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. Less than 1% of members of occupational pension schemes retire on maximum benefits (many receive only 20% - 30% of pre-retirement earnings) and for many others their o...

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... retirement if, for 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

Rules determined by HMRC and based on:

Amounts that can be contributed

Tax relief available

How tax relief is given

Additional benefits that can be included

Death before retirement

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...

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...he individual every three years. For those earning less than £10,000 but more than £6,420 in the 2023/24 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 pay the full 8%, with contributions in the 2023/24 tax year paid on earnings in excess of £6,420.

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%...

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...s 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 are now looking 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. 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, would provide at the policyholder's options, or is sold or held out as providing, 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) Under which the benefits 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, accommodation or goods necessary or desirable for the continuing care of the policyholder because he cannot live independently without assistance.”

Types of policy

Within this high level definition there are two distinct types of long term care product:

Pre-funded LTCI - covers both regular and single premium contracts that are either pure protection products or Long Term Care Insurance (LTCI) investment bonds which include pre-funded long term care provision. These policies are taken out in advance of actually requiring care. The policy pays out a regular tax-free amount when the policyholder is unable to perform a number of activities of daily living (ADLs)

Immediate care LTCI - a form of impaired life annuity that helps to pay for the costs of long term care at the point at which it is required. In exchange for a single lump sum payment they provide a regular incom...

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...s, pension funds and the surrender value of any life assurance policies including investment bonds.

Almost all income is taken into account in the assessment apart from the personal expense allowance. Income included as part of the assessment will include:

Earnings

Pension

State and other benefits

Pension credit

Trust income

Income from investments - dividends, bonuses

Income from investment bonds – withdrawals (not full surrenders)

Income from letting (including sub-letting)

Attendance allowance

Some income may be completely disregarded, such as council tax benefit. Some income may be partially disregarded, i.e. 50% of occupational pension benefits where the partner or spouse relies on this money to remain in their own home.

The home will be included in the capital assessment but it will be disregarded from the calculation of capital for a period of up to twelve weeks from the date permanent care begins.

In addition, the home will be excluded from the assessment if it is occupied by:

A spouse or civil partner

An unmarried partner

A relative aged 60 or over

An incapacitated relative aged under 60, or

A child under 16 who the claimant is liable to maintain

If no other eligible person lives in the property, the local authority will take the value of the home into account when means testing but it cannot force the home to be sold. Instead, the local authority may agree to hold a legal charge over the property and will recover the cost of the care fees when the person dies and the house is subsequently sold. There is no interest charged on the deferred LTC payment provided the money owed is paid within 56 days after the claimant’s death.

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. 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 ac...

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...to provide capital growth, income or a combination of the two and the underlying investments can be in one of four asset classes: shares (equities), bonds (loans to the Government or companies and also known as fixed-interest securities), property and cash. 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 ...

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...tract out investment management decisions to a specialist third party.

A manager may also switch trustees, although because of the work and costs involved this is a relatively rare occurrence unless enforced (e.g. as a result of a takeover between banks).

Registration

Both the manager and trustee must keep and maintain a register of unit holders. Often this requirement is carried out by the manager or sub-contracted to a third party. The register evidences the investor’s title over the units.

It must contain the following:

Name and address of the unit holder

Number of units of each type held by the unit holder

Date on which the holder was registered

Under FCA regulations, the manager and the trustee must take all reasonable steps to ensure the register is complete and up-to-date at all times.

Reporting

Unit trusts must publish an annual report detailing the trust’s accounts and must also publish half-yearly reviews allowing unit holders to monitor their performance.

If it is to be marketed to the general public, a unit trust needs authorisation from the FCA.

If it is not authorised, it cannot be promoted and marketed to the public.

Authoris...

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...s within the funds. They are subject to income tax rather than corporation tax. Another important use of unauthorised unit trusts is for managers of enterprise zone property holdings.

Internal taxation of the unit trust

Any unfranked income arising within a unit trust will be subject to corporation tax of 25% after deduction of expenses. No tax will be payable on franked (dividends from UK share...

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...e with the rates applicable to savings interest and the personal savings allowance

Any capital gains made by the investor will provisionally be liable to capital gains tax, subject to any allowances and exemptions

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

This is calculated on a price per unit basis in line with FCA regulations.

FCA regulations determine the highest price at which units can be sold to the public and the lowest price at which they can be repurchased by the manager.

Additional units must be created to cover demand. The manager is also allowed to cancel units where these are redeemed from the public. Therefore the unit trust can expand or contract in accordance with the market.

Many unit trusts still quote a two way price system. Investors buy units at the “offer” price (higher buying price) and redeem them at the “bid” price (lower selling price). The difference between the two prices is known as t...

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...he investment provider

Annual management charge

Normally deducted from the trust’s annual income. It can be charged to capital in some circumstances.

The charge is typically 0.5% to 1%, with overseas or specialist funds tending to have the higher charges.

Gilt and cash funds usually charge less. Index tracker funds can charge around 0.5% to 1.0%.

Discretionary portfolio managers may carry out two levels of charges; one to pay the manager of the underlying investments and a further charge to cover the overall management service.

Performance related charge

The new COLL regulations make provision for performance related fees, which means that managers can receive a bonus based on 20% of the year’s growth of the fund or they can be based on performance in relation to an index benchmark.

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.

Funds are valued on a net asset value basis.

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.

Short term borrowing of up to 10% of the net asset value of the fund is possible on the same basis as unit trusts.

They are incorporated under the Financial Services and Markets Act and are authoris...

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...applied if there are unusually large inflows or outflows of funds.

The FCA will allow a single “swinging” price to be levied instead of the dilution levy method. Where an OEIC uses this method, it will operate in a similar way to bid-offer spreads of unit trusts.

Note also that since 2006 the ACD can adopt a dual pricing policy, in which case valuation is carried out in the same way as unit trusts.

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

Dealing and management

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

OEICs can issue bearer shares which are convenient for some investors (e.g. non-UK domiciled shareholders).

Taxation

OEICs are taxed in the same way as that which applies to unit trusts, both internally and for the investor.

The FSMA 2000 does not permit offshore funds to be promoted in the UK unless they are authorised unit trusts, authorised OEICs or another recognised scheme.

Funds can be authorised if constituted in other European Union states

If authorised in designated territories such as Bermuda, Guernsey, Isle of Man, Jersey

Funds can be recognised and thus authorised by the FCA on an individual basis...

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...tor Status

This category of fund is often referred to as a roll up fund

All income is accumulated in the fund

On receipt of a distribution or on total encashment, a charge to income tax arises rather than capital gains tax

Those not resident in the UK will pay no UK income tax or capital gains tax on an offshore holding but they may be subject to tax in their new place of residence

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 actually structured as listed limited companies that invest in other companies.

The companies that ITs can invest into range from large listed organisations to small unquoted private companies.

As a result of their company status, they are referred to as “closed ended” in that they only have a limited share capital in issue at any one time. An individual will purchase shares in an investment trust company with their available investment funds and these arrangements can be established as regular savings schemes with quite small minimum contributions or alternatively can be bought with an available lump sum.

The share price paid will be dependent upon supply and demand. The price will often trade at a discount to the actual net value of the investments in the scheme (known as discount to NAV). In many circumstances this could give an advantage to the investor of an increased income (dividend) stream relative to the actual money invested.

As these investments are limited company shares, returns will be in the form of dividends and capital gains to the value of the share price. In other words, where ordinary shares are issued, they behave in exactly the same way as any other company share.

Variations are available to investors in order to meet differe...

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...largely counteract growth

Income Shares

Traditional income shares give a right to the income of the trust with a fixed redemption payment at maturity, subject to sufficient assets being retained in the trust

Annuity income shares offer a high level of income from the trust with a nominal redemption payment which could be vastly less than the purchase price paid

Ordinary income shares are often found in trusts with zero dividend preference shares. They receive all of the income of the trust and all the surplus capital after zero holders have been paid. There is, of course, a risk that they will receive very little or no income at all

Capital Shares

Entitle the shareholder to the capital remaining at redemption after all other classes of share and borrowings have been paid

Investors receive no income but do receive the possibility of large capital returns on the basis of growth from all share classes in the trust

Equally they could end up receiving little or nothing!

Warrants

Some investment trusts issue warrants (the right to buy shares at a fixed price at a fixed date in the future), the features are:

They provide no income

Their price is a fraction of the value of a share. They can be very rewarding to the investor but equally could be highly risky

They can be bought and sold at anytime on the stock exchange until their final exercise date

Usually worth considering that the investor exercises option if he is able to buy shares at a discount

If not traded or exercised, warrants will expire worthless

Individual Savings Accounts (ISAs) are not investments themselves but flexible, tax-efficient savings wrappers 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 (including Help to Buy) – which includes National Savings & Investment products, bank and building society accounts and cash ...

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... but funds cannot be withdrawn until the child reaches age 18. Contributions can be made by parents, grandparents, other family members and friends.

Help to Buy ISA

A Help to Buy ISA is a type of cash ISA aimed to assist with the purchase of a home. An investor cannot contribute to a cash and Help to Buy ISA in the same tax year. These are no longer available to new investors, but existing investors can continue to contribute until November 2029.

Lifetime ISA

Lifetime ISAs became available in April 2017 for adults under age 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 are linked to 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 investment c...

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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

Taxation of fund

Income

Savings income taxed at 20%, e.g. interest from gilts, cash and bonds

Dividends from UK companies received net with no additional tax to pay

Non-savings income such as rent is taxed at 20%

The expenses of an insurance company can be offset against its unfranked investment income (income other than from UK shares)

Capital gains

Are taxed at 20% subject to indexation relief

Taxation of investor

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

  <...

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...been in place

The effect of this is to produce a “slice” of gain that can then be added to other income in the year. If under the higher rate tax band, 0% tax will be payable. For any portion over the higher rate tax band, 20% tax will be payable and for any portion in the additional rate tax band, 25% tax will be payable. This tax charge is then multiplied by the number of complete years of investment to produce the final liability

The full formula for calculating a gain is: (encashment value + previous withdrawals) – (original investment + previous chargeable gains)

The basic structure of these types of investment bond has already been discussed. We will therefore concentrate on the types of investment funds that investors can select:

Managed fund

This type of fund is a popular default fund for investors who do not necessarily wish to concentrate on any specific investment area, perhaps due to a lack of investment expertise. It will typically combine investment in UK equities, fixed interest funds, cash and property. Managers will hold and alter specific weightings of each asset type to create the most favourable returns. The balance of investments held in these fund types would provide some exposure to capital risk but would, through appropriate diversification of assets, attempt to avoid exposing the investor to any very high risk investments. Usually this will be at the expense of high returns.

Cash fund

This fund will invest in money market cash-based securities. It will normally be used as a “safe haven” for investors at times where stock markets are performing poorly, as an interim measure when switching between higher risk funds or when the investor is close to withdrawing funds and wishes to “crystallise” any gains ...

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...ion (MVR) to surrender in times of adverse market conditions. This is to ensure that investors’ withdrawals do not exceed the value of the underlying investments in the fund, thus protecting remaining investors. This adjustment would not apply on death or in certain circumstances if the investment is held for a certain number of specified years.

The basic structure of these funds is still as a non-qualifying whole of life assurance policy, so the same rules apply as described above in terms of withdrawals and taxation.

A variation of this is a unitised with profit investment. These give the full 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 rat...

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...f course, it should be mentioned to investors that in the event of poor stock market conditions, their returns could be unspectacular to say the least (i.e. worst case scenario is to receive a return of the capital invested).

Assuming that they are held to maturity they are relatively low risk but, if surrendered early, the investor may receive a value below their investment due to the fact that the underlying structure of investments may be complex and difficult to liquidate.

These plans offer a very high level ...

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...of the original capital is returned.

Generally issued by subsidiaries of UK life offices in countries such as Luxembourg, the Isle of M...

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...nt and relief for any time spent outside of the UK will be given against the overall gain arising.

Some investors want to have their ...

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...ed these days to non-UK residents.

The scope of this material is not wide enough to cover the subject of pensions in any great detail.

However, when considering an individual’s savings and investment needs, pension planning could be a key priority.

A range of pension arrangements are available coverin...

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...free of any forms of income and capital gains tax

Where benefits are drawn at retirement, part of the accumulated fund can be secured to provide a tax free cash sum of up to 25% of the total value of benefits; the balance will need to secure an income which will be taxable

These policies are defined as regular premium life assurance policies effected for a fixed term. They pay out on either maturity of the term or on previous death, whichever is sooner.

Amongst other requirements, an endowment assurance must provide a minimum level of life cover of 75% of the premiums payable over the term (which can be reduced proportionately for over 55 year olds) and must be for a minimum term of 10 years in order to be classed as “qualifying” under life assurance policy rules.

If the policy satisfies the ‘qualifying’ criteria then no chargeable event gain will arise on any policy proceeds on death or maturity. This will effectively mean that there will be no liability to higher rate tax on the policy gains. 

Some arrangements have been available which run for shorter terms than 10 yea...

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...ecoming non-qualifying.

Funds can be accessed at any point during the policy term and on maturity. With unit-linked funds, the payout will reflect the term that the policy has been running (especially punitive in the early years due to higher set up charges) and the value of the underlying assets within the fund. It is not uncommon for early surrender values to be more or less nil.

We have already discussed how life assurance policy funds are taxed internally (see investment bonds). The same criteria will apply to endowment policies.

The investor will only suffer tax on policy proceeds if the life policy is already or has become non-qualifying as a result of encashment. Even in these circumstances, tax will only be payable if as a result of the chargeable gain being added to other income, the policyholder is a higher rate taxpayer.

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, growth or a combination of the two.

In the short term a small number of lump sum products (guaran...

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...tements

Online valuations

Automatic rebalancing of portfolios

Adviser fees deducted from cash holdings

These features also benefit advisers who can see the full nature and value of a client’s portfolio and therefore offer a more streamlined and cost-effective service.

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.

Many people either choose or exclude certain types of investments for ethical, moral or religious reasons.

Sustainable Finance

Sustainable finance allows investment managers to take environmental, social and governance factors (ESG) into account w...

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... 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. It is potentially payable by everyone who is UK domiciled and is based on the value of their worldwide assets. For non-UK domiciled individuals it is based 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...

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...y 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