Investments Topic 11 - Collective Investments (Life Assurance)

Question 1

A qualifying policy is one that

Answer 1

meets the qualifying rules, and this means that they are free from tax when the benefits are paid out.

Question 2

Qualifying rules for life assurance policies are:

Answer 2

• Premiums must be paid at least annually
• Policy must have a term for at least 10 years
• Policy must provide a death benefit of at least 75% of the premiums payable over the term
• Premiums in one year cannot be more than double those in any other year
• Premiums in any one year cannot be more than 12.5% of total premiums payable over the term

Question 3

When calculating the gain for a non-qualifying policy, you must calculate the difference between

Answer 3

the current cash value of the plan and minus the total premiums paid up until that point.

Question 4

Non-qualifying policies

Answer 4

Fail to meet qualification rules, charges payable on encashment or death. This includes investment bonds.

Question 5

Endowments are

Answer 5

a regular premium investment orientated life assurance contract that pay a sum on a predetermined maturity date. Used to pay school fees, mortgages etc. Life assurance element ensures target is met even if they don’t live to the maturity date.

Question 6

With-profits funds

Answer 6

• Very conservative approach, low returns but safer
• Profits from the company are split into reserves, and to pay with-profits clients
• Money in reserves is saved for a ‘rainy day’ and can be paid out another time
• Usually inflexible, term cannot be changed and premiums cannot be changed

Question 7

Low-cost endowment

Answer 7

as endowments are quite expensive, this poses a chance for a cheaper endowment which consists of a with-profits endowment and a decreasing term assurance. The sum assured is usually much less than the amount needed, and the term assurance decreases accordingly.

Question 8

Unitised with-profits fund

Answer 8

investor buys units in a with-profits fund, which means the value of the units cannot fall and bonuses are added to the value of the units or by creating more units. This way usually means the units are undervalued to protect all other investors.

Question 9

Unit-linked endowments

Answer 9

offered for a term between 10-30 years but this can be changed, as well as the premiums can be changed. Unit-linked funds are similar to unit trusts except they are subject to life fund legislation.

Question 10

Unit-linked endowment charges

Answer 10

• Initial charge usually 5%, represents the bulk between bid and offer prices of units
• Monthly charge for life assurance is deducted from units
• Monthly or annual policy charge taken from premium before unit allocation or deducting units
• Annual management charge, typically 1-2%
• May be early surrender charge

Question 11

Traded endowment policies

Answer 11

• Instead of surrendering endowment policies, the policies can be traded
• The investor can get up to 35% more for their policy, and the buyer has some security of the value of the policy and the benefits
• Buyer will then pay the rest of the premiums

Question 12

Investment bond

Answer 12

essentially a whole-of-life assurance policy

Question 13

the 3 main differences between an investment bond and conventional policies is:

Answer 13

• Only done via lump sum
• Life assurance element limited, usually to 101% of the policy value on death
• These are non-qualifying policies

Question 14

Segmentation

Answer 14

investment divided into sub-categories, which can mean you can treat sections separately for encashment and do a partial encashment

Question 15

3 bonuses that can be granted for a with-profits investment bond

Answer 15

• Annual reversionary bonus
• Guaranteed minimum level of bonus
• Terminal bonus

Question 16

Guaranteed income and growth bonds

Answer 16

Essentially limited-term life insurance investment bonds that offer certain guarantees.

Income bond offers guaranteed annual income, growth bond offers guaranteed growth by the end of the term. Income bond taxed as normal investment bond, gains on growth bond taxed as gains would be (CGT).

Question 17

Distributor bonds

Answer 17

Bond that operates differently as income and capital are separated.

• Investments made into distributor fund
• Income from the fund paid out regularly
• Income paid out from the fund’s income, meaning capital is protected

Question 18

Tax treatment of onshore bonds - withdrawals

Answer 18

• Up to 5% withdrawn each year tax-free
• The withdrawal limit is cumulative, if you skip one year you can take 10% out next year
• Once 100% of original capital is withdrawn, further withdrawals classed as gains

Question 19

Tax treatment of onshore bonds - Chargeable events:

Answer 19

• Full encashment
• Death of life insured
• Excess withdrawals
• Assignment of money’s worth – selling bond or exchanging for something of similar value

Question 20

The calculation for gain on investment bonds

Answer 20

Gain is established by taking the surrender proceeds PLUS any withdrawals made LESS the initial investment (plus any excess withdrawals already dealt with).

Question 21

Annual equivalent

Answer 21

This is when the gain is divided by the total number of years the bond has been in force, this is because not all gains would have been gained in 1 year.

Question 22

Use of investment bonds to satisfy customer needs

Answer 22

Tax efficiency
* As long as money is kept in the bond, there is no tax to pay on gains or income on the investment
* Differs to UT and OEICs as they pay tax on the dividends
* This is as long as you withdraw under the limit (5%)

Pensioners
* Investment bonds specifically excluded from valuation of assets when assessing how much they should contribute to their care

Other reasons to use investment bonds
* Access to professional fund management
* Switching
* Administration
* Tax treatment

Question 23

Offshore bonds

Answer 23

Is what it says it is, bonds held offshore, and are similar with one big difference – the fund is not taxed while it remains invested.

Question 24

Annuities

Answer 24

• Annuities are a fixed income for retirement based on life expectancy from a lump sum, invested into a range of gilts
• Divided into 2 broad categories – purchase and compulsory purchase
• Compulsory purchase is those purchased with pension proceeds

Question 25

Life annuity

Answer 25

• Payments made for the rest of their life and ceases on death
• Guarantee can be arranged, where payments continue into the estate if the holder dies within the stated period from the contract beginning

Question 26

Temporary annuity

Answer 26

• Used to pay over specified term – 5, 10, 15 years and so on. If the holder dies, payments cease
• Annuity certain can be in place so payments don’t stop if holder dies within the term

Question 27

Escalating annuity

Answer 27

annuities that have increased payments each year, in line with benchmark or invested in index-linked gilts

Question 28

With or without proportion

Answer 28

if holder dies before next payment, most annuities do not make final payment – this is called without proportion

Question 29

Investment-linked annuities

Answer 29

• Invested into with-profits or unit-linked fund
• This means payments can move either up or down as the investments do
• Income is paid by cancellation of units
• There is usually a minimum level below which the annuity cannot fall

Question 30

Compulsory purchase (pension) annuities

Answer 30

Essentially annuities used for pensions, rates are based on life expectancy and gilt yields. This is a lifetime annuity and can be arranged on a single-life basis.