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R02 April 2020 > 6 - Characteristics, risks, behaviours and tax considerations of investment products. Part 2 - Other indirect investments including life assurance-based products > Flashcards

6 - Characteristics, risks, behaviours and tax considerations of investment products. Part 2 - Other indirect investments including life assurance-based products Flashcards

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1
Q

What is an MVR on a with profits policy?

A

Market value reduction - usually applicable for surrenders or switches or in times of adverse market conditions

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2
Q

What are the two different types of unitised with profit policies?

A

Fixed price and variable price

Fixed - unit price is the same and number allocated through the year increases by a % of the annual bonus rate

Variable - unit price is increased through bonuses and guaranteed not to fall

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3
Q

What are the advantages of unitised with profits investments?

A

Bonus rate is declared annually in advance
It is easier to understand the value of the investment
Switches can be made to other unit-linked products (may be subject to MVR on switches)
The insurance company has less overall committment of reserves than traditional with profit funds
A final bonus may be payable on death or maturity

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4
Q

What are the characteristics of a conventional with profits policy?

A

Bonus declared annually in arrears
Investor can see the build up of funds by the bonus declaration
However, cannot easily calculate the current value of the policy

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5
Q

How do companies try to maintain a good balance in the free asset ratio?

A

Retain enough in good years to smooth out in poor

Provide each generation of policy holders with the appropriate returns

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6
Q

What are the advantages of with profit policies?

A

Provide access to equity markets for the risk averse
Bonus is not always linked to market performance - companies use reserves to cushion
They generally outstrip inflation
In some cases they allow investors to participate in company profits
Have ownership rights in the life office (and will benefit if demutulalised)

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7
Q

What are the disadvantages of with profits?

A

They lack transparency
Returns can be dependant on the companies subjective view of long term investments
They might be inflexible and give poor returns on early surrender or if MVR applies

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8
Q

What should policy holders consider if they have a closed with-profits policy?

A 
Strength of the insurer
Asset allocation (high fixed securities are likely to perform worse that equity funds)
Current bonus rate
Long term performance of the fund
Surrender value
Penalties such as MVR
How long until the end of the policy
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9
Q

What are the consequences for an investor remaining in a closed fund?

A

Policy holders may incur no penalties to exit (such as MVR free anniversaries) taking their fair share of the fund, which weakens the overall fund

Investors need to weigh up the option of exiting and re-investing

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10
Q

What is the benefit of pound cost averaging to a policy holder looking to cash in their policy?

A

A saver will receive a better return if the fund has been at a low price during the term of the policy and rises just before encasement as they will have a greater number of units.

The units will have been bought on average at a lower cost than those who have had a steady increase.

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11
Q

Which types of funds are more unique to life assurance policies?

A

With profit funds
Guaranteed income and growth bonds
Property funds with asset holdings rather than property shares
Mixed or managed funds, providing a balance on investments

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12
Q

What is tha cap on MIP contributions (maximum investment fund)?

A

£3600

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13
Q

What is the guaranteed sum assured for a unit linked policy?

A

75% of the premiums paid over the life of the policy or up to the age 75 for whole of life

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14
Q

When are fixed term endowments generally most suitable?

A

When an investor can commit the funds for the full term of the policy

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15
Q

What are the characteristics of a high income bond?

A

Offer a high level of income but do not guarantee the return of the capital

Return of the capital will depend on the performance of one stock market index or an average of two or three

Provided it meets set targets, the capital will be returned, if not it may be less than the original investment

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16
Q

What is the benefit of an onshore unit linked bond to an investor in terms of tax paid?

A

Liability to basic rate tax is covered by the tax paid within the fund and the investor may take 5% without an immediate tax liability. (for 20 years or until the capital has been returned)

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17
Q

What does the ABI require of a distribution bond in terms of asset content?

A

max 60% equity
min 50% sterling based assets
yield at least 110% of FTSE all share index

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18
Q

How does a distribution bond operate differently to a untised bond?

A

There is a clear definition between income and capital
Income is taken in the form of payments direcrtly as a result of income from the bond - no units are cashed in
Unit prices will fall in line with pay out on distribution date
Taxation is the same as unit linked bondds - i.e. 5% allowance rules apply
Regarded as medium to long term as exit penalties are high
Appropriate for a cautious investor

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19
Q

What is the difference between a guaranteed equity and protected equity bond?

A

With protected equity bond the investor can choose at reguar intervals, how much of ther equity is protected, typicall between 95% and 100%

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20
Q

What is the tax advantage of holding bonds as investments for trustees?

A

The underlying life company would pay corporation tax on income at a lower rate tahn the trustees would pay on income.

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21
Q

What is the tax rate on trust income under £1,000 and over £1,000?

A
  1. 5% on dividends and 20% on other income under £1000

38. 1% income tax on dividends and 45% on other over £1000

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22
Q

When might there be a chargeable gain on an investment bond?

A

more than 5% withdrawn per year
full encasement
death of the life assured

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23
Q

How is a chargeable gain calculated for an offshore bond?

A

Number of days resident in the uk/number of days the policy has left to run

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24
Q

What are the two calculations that take place for encashement of an offshore bond?

A

The basic rate tax calculation is carried out at 20%
(subject to personal allowance and savers starting rate of £5000)

The higher or additional tax calculation is undertaken times the number of relevant years to determine the total higher rate payable on the gain (subject to top slicing)

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25
How does top slicing differ for on shore and off shore bonds?
Offshore, it is always calculated back to the start date of the policy, onshore to the last chargeable event
26
Why are on shore bonds sometimes preferable to off shore?
Off shore bonds do not qualify for indexation relief and therefore taxed at 40 and 45% respectively Some offshore income may be subject to witholding tax Charges offshore are generally higher An offshore bond has no tax to deduct the management expenses so reduces the gross roll up (onshore deductible from the fund for tax purposes) An onshore bond for a higher rate payer 20% is charged on the net return vs 40% for offshore of the gross return
27
How does a friendly society benefit in terms of tax on income?
It does not pay any
28
What are the investment limits for tax exempt products within friendly societies?
£270 per year, or £25 per month for monthly/quarterly investments therefore £300 Parents and children can have their own policies
29
What are the genreal taxation rules for life assuance funds?
Dividends are exempt, uk or overseas All other income is taxed at 20% Capital gains are taxed at 20% after indexation allowance
30
What is the criteria for a qualifying life policy?
Term at least 10 years premiums payable at least annually for least 10 years Min life cover 75% of total premiums premiums payable in one year must not be more than double in any other year no premium more than one-eighth of the total premiums over the term Limit of £3600 premiums per annum from 6/4/13
31
When would tax be payable on surrender?
If the surrender value exeeds the gross premiums, at the payers top rate minus basic rate If the payer is basic rate, after top sliced gain, no tax liability
32
What tax is payable on a qualifying policy at maturity?
Free of any annual taxes provided: It is in the hands of the original life assured If it is surrendered after 10 years
33
What are the chargeable events for non -qualifying policies?
``` Death Maturity Surrender or final encasement Part surrenders Assignment for money ```
34
Can the 5% allowance for non-qualifying policies be carried forward to use in future years?
Yes it can
35
what are the 5 steps to calculate a taxable gain of a policy?
1. Calculate the total taxable income for the year & ID how much falls into Starting rate for savings/personal savings allowance/nil, higher. additional rate bands 2. Calculate the tax due across all bands, deduct the basic rate which is treated as already paid 3. Calculate the liability to tax on the annual equivalent by dividing the gain by the number of years 4. Calculate the liability to tax on the annual equivalent - deduct basic rate treated as paid and multiply by full policy years 5. Deduct step 4 from step 2 to give the top slicing relief due
36
How could you use independant taxation to reduce tax liability?
Assign the bond to spouse before the surrender is made | An assignment is not a charegable event and is free of CGT and IHT (Uk domiciled)
37
If a person is claiming universal credit/child tax credit, what might be the implications if adjusted net income exceeds £50K?
It could reduce or eliminate the eligibility
38
When would there not be a chargeable gain on the sale of a qualifying life policy?
Is sold after 10 years
39
Would there be a CGT liability for the buyer at maturity of a qualifying policy?
yes, as they are not the original beneficial owner
40
What are the tax disadvantages of investment bonds?
A non-tax payer cannot claim back tax paid within the fund As very few investors are subject to annual CGT, for most clients investing in life assurance policies will involve paying CGT on gains within the fund They could be postponing tax liability if they expect the rate they are paying to rise in the future
41
Are exchange traded funds eligible for inclusion in ISA's?
Yes
42
What is the difference between an ETN and a ETF?
An exchange traded note has no portfolio of investments and do not own anything, they are using derivatives to track the index
43
What are the main conditions of a PAIF (property authorised investment fund)?
at least 60% of income must be from the exempt property income investment business the value of the assets involved must be at least 60% of the assets held at the accounting period its shares must be widely held - no more than 10% per investor of NAV funds
44
What is the tax position of a PAIF?
The point of taxation moves to the investor from the fund, in the same way a direct property investment would It can only be an OEIC
45
What are the conditions for a fund to qualify as a REIT (real estate investment trust)?
75% or more of the total gross profits must be from property rental business the value of the tax exempt part must be at least 75% at the accounting period they cannot have excessive debt financing - interest on borrowing must have 125% cover by rental profits
46
In what ways are VCT's similar to investment trusts?
Both are listed companies run by fund managers who are generally members of larger investment groups Investments in both can be made by subscribing for new shares when a trust is launched or by purchasing shares from other investors once the trust is established.
47
If an ISA holder moves abroad, can they keep their ISA?
Yes, but they cannot add to it
48
How hold do you need to be to invest in a Cash ISA? Stocks and Shares Isa?
Cash - 16 Stocks and shares - 18 under 40 for a lifetime ISA
49
What are the four types of ISA?
Cash Stocks and Shares Lifetime Innovative finance
50
What type of shares can you transfer into a stocks and shares ISA?
Shares from an approved incentive share scheme or SAYE must be transferred within 90 days of emerging from the scheme
51
What types of investment are eligible for ISA?
``` Shares Small & medium enterprise securities Corporate bonds Listed bonds Gilts and similar government securities (EEA) Unit trusts and OEICs Units and shares within a recognised UCITS UK investment trusts Non UCTIS (without access restrictions) SAYE shares & approved schemes Units in stakeholder investments Life assurance policies Core capital deferred schemes Certain securities such as retail bonds ```
52
What are the three stakeholder products that can be held in an ISA?
Deposit account Medium term investment product (MTIP) Smoothed MTIP (similar to a with profit policy)
53
What are the conditions for a stocks and shares ISA?
annual charge limited to 1.5% for first 10 years & 1% thereafter Minimum investment cannot be higher than £20 no more than 60% in riskier funds The buy and sell price of shares in the fund must be the same & published daily
54
What are the main types of ISA available?
``` Unit trust and OEIC Investment trust Managed Self select Corporate Derivative based Cash Help to Buy Innovative finance Lifetime ```
55
What are the government bonuses for help to buy ISA's?
£50 for every £200 saved up to £3,000 max If £12K is saved, boosted to £15K
56
What is the government bonus for a Lifetime ISA?
bonus of 25% of investmed amount up to £1000 per year
57
What other charges may be levied by ISA managers?
Early encashment penalties Commission Dividend collection fee Report charges
58
Can you transfer part of a current years' ISA?
No - you have to transfer the whole of the current year but can transfer part of a previous year
59
If you transfer from a Lifetime ISA to another type of ISA, is there a penalty?
Yes, 25% withdrawal fee
60
What are the time limits for ISA transfers?
15 days for Cash & Cash Lifetime, 30 days for others
61
What happens to an ISA on death?
It becomes a continuing account of the deceased. No further money can be added but retains tax status. Must be closed within 3 years of the date of death to retain tax free status
62
Can a partner within a civil partnership or marriage inherit an ISA allowance?
Yes, they can inherit a on-off additional allowance at the higher value at date of death or when passed on
63
What types of Junior ISA can be held?
Cash and stocks and shares
64
What is the subscription limit for a junior ISA?
£4368
65
When could a person hold both a cash and junior ISA?
between 16 and 18
66
What are the three types of Child Trust Funds?
Savings Share accounts Stakeholder accounts
67
Why is a PLA (purchased life annuity) more tax efficient than a pension annuity?
The capital element is tax free as it is considered as a return of the original capital, a pension annunity is taxed as full income
68
What are the two types of derivatives that are traded on exchanges?
Futures and options
69
What position is a buyer and a seller of a future said to have?
Buyer has the long position - they agree to buy at a future date at a future price - hoping prices will rise Seller has the short position - they agree to sell at a future date at a future price - hoping prices will fall
70
What is marking to market?
The daily revaluation of the contract mirroring changes in the price of the underlying asset
71
What is the EDSP (exchange delivery settlement price_
The closing price of the futures price at the time of delivery, which matches the cash price of the underlying asset
72
What is the difference between a call and put option?
Call option is the option to buy the underlying asset Put option is the option to sell the asset The seller is obliged to meet the obligation placed on them by the buyer The seller of a call optoon must sell to the option holder The seller of a put option must buy from the option holder
73
Who would pay any margin payments - the buyer or the seller?
The seller
74
What are the options open to option holders?
Exercise the option sell the option before expiry let the option expire
75
What are the two component part of an option's value?
Intrinsic value - the value above or below the agreed strike price Time value - the amount an investor is prepared to pay for an option above its value in the hope it will change before expiry
76
What are the two major uses for hedging?
To protect an existing exposure against future adverse movements To try to profit by correctly forecasting future price movements
77
What options might a fund manager have if he expects markets to rise and hasnt got funds to invest straight away?
Wait until the money is received and buy at the higher price Borrow funds to invest and repay with interest when funds are received Use derivatives - i.e. buy futures or buy call options
78
If a fund manager belives a market is going to fall and doesn't want to sell part of the portfolio, how could be use derivatives?
He could sell futures | He could buy a put option
79
What are the benefits of using futures?
Lower dealing costs Speed of dealing Liquidity - trading any volume at any time without dramatically affecting market prices
80
What is the risk for the buyer of both call and put options?
limited to the premium paid
81
What is the reward for buyers of options?
Unlimited - the higher the price of a call option above the exercise price, the the greater the reward For a put option the greatest reward would be if the price fell to zero
82
What is the largest risk for a writer of an option?
If they do not own the shares or assets as they may then have to buy them in the market if the option is exercised
83
How is the profit from derivaties taxed for an investor?
Classed as CGT (unless the underlying asset is a gilt or qualifying coroporate bond)
84
What is a hedge fund?
A pooled investment, where a fund manager invests in various traded securities inorder to provide positive returns
85
What are the two main uses of futures and options?
Hedging and speculation
86
Why do most hedge funds set up off shore?
To limit set up, regulatory and administration costs
87
What are the four broad hedge fund strategies?
Long/short funds Relative value funds Event driven funds Tactical trading funds
88
What are the benefits of investing in a structured product?
A wide range of underlying assets are available There is no exposure to a partilcular managers style or ability (unless linked to an specific fund or portfolio) The degree of upside participation will be explicitly stated A level of capital protection is generally included The risk and return are fixed and transparent
89
What are the drawbacks of structured products?
Caps on participation may limit returns in a strong market Kick out features can mean a product matures early Returns may be diluted by averaging of index measurements If the product cannot be sold in the secondary market, maturity could take place in a falling market and profits could be impacted Most retail products are fixed term and early encashment may be prohibited or costly Falls in markets could be significant enought to lose its capital protection
90
What risks should be considered when buying a structured product?
Return - exactly how any when it will be calculated Risk Profile - risks to capital, assets within the investment, provisions, FSCS cover available (£85K limit) Costs & Tax implications Encashment - early penalties, transparency of pricing, liquidity in secondary market Credit risk - creditworthiness of issuer, counterparties, rating of zero-coupon bond or other instruments used, protection of collateral
91
What are the two most important effects of Sharia Law on investments?
There are restrictions on paying interest (Riba) | They must not make investments in gambling, alcohol, pork products, tobacco or other items that go against muslim values
92
What are the three types of Sharia compliant funds?
Equity - returns through capital gains, dividends need to be approved by a Sharia board Commodity - To buy Halal commodities at a fixed price to resell for profit, however futures are deemed as gambling Ijarah - holds tangible assets such as property and receives income such as rent.
93
What is a sukuk?
A Sharia compliant bond, which is asset based. the Sukuk is issued to the subscriber and represents proportional ownership of the asset
94
What are investment notes?
Structured products that once issued are listed on the LSE. They offer the investor the opportunity to sell theri note and take profits early if the market rises before maturity
95
What are the disadvantages or unit trusts/OEICs?
Further management charges are payable in addition to intial and AMC levied by the groups Changes in the portfolio of funds may be expensive (due to buy-sell proce spread & intial charge made by OEICs) There is little direct involvement by investors Changing investment managers may involve higher costs
96
What are the advantages of Investment trusts rather than unit trusts/OEIC's?
The cost of purchasing shares is generally lower The AMC of an older investment trust is generally considerably lower Investment trusts can provide a higher level of income if there is a discount to NAV (which there generally is), therefore you can buy a higher volume of securities and therefore a greater level of income There are several different types of trust securities that have specialist uses, such as split capital trusts
97
What are the advantages of Investment trusts rather than unit trusts/OEIC's?
The cost of purchasing shares is generally lower The AMC of an older investment trust is generally considerably lower Investment trusts can provide a higher level of income if there is a discount to NAV (which there generally is), therefore you can buy a higher volume of securities and therefore a greater level of income There are several different types of trust securities that have specialist uses, such as split capital trusts - which divide the investment returns into differnt classes (whereas OEICs and UT's only have one) Shareholder pressure can cause a change in performance or replacement of a manager They can borrow to invest, OEIcs and UT's cannot
98
Which is said to be a higher risk, Investment trusts or Unit Trusts and OEIC's?
Investment trusts - the level of discount to NAV could grow meaning there may be more investors trying to sell than buy (UT's and OEICS cannot fall below the value of the underlying investment) - as a trust can borrow, it could increase the volitility of the trust and therefore its risk profile (UT's and OEICS has tighter restrictions)
99
If a fund is a UCTIS fund, what is the implication in terms of investment of the funds assets?
The fund manager has more flexibility on how the funds are managed. This inclues the ability to leverage, sell, short and use derivatives

R02 April 2020 (14 decks)

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