less (and, therefore, the expected level of debt accumulated will be lower). Clients can retain full ownership of the property and can still benefit from future rises in the value of their home. The main drawback is of course that a sizeable debt can quickly be accumulated.

                                

Home Reversion schemes: With this scheme, the client would actually sell part or all of their property in exchange for a lump sum or regular income and a lease allowing them to live in the property for the rest of their life for a zero or nominal rent. On death, the reversion provider would sell the house and receive the proceeds of the sale (or part if only part of the property were sold to them originally).

In chapter 3.2 we looked at how to quantify the need for life cover, taking into account potential capital needs, short and long term income needs and existing cover. We will now look at making recommendations to meet these needs – the main areas to consider are:

Type of cover required

Level of cover required

Term required

Lives assured and basis of cover

Trusts

T ype of cover

There are various types of cover available, each of which are capable of meeting different client objectives. We will now look at a brief overview of the main types of cover:

Term Assurance

Term assurance plans pay out a benefit on death within a specified term and so are suitable for meeting protection objectives within a specified timeframe. There are various different types of term assurance plans and premiums can be on either a guaranteed or reviewable basis (where they may be changed following a policy review)

Level Term Assurance : The amount of cover remains level throughout the term of the policy (aside from any inflation-linked or guaranteed insurability increases)

Decreasing Term Assurance: The cover reduces each year (by a fixed or variable amount) and is primarily designed to protect a reducing level of debt, such as a capital & interest mortgage.

Increasing Term Assurance: The sum assured will increase throughout the term and the premium will usually increase by a similar proportion. This type of cover can be useful to protect an amount that is likely to grow over time, for example a share in a business or for family protection, where cover can be increased on the birth of a child.

Convertible Term Assurance: This type of policy is a level term assurance plan with the option to convert the plan to a whole of life plan or endowment, without the need for further medical evidence (previous medical underwriting conditions will usually be carried over). This type of policy allows clients to keep their options open and may be very valuable where there is a deterioration in health.

Renewable Term Assurance: This is a term assurance plan (usually short term, say 5 years) with the option to renew it for another specified period of time at the end of the term, without further medical evidence. Premiums are likely to increase at renewal (as the client will be older). The renewal option can apply to other types of policy, for example, a RICTA policy is a Renewable Increasing Convertible Term Assurance.

Family Income Benefit: This is term assurance that pays out the benefit in instalments rather than a lump sum and is normally cheaper than a level term assurance policy. It can be a good solution to replace a set income over a specific term (i.e. protection against the death of the main breadwinner while children remain financially dependent).

Gift Inter Vivos: This is a type of decreasing term assurance designed to cover the IHT liability attached to a lifetime gift (amounts in excess of the available nil rate band – below this level term assurance is not required). The cover will decrease in line with the rates of taper relief that apply in years 4-7 after making the gift.

Waiver of premium

For an additional cost waiver of premium benefit can be added to a term assurance policy – with this benefit, in the event that the policyholder is unable to work due to illness or accident, the premium would be waived (usually after a waiting period, of say 6 months). This provides clients with extra piece of mind, although it may not be as important where an income protection policy is already in place.

Whole of Life

As the name suggests, a whole of life plan is designed to provide cover throughout the lifetime of the life assured (as long as the cover remains in force). It is often used for estate planning, as an IHT liability will not occur until death and it is impossible to predict for how long a client  is going to live.

Whole of life plans can be very flexible and may allow the sum assured to increase/decrease during the term of the plan, in order to tailor...

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...ath: A policy that doesn’t pay out until the second of the lives assured dies could be suitable where the need doesn’t arise until second death, for example a couple putting in place insurance to provide funds for an IHT liability.

Trusts

Placing a life policy in trust keeps the proceeds outside of the deceased’s estate for IHT purposes and ensures the proceeds are paid out to those intended to benefit quicker than if waiting for probate. Ideally the settlor(s) should provide the trustees with a letter of wishes to ensure that their wishes are plainly understood.

The choice of trustees should be carefully considered, as they will ultimately determine the destination of the benefits. The trustees themselves should also be made aware of their legal obligations as a trustee and the potentially serious implications if they don’t meet them.

Budget

Whilst in an ideal world clients will be able to take out the policies required to meet all of their life cover needs in full, many will not have the funds to do so and will have to decide what their priorities are. This could mean clients meeting only their highest priority needs and leaving some unmet or alternatively they could consider the following:

Could the amount of income required be reduced? Perhaps the surviving spouse might be able to return to work

Could the term be reduced? Perhaps by building up savings

Could some sacrifices be made? For example taking children out of private school should one of the parents pass away or trading down to a cheaper house.

Example life cover recommendations

Returning to the example of John & Tessa Smythe from chapter 3.2, we established that Tessa would have a shortfall in income if John were to pass away which they wish to protect against. The shortfall is estimated at £8,952 p.a. net in today’s terms for 13.5 years (while the children were still financially dependent, and after the Bereavement Support Payment stops) and £1,140 p.a. net in today’s terms for the following 14 years (until pension age). John would not have an income shortfall if Tessa were to pass away first.

They have a decreasing term assurance policy in place to cover their (original) mortgage, however the sum assured is only £89,000 with 10 years remaining, whilst the current mortgage has £105,000 outstanding to repay and a remaining term of 15 years. They want to ensure that this shortfall is addressed. The premium for this policy is £35.00 per month. Both John and Tessa are in good health and have no medical issues.

Their financial planner recommends the following course of action to meet the needs identified at the analysis stage:

1) Take out a family income benefit policy, written on John’s life, which pays a benefit of £1,140 per annum for a term of 29 years. The policy should be index-linked to keep pace with inflation and to ensure that the cover meets Tessa’s income need in ‘real terms’

2) Take out a family income benefit policy, written on John’s life, which pays a benefit of £7,812 per annum for a term of 15 years. As with the first policy the level of cover should be index-linked. A combination of the two policies will ensure that total cover is £8,952 for the first 15 years and £1,140 for the last 14 years, thus avoiding paying for more cover than is necessary (which could occur if only one policy were taken out).

3) Replace the existing decreasing term assurance policy with a new one, on a joint-life, first death basis, for £105,000 of cover and a term of 15 years. This will protect the mortgage in full for the remaining term and eliminate any shortfall. The premium for the new policy may also be cheaper than the current plan (although the final cost is subject to medical underwriting and the clients will be a few years older)

Their planner also recommends that waiver of premium be taken out on all three policies and that the family income benefit plans are assigned to Tessa.

In chapter 3.2 we looked at how to quantify the need for health cover, in particular using income protection insurance (IPI) and critical illness cover (CIC) to meet client objectives of replacing income and providing capital in the event of illness or accident. We will now look briefly at the main points to consider with recommendations for these two types of policy:

IPI

Benefit level – the required level of cover will have been determined at the analysis stage (see chapter 3.2) but will, of course, be capped by the maximum benefit available from an IPI policy (generally 50-60% of pre-claim earnings, less State benefits)

Term – Each client’s needs will be specific to their situation, however the term on an IPI policy is often aligned to a client’s anticipated retirement date, in order to provide cover for the whole of their working life. The benefit on an IPI policy will usually only be paid up until a maximum age (usually between 50 and 70, depending on the policy)

Premium type – Premiums can be g...

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...’ conditions only or core conditions plus additional conditions as well (at a higher cost). Even where the same condition is covered on different policies, there may be varying definitions of the conditions to be met before any claim would be successful, for example the level of severity required. Planners will need to be familiar with these variations and the quality of cover on offer from each provider.

Trusts: Where the policy provides both life and critical illness cover it can be written under trust, however a ‘split trust’ would normally be used – this allows the life assurance benefits to be paid to the beneficiaries as required, whilst the critical illness benefits are held for the absolute benefit of the life assured (which means they will have full access to the benefits)

There may be additional factors to consider with both these types of cover, although they are beyond the scope of this course. Choosing which product provider to use for this (and other types of cover) will be dealt with in chapter 4.2.

Clients may want to build up a lump sum by investing money on a regular basis or as and when capital becomes available. The longer the timescale, the greater the chance that an equity based investment  will deliver a positive return. For shorter terms (under 10 years) an equity based investment is relatively risky, whilst for terms of 5 years or less such an investment is unlikely to be appropriate.

Clients should first ensure that they have a short term cash reserve, typically 3-6 months of income or expenditure, to provide for emergencies (i.e. redundancy or incapacity), before investing capital over the longer term. This would also avoid them having to sell investments at a bad time in order to meet short term needs, for example during a downturn in the market before the funds have had time to recover.

Whilst each client’s objectives are individual to them, very generally speaking clients who are working will tend to invest for capital growth, whilst those in retirement are more likely to invest for income (or a mix of both).

Investment Policy statement

One way of summarising the investment strategy for a client is by putting together an investment policy statement. This should cover:

Purpose/objective of investment

Timeframe

Capital growth or income targets

Agreed risk profile

Agreed asset allocation

Agreed rebalancing frequency

Fund selection strategy

Tax wrapper selection

Any ethical or other constraints

The statement and strategy may be revised over time, in line with changes in the client’s objectives and situation and changing economic conditions.

This statement will be individual to the client, however financial planners should have their own investment process which should act as a model for investment recommendations. Clients should by no means be shoehorned into following the process rigidly where it isn’t suitable. The audiovisual presentation looks at an example investment process.

Asset Allocation

We looked at how asset allocation works in chapter 3.2. It is generally accepted that asset allocation is by far the most important factor in determining the returns from a portfolio (as opposed to fund/stock picking or market timing).

The asset allocation for a client’s investment will depend on their agreed risk profile, capacity for loss and objectives. Most firms will have model asset allocations for the different risk profiles on their scale and the example below shows what this might look like for a firm, showing asset allocations for the most common risk profiles of 3-7 (on a scale of 1-10):

Wizard Financial Planning Model Asset Allocation

3

4

5

6

7

UK Equity

10%

20%

25%

35%

40%

European Equity

5%

6%

7%

7%

7%

North American Equity

10%

12%

13%

12%

12%

Japan Equity

-

5%

5%

6%

7%

Far East Equity

-

-

10%

12%

14%

Emerging Markets Equity

-

-

5%

8%

15%

Property

7%

7%

5%

-

-

UK Gilts

21%

10%

5%

5%

-

UK Corporate Bonds

22%

30%

20%

15%

5%

International Bonds

15%

5%

-

-

-

Cash

10%

5%

5%

-

-

100%

100%

100%

100%

100%

These are hypothetical asset allocations based on real life experience and there are wide variations in the models used by different fir...

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...e same underlying funds can usually be held within any of the most commonly used wrappers, except for Onshore Bonds which will almost always be much more limited in their fund range. The choice of tax wrapper will of course depend on the current (and anticipated future) tax position of the client, their objectives and any existing wrappers they may already have and contribute to.

The table below summarises the tax position of the main tax wrappers:

Initial tax relief

Tax on growth

Tax on encashment

ISA

No

Tax free

Tax free

Collectives

No

Income taxable

Gains tax free

Gains subject to CGT

UK non-qualifying life policy (inc onshore bonds)

No

Income and gains taxable*

Gains subject to income tax if takes the investor into higher rate tax band**

Offshore life policy

(inc offshore bonds)

 

No

Tax free

Gains subject to income tax

Pensions

Yes

Tax free

25% tax free

Remainder subject to income tax

* taxed internally within the fund – tax credit equivalent to basic rate tax given to investors

** tax may be reduced by top slicing relief. Gains may also impact on an investor’s personal allowance. Gains on qualifying policies will be free of personal taxes where the criteria are met

As well as the main tax wrappers, the likes of VCTs and EIS may be appropriate for a certain types of clients, particularly experienced investors who wish to take advantage of the various tax breaks available (and can afford to take a greater level of risk with their funds).

When it comes collectives, these can be very tax efficient tax wrappers where anticipated gains are likely to fall below a client’s CGT annual exempt amount, and investment income is covered by the personal allowance, the personal savings allowance, the dividend allowance and the 0% savings rate tax band. ISAs and Pensions are, of course, restricted as to the amounts that a client can invest each year, given their tax advantages. Investment bonds allow clients to take a tax deferred income of up to 5% per annum (of the original investment amount and subject to an overall limit of 100% of the amount invested). Clients with larger sums to invest will usually be recommended a mix of some or all of these tax wrappers.

IHT position : Whilst attractive when it comes to growth and encashment during a client’s lifetime, when it comes to Inheritance Tax an ISA is normally the least efficient tax wrapper as it cannot be gifted or held under trust. An ISA can now hold AIM shares, which will normally fall outside of the estate after a 2 year holding period, however this will be too high a risk strategy for most clients. Recent changes have made pension plans much more attractive in terms of passing on wealth to the next generation, whilst the other tax wrappers can all be placed under trust or assigned when it comes to IHT planning.

Platforms/Wraps

Financial planners should take into account all the investments held by a client when considering their overall asset allocation. This is more difficult and time consuming where a client has investments all over the place with various providers. As a platform allows investors to hold various tax wrappers in the same place and produce consolidated reports, it should be easier to determine a client’s overall asset allocation when their assets are held on a platform.

The two main areas that clients may wish to plan for are:

Private school fees – some clients will be very clear in their mind that they want to send their children to a private school (as others will be that their children will go to a state school). Others however will not be as certain, so their planning needs to remain flexible.

Higher education costs/fees or vocational training – whilst in the majority of families the children themselves take on the burden of funding their own further education (with the help of student loans, bursaries, grants etc), some parents (or grandparents/family members) will want to help the children with this part of their education.

Planning in this area can vary considerably depending on the present age of the children, family circumstances and the potential costs involved – the costs can be hard to predict accurately, especially when planning several years in advance.

Clients may want to plan in advance to cover the full education costs or just part of them. Alternatively, their objective may be to try and cover any anticipated shortfalls (as identified in their lifetime cash flow forecast) – such gaps between income and expenditure are more likely to occur in years where more than one child is attending private school for example. Another objective may be to build up an emergency reserve equivalent a few years’ school fees, in case financial circumstances change for the worse, to avoid unwanted scenarios such as children having to be wit...

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...ore being built in to a cash flow to help determine what level of funding may be required.

Investment Vehicles

ISAs, collective investments and cash are likely to be the most appropriate vehicles for this type of planning, although there may sometimes be a case for the use of offshore bonds. As an example, where part or all of the investment is likely to be assigned to the child at a point where they may be a non-taxpayer, it may be beneficial to use an offshore bond as tax should fall on the child (provided they are over 18 when policies assigned/surrendered). Qualifying life policies may also be considered, although these need to have a minimum term of 10 years to maintain the tax advantages.

Where institutions offer discounts for advance payments of education fees, the effective rate of return may be relatively attractive and so should also be considered.

Protection needs

Parents/family members, where possible, should have sufficient life and health cover to ensure that the fees would be covered regardless of their death or disability. Sums assured should be based on the cash flow projections used earlier in the process.

Other options

Other alternatives to advance provision would include parents borrowing to meet education costs (for example where parents have left it too late to plan in advance) or perhaps considering a change of institution – this could involve moving to a good state school or simply switching to a cheaper private school (or being day pupils rather than boarders).

One of the main objectives for clients who are not yet retired is likely to be ensuring that they have enough money to live on in retirement. At the analysis stage, the planner will have established the client’s target income in retirement and whether they are on track to achieve it, via a lifetime cash flow forecast (see chapter 3.1). Any existing arrangements will also have been analysed (see chapter 3.2) and the potential benefits derived from them factored into the forecast as well. There may also be capital requirements at retirement, such as buying a new car or taking holidays, which have traditionally been met by tax free lump sums from client’s pension arrangements.

Some clients plan to continue working on a part-time or consultancy basis (semi-retirement) and will need a flexible strategy, allowing them to draw on income or capital as and when they need it (rather than at set intervals).

Many clients will simply want a safe, fixed and guaranteed income for the rest of their lives.

Planning to meet any shortfalls identified can be done in a number of ways:

Employer pension provision

Defined benefit schemes – For those lucky enough to be a member of such a scheme, with the option to top up their provision, this may be the best way of increasing their income in retirement. The major drawbacks to this would be lack of control/choice or where the scheme is in danger of not being able to meet its obligations (although this will be mitigated to some extent by the protection offered by the Pension Protection Fund).

Defined contribution schemes – Where the client has the option to join a scheme to which the employer will also contribute, they should almost certainly do so. This will apply to most employees now with the introduction of auto enrolment. Where they are already in such a scheme and the employer offers to ‘match’ any increased provision (even up to a certain level), this again is likely to be the best way of topping up their provision to meet any target shortfall.

Individual pension provision

Where clients are responsible for their own provision, in most cases a personal pension or SIPP will be used. The financial planner will have wor...

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...isk averse and her planner feels that this option should only ever be used as a last resort

Grace kept the family home following her divorce and is prepared to downsize her property on retirement to a smaller property

Grace categorically does not want to continue working past 67 and therefore the options of deferring retirement or part time work in retirement were ruled out

She is prepared to cut down on discretionary expenditure and estimates that she can free up around £100 per month towards this planning

She does not want to accept a lower level of income at retirement unless she has no other choice

After analysing her plans, there would be no advantage to topping up any of the paid up plans and her SIPP remains the most suitable vehicle going forward

Her current investment strategy on her SIPP has performed slightly better than expected over recent years and regularly exceeded the target level of return

Her planner agrees to review the paid up plans to see whether there is any benefit in consolidating them into the SIPP, to make it easier to apply a uniform investment strategy across the board. The investment options on the RAC in particular are extremely limited

Her financial planner recommends that she redirect the £100 per month that can be freed up from reductions in discretionary expenditure into her existing SIPP, using the current investment strategy. The monthly contribution will be increased to £125 once the SIPP provider claims basic rate tax relief on her behalf and as a higher rate taxpayer she will be able to reclaim a further 20% relief via her self-assessment tax return.  Grace and her planner make a conservative assumption that £100,000 of capital could be generated by downsizing the property in future, although this is extremely difficult to forecast with any degree of accuracy. By reinvesting this capital for income, together with the increase in pension contributions, her financial planner believes that the shortfall can be covered and a slight surplus created, although this of course is based on a number of assumptions (which inevitably will turn out differently - hence the need for regular reviews of the plan – see chapter 5).

Once a client retires, they will need to derive an income from the assets they have accumulated over their lifetime. The main source of their retirement income will usually be their pension arrangements and we will now look at the main options when it comes to taking benefits from these schemes. For all schemes, clients and planners will first need to consider:

Whether to take any available tax free cash lump sum (PCLS)

If so, whether any of this is to be reinvested to provide income

Whether any of the tax free cash lump sum is to be used to repay a mortgage or other outstanding liabilities or fund any other capital requirement

What provision the client wants to make for any spouse or dependants

Client’s state of health

Defined benefit schemes

On a defined benefit scheme clients will first be faced with the question of whether or not to commute the pension and take a tax free lump sum (although on some schemes there is no choice but to take the tax free cash). Most of the time the tax free sum will be taken for the following reasons:

The lump sum is tax free whereas the pension is taxable – this of even greater to consideration to higher rate or additional taxpayers

The pension will cease on death (after any guarantee period, although survivors’ pensions will continue) whereas the lump sum payout is certain and clients can ensure that they get the benefit from this during their lifetime

Many clients need the lump sum to meet a specific objective such as repaying their mortgage, buying a car or going on cruise

Despite this, however, planners should always check the commutation factors to see whether or not it represents good value for money, particularly where the client has no specific capital requirements. Additional guaranteed, index-linked income may offer better value than the tax free sum based on an average life expectancy.

Defined contribution schemes

Defined contribution schemes such as personal pensions, SIPPs or money purchase occupational schemes offer a variety of ways to take benefits:

Annuity purchase (conventional, investment-linked, flexible or ‘third way’)

Drawdown

Uncrystallised Funds Pension Lump Sums (UFPLS)

Phased retirement

Clients are, of course, not limited to one or other of the above and it may often be appropriate to combine strategies.

Annuity purchase

The most common way of converting pension funds into income has traditionally been to buy an annuity. Since the new pensions legislation (effective from 6 April 2015) removed the previous limits on drawdown however, annuities have declined in popularity and  this is expected to continue  as drawdown becomes more popular. Regardless of these changes however, annuities are still likely to be the most suitable option for many people. At the same time it is likely that further types of annuities and innovations in the market are likely to be introduced in response to the new legislation.

A conventional annuity works as follows:

An annuity is purchased from an insurance company with some or all of the remaining pension fund after any tax free cash has been taken.

One of the factors considered when determining the level of annuity offered to the client is their life expectancy. This is, of course, impossible to predict accurately, as, inevitably, some people will live longer than expected and some shorter. This will result in some people getting their money back (with interest), whilst others ef...

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... phased retirement are:

Clients will lose the opportunity to take the tax free lump sum in one payment early in retirement. This cannot be reversed later on

Those waiting for annuity rates to improve may find that they actually decrease

The value of the fund and therefore the income available may fall due to poor investment conditions and/or performance

Short-term annuities

The idea of short term annuities is that part or all of the fund remaining (after taking tax free cash) is used to purchase a short term annuity. When the first one ceases another one is bought and so on (until another strategy is decided upon). The main risk involved is that future annuity rates decline and the client ends up worse off than they would have been had they simply bought a lifetime annuity at the beginning. If part of the pension fund is held back and remains invested then there will be the usual investment risk and the potential for a fall in the value of the fund.

Two-pools approach

For those clients who need an income from their investments within the next eight years or so, the two-pools approach to asset allocation may be a relevant strategy for retirement income planning.

With this approach assets are divided into two main pools, a safety first pool and a long-term adventurous pool. The idea is that the safety first pool would provide sufficient funds for the client to draw on until the long-term adventurous pool, which would be mostly equity based, had recovered from any market downturn. The aim of the long-term pool would be to provide capital growth and to replenish the safety first pool whenever it runs out.

Safety first pool

First the planner and client agree on how long they think it would take markets to recover in the event of a significant downturn, say be 5-8 years. Then they multiply the amount of income needed each year by the agreed time period to determine the ideal level of the safety first pool, which should be invested in cash, National Savings products or short-dated gilts. Some planners extend the list to include investment-grade corporate bonds and other relatively stable investments.

Long-term adventurous pool

With income already provided for over the next few years, greater risk can be taken with the remaining investments. These can be invested into asset classes with greater potential for growth over the long term, such as equities, property or other alternative asset classes.

Example: Desmond has £400,000 available for investment. He needs gross income of £15,000 per annum on top of his pension income and he and his planner agree that it would take on average 7 years for the market to recover from a severe downturn. As such they agree that he should have a safety first pool of £105,000, which can be adjusted slightly to take into account both inflation and the potential returns from the capital. They hope that over this period the long term pool of £295,000 will have grown by at least £105,000 in real terms so that it can top up the short term pool (and ideally by more, with the balance continuing to be invested for the long term).

The main advantages of this approach is that it secures an income for the client over the agreed period and allows the long-term pool to be focussed purely on growth, giving the client some time to ride out a major market downturn. The main drawback is if the market doesn’t recover in time, which would mean selling growth assets before any recovery occurs.

This is an area that becomes more important to clients as they get older, particularly after they have retired. The main objectives that clients may want to plan for are:

To ensure that their estate pays no more Inheritance Tax than necessary

To ensure that their estate is distributed according to their wishes after they die

There are a number of ways to plan for these objectives and we will now look at the main strategies:

Wills

A valid will ensures that a client’s assets go to the people that they wish to benefit on their death. Dying without a will (or with a will that is invalid) will see a client’s estate distributed according to the laws of intestacy instead (see chapter 3.2). Accordingly, planners should emphasise the need for clients to have wills drawn up and to  keep them up to date. Wills can also be used to set up trusts, for example for vulnerable family members, and can make provision for the guardianship of any children (if both parents were to die).

The financial planner should determine the full provisions of the client’s will before embarking on any further estate planning strategies.

Mitigation

Most IHT mitigation strategies involve the client giving up capital or other assets in exchange for potential savings in IHT. Typically this involves a gift of capital or investments into a suitable trust or an outright gift to their beneficiaries, both of which will generally require the donor to survive a further 7 years before the gifts fall outside of the estate (and the full IHT benefit is realised). Any growth on the investments will however fall outside of the estate from the outset.

Some schemes can also provide the client with a regular ‘income’, for example a discounted gift trust (DGT) or a loan trust scheme. ...

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...ve

On discussing these options further with their planner, Philip and Fiona are reluctant to give away any capital at this stage in life and want the option to draw on it for future pursuits such as travelling. The option of giving away £460,000 was therefore ruled out. Investing in a BR scheme, where they could maintain access to the capital and potentially draw an income as well was discussed, however Philip and Fiona are both cautious investors and did not like the idea of investing in AIM or unlisted shares.

Philip and Fiona both enjoy guaranteed pensions for life and have a comfortable surplus income in retirement - as such they can afford to take out further life cover to provide for the potential IHT shortfall. Their planner investigated their existing policy further, however, it transpires that the sum assured on the policy cannot be increased. The planner then conducted a cost comparison between taking out an additional policy for £184,000 and replacing the existing policy with £284,000 of cover – the existing policy however is very cheap compared to today’s prices and it would be most cost-effective for Philip and Fiona to take out a new whole of life policy for £184,000, which their planner recommends for them (to be written in trust). On discussing the types of policy available their planner recommends a policy with guaranteed premiums, like their existing plan, as they would prefer the certainty of knowing how much the plan is going to cost them for the rest of their lives. Their planner also recommends that the sum assured be index-linked, to try and keep pace with inflation on their assets and that they establish lasting power of attorney in case either of them becomes incapable of managing their own affairs through illness or accident.

This concludes our look at the main areas where recommend...

Shortened demo course. See details at foot of page.

...ious illness or where the spouse of a client passes away.

This revision test (opens in a new window)...

Shortened demo course. See details at foot of page.

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