Case Study 1 Exam Questions

Question 1

What additional information do you need to ensure that Daniel and Sophia can generate a sustainable income throughout retirement?

Answer 1

 How much income and/or capital will they need in retirement in today’s terms?
 Do they intend to work part-time in retirement?
 What pension options are available from their workplace pensionschemes?
 Views on inflation and willingness to take risk in this respect?
 Their State Pension forecasts and when it becomes payable?
 Contribution history and willingness to meet any gaps?
 Did Daniel retire at or before the DB scheme’s normal retirement age?
 Solvency of Daniel’s DB scheme?
 Escalation of Daniel’s DB pension?
 Availability of spouse’s pension under DB scheme on Daniel’s death?
 Are higher matching contributions available from Daniel’s employer?
 Is salary sacrifice available from Daniel/ Sophia’s employer?
 Is Daniel/ Sophia willing to make additional regular contributions?
 Is Daniel/ Sophia willing to make additional lump sum contributions?
 Affordability of contributions based on cash flow analysis
 Willingness of Daniel/Sophia to contribute to pensions once non-earners to benefit from tax relief / remove funds from their estate for IHT purposes/ boost their income in later retirement?
 Asset allocation within each pension fund?
 Fund performance to date?
 Possibility of switching funds to align with stated ATRs?
 Capacity for loss?
 Pension fund charges?
 Projections of existing funds to retirement age?
 Options available at retirement under each scheme and how they intend to take benefits?
 The extent to which they’d be prepared to rely on their other assets?
 Likely tax position in retirement?
 Have they nominated each other as beneficiaries of death benefits?
 What would they like to happen after first / second death?

Question 2

Explain to Daniel and Sophia how a lifetime cashflow model could be used to assist them in meeting their objective of ensuring they have a sustainable income throughout retirement? (Could be adapted to current cash flow and asked of Sanjeev and Maya for affordability)

Answer 2

 It can identify shortfalls
 Based on their current and future income and expenditure
 Returns required from their investments to supplement existing
pension income
 Stress-test existing pensions / investments
 Apply range of growth rates based on their ATRs
 Show impact of inflation
 Show impact of withdrawals from investments
 Can be adjusted as circumstances change over time

Question 3

Identify the main factors and assumptions that you should discuss with Daniel and Sophia when formulating a lifetime cash flow model. (Could be adapted to current cash flow and asked of Sanjeev and Maya for affordability)

Answer 3

 Target amount required now and in the future
 Their ongoing health/ life expectancy/ potential long term care needs
 Their attitude to risk (this impacts potential investment strategies) and capacity for loss
 Any expected changes to their income
 Expectations of inflation
 Any significant lump sum capital requirements
 Pattern of expenditure throughout retirement
 Current/ likely tax rates
 Any expected capital lump sums
 Other non-pension assets, financial and non-financial
 Provisions of their wills / intended lifetime gifting
 Affordability – now and in the future of lump sum investments
 Expected growth rate for any investments
 Use of tax efficient wrappers, e.g. pensions, ISAs
 Other potential sources of income / capital if downsize
 Assumptions for charges

Question 4

Explain to Daniel and Sophia the risks of relying solely on lifetime cash flow models. (Could be adapted to current cash flow and asked of Sanjeev and Maya for affordability)

Answer 4

 Assumptions can turn out to be wrong
 Figures are estimates only and will need regular reviews
 Their objectives or circumstances may change
 Availability of tax wrappers and allowances may be withdrawn
 It does not take into account market risk
 It does not consider liquidity risk

Question 5

Outline the process an adviser should follow when advising Daniel and Sophia on their pensions arrangements.

Answer 5

Fact find
 Risk and capacity for loss profile assessed
 Client agreement and documents presented and signed
 Obtain DB scheme details / analyse
 Obtain State pension forecast
 Check for gaps in record and which can be plugged
 Carry out research
 Formulate a recommendation
 Present recommendation
 Review

Question 6

Explain briefly to Daniel and Sophia the purpose of a stochastic modelling tool, the type of information it can provide and how it can be useful for ensuring they do not run out of funds in retirement.

Answer 6

Analyse potential risks and returns
 Compares ATR against current portfolio
 Tool suggests asset allocation
 To meet objective (e.g. to not run out of funds)
 A forecast shows the potential future values
 In a range of different market conditions
 Indicates if they need to invest more / are on track / exceeding

Question 7

State the limitations of using an asset allocation model for income planning.

Answer 7

 It does not recommend an appropriate tax wrapper/does not take into account the client’s tax status
 Charges are not taken into consideration
 Questions asked not always relevant to the client’s circumstances
 Different models produce different results
 Underlying assumptions subject to change/based on historic data
 Needs to be reviewed/only relevant at a specific point in time

Question 8

Outline the key factors that an adviser should consider when advising Daniel and Sophia on their strategy for ensuring they have sufficient income throughout retirement.

Answer 8

 Planned target income
 Deferral of State pension (or not)
 Possible return to part time work (or not)
 Asset allocation
 Maximising pension contributions now
 Use of non-earner limit £3,600 once retired
 Details of Daniel’s DB scheme pension / their workplace pensions
 Use of allowances – ISA, CGT
 Charges
 Budget
 Use of other assets
 Priority of objectives
 ATR
 Willingness to use trusts
 What they want to happen on 1st death in terms of pension fund /
protecting surviving partner

Question 9

Identify any reasonable assumptions you might make in relation to Daniel and Sophia’s retirement planning.

Answer 9

 That any gaps in State pensions will be filled if affordable
 Willingness to defer State pensions if affordable
 Unlikely to return to work
 Willing to make additional contributions now using carry forward if necessary
 Willingness to make regular contributions into pension schemes once retired, subject non-earner limits
 That any ongoing contributions remain affordable
 That they remain in good health
 That the £200,000 will be invested for their retirement
 That they are willing to use other investments to generate a retirement income when needed
 That their tax status will remain the same throughout retirement
 They have nominated each other as recipients of death benefits
from pension schemes (or that they will do so)
 They will want to provide an income after 1st death

Question 10

Evaluate the suitability and tax efficiency of Daniel and Sophia’s pensions for their retirement.
(NB sometimes suitability and tax efficiency are combined in the one question, sometimes they are separated out; same goes for pensions and investments.)

Answer 10

 Daniel is a medium risk investor
 His DB pension provides a guaranteed income
 That escalates over time
 And usually provides a spouse’s pension
 Which will also escalate
 Even if the scheme becomes insolvent
 PPF protection is usually 100% for pensions already in payment, 90%
if Daniel retired before the scheme’s normal retirement age, 50% of
which can be paid as survivor’s pension to Sophia
 Daniel’s DC pension is invested in UK growth which may match his
ATR
 However, if he wishes to take an annuity, it may not suit this objective
 Sophia is also a medium risk investor
 Sophia’s DC pension is invested in UK treasury and fixed interest
which feels too cautious for her ATR
 However, if she wishes to take an annuity, it may suit this objective
We do not know if the couple will receive full State Pensions
 We should request a State pension forecast
 And consider making voluntary Class 3 NICs if there are any gaps
 Daniel is a basic rate tax payer once his current pension contributions are taken into account
 Sophia is higher rate
 By making larger pension contributions, Sophia may become a basic
rate tax payer
 Both Daniel and Sophia would benefit from tax relief
 If they made additional regular or lump sum pension contributions
 Both appear to be able to take advantage of carry forward

Question 11

Identify the key benefits and drawbacks of the following funds in the couple’s pension portfolio:
Typically you’ll only be asked about one fund per case study, but you won’t know which one until you get in the exam so we cover them all for you.
(Alternatively, the question could ask you to give reasons to retain (i.e. the benefits / ticks) or reasons to switch funds (drawbacks / crosses).

(Daniel - pension)

Answer 11

UK Growth Fund
Advantages
 Adds diversification to his overall portfolio
 Potential for growth / inflation protection
 Actively managed
 May be in line with ATR
 May be in line with need for sustainable income in retirement
 No currency risk
 No political / regulatory risk
 Should be able to switch easily
 With no tax implications as in pension wrapper
 Won’t be included in estate on 1st death as pension fund
 Can be kept out of 2nd estate if remains within pension wrapper
 Income and gains tax-free as in pension wrapper
 Accessible as over 55

Disadvantages
 Single geographic location – lacks diversification
 May be single asset class – lacks diversification
 May not be suitable if wishes to take an annuity in two years’ time
 Drawing on pension funds less tax efficient than drawing from
investments as pension funds IHT free

Question 12

Identify the key benefits and drawbacks of the following funds in the couple’s pension portfolio:
Typically you’ll only be asked about one fund per case study, but you won’t know which one until you get in the exam so we cover them all for you.
(Alternatively, the question could ask you to give reasons to retain (i.e. the benefits / ticks) or reasons to switch funds (drawbacks / crosses).

(Sophia – pension)

Answer 12

UK Treasury and Fixed Interest Fund
Advantages
 Actively managed
 Adds diversification to her overall portfolio
 Spreads risk within the sector
 No currency risk
 No political/regulatory risk
 May be in line with need for income in two years’ time
 Should be able to switch easily
 With no tax implications as in pension wrapper
 Won’t be included in estate on 1st death as pension fund
 Can be kept out of 2nd estate if remains within pension wrapper
 Income and gains tax-free as in pension wrapper
 Accessible as over 55

Disadvantages
 Single asset class – lacks diversification
 No geographic spread for diversification
 May be too cautious for ATR
 May not require the income at present
 Income payments not guaranteed
 Income payments may erode capital
 Limited growth / protection from inflation
 Charges may erode value of fund
 Drawing on pension funds less tax efficient than drawing from
investments as pension funds IHT free

Question 13

Identify and explain in detail the key client-specific factors that you’d take into account when assessing Daniel and Sophia’s capacity for loss in relation to their retirement.

Answer 13

 As a couple they have a large emergency fund and are wealthy
 They have secure sources of increasing income (Daniel’s DB
pension and their State pensions (at State Pension Age))
 In addition, they have their investments and
 Intend to release £200,000 of capital by downsizing
 They are in their early 60s
 They can tolerate some loss / volatility in their investments in the
longer term
 We do not know what their expenses are
 But they plan to retire in two years’ time
 They have no debt
 They have no IHT liability on 2nd death
 They are in good health

Question 14

Explain how carry forward works and how it could help Daniel and Sophia achieve their financial aims.

Answer 14

 Annual allowance in current tax year is £60,000
 Can carry forward unused allowance from previous 3 tax years
 Up to £40,000 for 2020/21, 2021/22 and 2023/24
 Could be less if individual is subject to a tapered annual allowance
 Overriding limit – total contributions paid in current tax year (even if
they relate to a previous tax year) cannot be more than 100%
relevant UK earnings in current tax year to obtain tax relief
 Neither appear to have used their full annual allowance in previous
tax years and can therefore make up for that this year if they so
wish / can afford to
 Could use some of their excess cash now to achieve this
 If wait until retire, they’ll be limited to an allowance of £3,600

Question 15

Explain to Daniel and Sophia how their pensions will increase over time.

Answer 15

 Their New State pensions will increase in line with the ‘triple lock’
 In April each year, they will increase by the higher of the increase in Average Weekly Earnings, the increase in the Consumer Price Index (CPI) (for the previous September) or 2.5%
 If they defer the State pension, when they restart their extra amount will increase in April each year in line with the CPI for the previous September
 Daniel’s DB pension will increase in line with inflation, although this may be subject to a cap
 The increases on their workplace pensions will depend on how they take their funds and the options chosen at outset

Question 16

Explain briefly to Daniel and Sophia the following options available with DC schemes to provide them with an income in retirement, including any income tax and IHT implications for each of these options:
- Option 1 – lifetime annuity
- Option 2 – flexi-access drawdown (FAD)
- Option 3 – uncrystallised fund pension lump sum (UFPLS) - Option 4 – short term annuity

Answer 16

Option 1 – lifetime annuity
 Take 25% PCLS
 Use remaining fund to buy annuity (which may match ATR)
 Income taxed under PAYE
 Capital would not be included in estate and any capital guarantee
would be IHT free

Option 2 – flexi-access drawdown
 Take 25% PCLS
 Enter into flexi-access drawdown
 Withdraw further funds as and when required either regularly or ad-
hoc
 Income taxed under PAYE
 Potential for tax-free gains on underlying fund
 Fund outside estate
 On death tax treatment depends on age – under 75 tax free, 75 plus
taxable
 Fund can remain outside of estate on 2nd death by only taking out
funds as and when required  May not suit medium ATR

Option 3 - uncrystallised fund pension lump sum (UFPLS)  Take UFPLS as and when required
 25% of each LS tax free
 Remaining 75% taxed as income under PAYE
 Potential for tax-free gains on underlying fund
 Fund outside estate
 On death tax treatment depends on age – under 75 tax free, 75 plus
taxable
 Fund can remain outside of estate on 2nd death by only taking out
funds as and when required  May not suit medium ATR

Option 4 – short term annuity
 Provides guaranteed income
 Retains some flexible income options within the pension  Can benefit if annuity rates rise in future
 Potential for capital growth remains on residual fund
 IHT benefits remain on residual fund
 Less administration
 Can include spouse’s pension / value protection
 Escalation to protect against inflation
 No investment risk
 May suit medium ATR

Question 17

Explain to Daniel and Sophia the main issues that they should consider when deciding if they should use flexi-access drawdown (FAD) in retirement, rather than purchasing an annuity.

Answer 17

 Flexi access drawdown (FAD) may not be suited to medium attitude to risk (ATR)/asset allocation/can invest in line with medium ATR.
 Potential for growth.
 Income is flexible/can change in line with requirements/ annuity is
inflexible.
 Can use tax free PCLS/ can create tax efficient income/ tax
planning.
 Retains tax free wrapper (CGT and Income Tax).
 Complex/ongoing administration/reviews/ongoing advice.
Ongoing charges/adviser charges.
 Income taken will restrict future contributions to £10,000 per
annum/money purchase annual allowance (MPAA).
 Funds can deplete/income not guaranteed/investment risk/fund
performance not guaranteed.
 Would they prefer a guaranteed income?
 No tax on death before 75 / taxable at marginal rate after age75.
 Improved death benefits / on death can pass to family/Inheritance
Tax (IHT) efficiency.
 Can purchase annuity at any time/annuity rates may fall/rise/health
may change/enhanced annuity rate may be available in future.

Question 18

Explain to Daniel and Sophia the factors to take into consideration when deciding whether to use a series of UFPLS to provide retirement benefits.

Answer 18

 Flexible income
 Improved tax-efficiency (only take funds when needed)
 Personal circumstances may change
 Flexible death benefits
 Pension fund can be passed on IHT free
 Annuity rates are likely to fall from current high
 Potential for growth
 May not need guaranteed income
 State pension / other assets as back up
 Possible emergency tax/month 1 tax implications?
 Whether they would like to make future pension contributions (as
MPAA would be triggered and limit this)

Question 19

State 6 advantages and 6 disadvantages of Daniel or Sohpia using flexi- access drawdown, rather than a lifetime annuity, to provide a sustainable retirement income.

Answer 19

Advantages
 Potential for fund growth
 Flexible income
 Tax-efficient income
 Tax planning (ability to keep income within a certain threshold)
 IHT free
 Annuity rates may improve
 Flexible death benefits

Drawbacks
 Increased fees
 Investment risk
 Fund may run out before they die
 Ongoing advice/reviews required
 Income not guaranteed
 Triggers money purchase annual allowance
 Mortality drag

Question 20

Identify the key factors you should consider when establishing a reasonable rate of withdrawal from Daniel and Sophia’s pensions in the future should they go for flexi-access drawdown in retirement?

Answer 20

 Income / capital needs in retirement
 Income from other sources
 Future tax position
 SIPP investment strategy
 Growth assumption
 Economic conditions / inflation
 Sequencing risk
 Charges
 Longevity
 Death benefits free from IHT

Question 21

Explain to Daniel and Sophia the impact of sequencing risk is and reverse pound cost averaging should they decide to enter flexi-access drawdown in retirement.

Answer 21

 Funds being drawn down are exposed to sequencing risk
 It refers to the greater impact an early loss has on a client’s capacity
to take withdrawals over the longer term
 Running down a fund amounts to pound cost averaging in reverse
 When the price of units is low, more of them are sold, when it is
high, fewer are sold
 Taking regular withdrawals of capital exaggerates the impact of
fluctuations rather than smoothing them

Question 22

What additional information would you require from Sophia to help her decide whether to continue the PMI cover post-retirement?

Answer 22

 Desire to use private healthcare in the event of illness?
 Willingness to use other assets to fund private healthcare?
 Is a continuation option available?
 Does the cover met their needs / what type of plan is it?
 Is the premium competitive?
 Affordability in retirement?

Question 23

State the factors Sohpia should consider when deciding whether to continue the PMI cover post-retirement.

Answer 23

 Premium
 Affordability now and in the future (premium will rise as she gets
older)
 Type of plan on offer (budget / standard / comprehensive)
 Is the premium subsidised? (could she get better value elsewhere?)
 Would she prefer to self-insure (use savings)?
 Does she have higher priority needs that should be met first?
 Views on NHS care?
 Increased choice over private treatment
 Excess / exclusions
 Premium wasted if claims not made.

Question 24

State the benefits and drawbacks for Sophia of continuing her PMI post- retirement.

Answer 24

Benefits
 Age may prevent her taking out affordable cover elsewhere
 Covers Daniel as well
 Speedier treatment
 Choice of hospital / consultant / treatment
 Different types of plan available
 Lump sum for overnight stay in NHS hospital
 Benefits are tax free
 May be affordable as in good health
 Any pre-existing conditions that have developed since outset may be covered if she renews with the same provider / they would not be with a new provider

Drawbacks
 May not cover pre-existing conditions
 May not be affordable / premiums increase as she gets older
 Covers acute conditions only
 It does not cover emergency treatment or chronic conditions
 It may only be a budget plan
 There is no guarantee she’ll be offered a renewal next year
 If she is, the price may rise significantly as a result of this year’s claim and any subsidy the employer may previouslyhave provided

Question 25

Explain to Daniel and Sophia the three different types of PMI plans available.

Answer 25

Basic
 Low cost but no extra benefits and limits on costs of treatment in year
 May restrict choice of hospital
 Premium reduced if insured pays first part of each claim
 Cover restricted to accommodation, drugs and doctor’s fees
 Excludes / restricts outpatient treatment, home nursing or private ambulance
 May be discount for healthy lifestyles / discount gym membership
 May suit those with small budget or those willing/able to pay proportion of costs to get cheaper cover

Standard
 More items covered, longer claim periods, higher limits
 Wider choice of hospitals
 May include outpatient treatment and psychiatric cover
 Consultant fees, diagnostics tests and physiotherapy included up to limit
 May suit those with larger budget, wanting wider cover than basic plan but unable to afford comprehensive

Comprehensive
 Most expensive but widest cover, longer claim periods, higher limits and widest choice of hospitals
 Home nursing, private ambulance, parent staying with child, alternative medicine, dental treatment, overseas travel, cash payment if stay in NHS hospital all likely to be included

Question 26

Outline the key issues that Daniel and Sophia should consider when planning a strategy to meet their long-term care costs

Answer 26

 They have significant assets so will be self-funders
 Life expectancy
 The type of care they would like to receive (at home / in a care
home)
 Estimated cost of long-term care
 Care cost inflation
 Budget
 Eligibility for state benefits in the future (attendance allowance)
 Whether they’d consider equity release
 Use of a deferred annuity
 Willingness to use existing assets to fund care

Question 27

Recommend and justify the actions you would take to ensure Daniel and Sophia can generate a sustainable income in retirement.

Answer 27

 Lifetime cash flow modelling
 To determine the amount required
 If affordability allows
 Daniel and Sophia to consider making further regular pension contributions
 Consider using carry forward to move funds out of cash
 To benefit from tax relief of 20%/40% on their contributions
 Maximising the potential for fund growth
 And place further funds in IHT free wrapper
 Daniel and Sophia to determine how they would like to take their pension benefits
 Then ensure fund choices are in line with this, as well as their ATR
 Review workplace pension fund performance
 To ensure ongoing suitability
 Draw income from other investments initially
 So remaining pension funds can stay within pension environment
 To benefit from further tax free growth
 And to retain IHT benefits
 Ensure completion of nomination forms for any pensions (and DIS)
 This will ensure that there is no delay in the funds being paid out on death
 And that they go to the intended beneficiary
Establish LPAs (if not done already)
 To ensure decisions can be made for them in the event that they are unable to do so themselves

Question 28

Why is it important to carry out regular reviews of Daniel and Sophia’s pension arrangements?

Answer 28

 Changes in personal / financial circumstances / objectives/ATR
 Impact of first death
 Monitor performance / identify underperforming funds
 Rebalance / change funds
 Contributions stop at 75
 Costs / charges / cheaper products
 Non-earner threshold
 Economic / legislative / tax changes

Question 29

Identify the key factors that Daniel and Sophia should consider before downsizing.

Answer 29

 Estimated equity released (is £200,000 accurate?)
 Costs involved in sale/purchase (solicitors, legal fees, stamp duty)
 Likelihood of finding a suitably located property?
 At a price they are happy with / at the right time?
 Likelihood of being able to sell their property?
 At a price they are happy with / at the right time?
 Prepared to rent if unable to find property at time of sale?
 Additional costs involved (rent, storage, removals)
 Or take out a bridging loan?
 Additional costs involved (secured loan, higher interest rates and fees
than normal mortgage)
 Risk of a crash in the property market
 Time / admin / stress that will be required / involved
 What happens if daughter moves in the future?

Question 30

What are the main benefits and drawbacks to Daniel and Sophia of downsizing?

Answer 30

Benefits
 House may be too large for their current needs
 Bigger homes are more expensive to maintain
 Energy costs and council tax bills are higher
 Therefore cost savings can be made by living in a smaller property
 Do not leave the property market entirely
 Has a physical asset that will hopefully increase in value to pass on to their daughter and grandchildren.
 Should retain benefit of RNRB through downsizing addition
 Creates a lump sum that can be invested for tax efficiency

Downsides
 May struggle to adapt to living in a smaller property
 Size of savings on maintenance and bills may not be as large as anticipated
 Impact of savings minimised by reduction in income due to being retired
 Emotional attachment to their property, may be reluctant to sell it.
 May feel that they will be depriving their daughter of an inheritance.
 Expensive: estate agent fees, stamp duty land tax, legal fees, removal fees, decorating costs.
 Easier to achieve the optimum results from trading down in a more buoyant market
 Capital released subject to investment risk
 May not grow as much as would’ve done had remained in property

Question 31

Outline the main drawbacks of investing a £200,000 lump sum.
(NB other questions relating to the investing of the lump sum feature under the next financial aim)

Answer 31

 Risk of capital loss
 Market timing risk
 Loss of liquidity
 No option for pound-cost-averaging
 Cannot use ISA allowance
 Could generate taxable gains for Daniel and Sophia
 Remains in estate for life / up to 7 years (depending on investment)

Question 32

Explain to Daniel and Sophia the impact on their RNRB if they do downsize.

Answer 32

The full RNRB may not be able available if the couple downsize prior to their death.
But the estate may be able to claim a downsizing addition to make up for the amount of RNRB which has been lost providing downsizing takes place after 7 July 2015 (which it will) and the former home would have qualified for the RNRB had it been held until death.
The new residence must pass to their daughter or grandchildren for the downsizing addition to apply. If only part of the home is left to the daughter/grandchildren, then the available RNRB will be calculated on the value of that part.

Question 33

What additional information would you require from Daniel and Sophia to help them improve the tax efficiency of their financial arrangements?
NB. To avoid repetition, we’ve focused on income tax, CGT and IHT in relation to investments only as we’ve already covered off pensions in Financial Aim 1.

Answer 33

 The precise breakdown of asset allocation (cash, fixed interest, property, equities) for each fund?
 The level of diversification / geographical split within the asset allocation?
 Liquidity of the portfolio?
 Fund performance?
 Whether Daniel and Sophia’s stated attitudes to risk vary in terms of their various objectives?
 The extent to which Daniel and Sophia’s investments match their stated attitudes to risk?
 Fund choice (or lack of)?
 Fund charges/exit penalties?
 Held on platform/directly held?
 Capacity for loss for Daniel and Sophia?
 Objective/income/growth/timescale?
 Use of personal savings allowance / dividend allowance?
 Use of CGT annual exemption amount?
 Does either of the couple have any CGT losses to carry forward?
 Willingness to make changes to portfolio to match stated ATR / improve performance / meet objectives?
 Willingness to use tax-free products?
 Willingness to transfer ownership of investments to maximise use of allowances?

Question 34

Evaluate the tax efficiency and suitability of Daniel and Sophia’s investments.
(NB sometimes suitability and tax efficiency are combined in the one question, sometimes they are separated out; same goes for pensions and investments.)

Answer 34

 The couple have not yet used their ISA allowances for the current tax year
 Assuming affordability allows, they should keep topping up their ISAs
 They could fund this from their excess cash holdings
 Providing accessible tax-free income in retirement
 The deposit savings account may enable Sophia to use her £500 personal savings allowance
 Thereafter, interest is taxed at 40% as a higher-rate taxpayer
The deposit savings account may enable Daniel to use his £1,000 personal savings allowance
 Thereafter, interest is taxed at 20% for a basic rate taxpayer
 To minimise the amount of tax payable at the higher rate, the couple could open two single accounts, with Sophia’s holding just enough to
use her PSA, and the rest in Daniel’s
 Any gift from Sophia to Daniel must be outright and unconditional to be
effective
 Neither Daniel nor Sophia have investments that enable them to use their dividend allowances (£1,000 dividend allowance in 2023/24, £500 in 2024/25)
 Nor their CGT annual exempt amount (£6,000 in 2023/24, £3,000 in 2024/25)
 They may therefore wish to consider investing some of the £200,000 into a collective investment scheme, such as a UT or OEIC for tax efficiency
 The collective could then be used to Bed and ISA in future tax years
 To minimise CGT liability
 And maximise funds held in ISA environment
 As they are married, the surviving spouse would benefit from the Additional Permitted Subscription on first death
 Keeping the funds of the 1st to die within the ISA environment
 Providing tax free income and gains over time
 Daniel is a medium risk investor
 His UK Equity ISA may be in line with this
 However, his pension is also invested in a UK Growth fund suggesting
little in the way of diversification outside the UK
 Sophia is also a medium risk investor
 Her S&S UK Gilt ISA may be too cautious for her
 And her pension is also invested in UK fixed interest assets suggesting
little in the way of diversification in terms of asset class or location
 S&S ISA holdings for Daniel appear to exceed the FSCS limit of £85,000
 Some of his capital is therefore at risk in the event of default
 The couple have £100,000 in premium bonds plus £110,000 in other cash accounts (£210,000 total on deposit)
 Which seems a lot given their ATRs
 And lacks protection from inflation
 The couple should keep their investments under review to check performance, alignment with ATR and confirm the likely future adequacy

Question 35

Identify the key benefits and drawbacks of the following funds in the couple’s investment portfolio:
(Alternatively, the question could ask you to give reasons to retain (i.e. the benefits / ticks) or reasons to switch funds (drawbacks / crosses).
Typically you’ll only be asked about one fund per case study, but you won’t know which one until you get in the exam so we cover them all for you.

Answer 35

Stocks and Shares ISA – UK Equity Income (Daniel)
Pros
 Adds diversification to his overall portfolio  Potential for growth / inflation protection  Actively managed
 May be in line with ATR
 May be in line with need for sustainable income in retirement  No currency risk
 No political/regulatory risk
 APS applies as married
 No restrictions on access
 Should be able to switch easily
 With no tax implications as in ISA wrapper
 Income and growth free from tax
 Using ISA funds rather than pension reduces estate for IHT
Cons
 Single geographic location – lacks diversification  Single asset class – lacks diversification
 Holding within estate for IHT purposes
 Holding exceeds FSCS limit

Stocks and Shares ISA – UK Gilt (Sophia)
Pros
 Actively managed
 Adds diversification to her overall portfolio
 Spreads risk within the sector
 No currency risk
 No political/regulatory risk
 May be in line with need for income in two years’ time
 Should be able to switch easily
 With no tax implications as in ISA wrapper
 Income and gains tax-free as in ISA wrapper
 No restrictions on access
 Additional permitted subscription available as married
 So ISA benefits are retained after 1st death
 Using ISA funds rather than pension reduces estate for IHT  Holding within FSCS limit
Cons
 Single asset class – lacks diversification  No geographic spread for diversification  May be too cautious for ATR
 May not require the income at present
 Income payments not guaranteed
 Income payments may erode capital
 Limited growth / protection from inflation
 Charges may erode value of fund
 Will be included in estate for IHT purposes

Question 36

Outline the process you would follow to enable you to review the performance of Daniel and Sophia’s investments.

Answer 36

 Letter of authority / obtain details
 Confirm date of purchase
 Confirm base costs / further investments / withdrawals / switches
 Identify any reinvested income
 Calculate gain
 Assess asset allocation
 Identify suitable benchmark
 Compare against benchmark
 Review charges
 Compare to risk-free return
 Review risk rating on fund (volatility)
 Assess funds against ATR and capacity for loss

Question 37

The couple are uncertain as to whether their investments are as tax efficient as they could be. What additional information would you require to advise them on whether to surrender, switch or retain them?

Answer 37

 Amount of original investment
 Date of original investment
 Any other capital sums invested
 Details of any previous encashments
 Performance
 Charges
 Asset allocation
 Suitability for Daniel and Sophia
 Use of CGT annual exempt amount
 Any CGT losses to carry forward
 Willingness to gift / use trusts for tax efficiency

Question 38

Identify the key issues that you should discuss with Daniel and Sophia when advising them on the ongoing suitability of their ISA holdings.

Answer 38

 Asset allocation
 Do they need the income?
 Simple admin
 Charges? Performance?
 Suitability of fund?
 How to fund current year’s allowance?
 FSCS issue for Daniel and potentially Sophia in future

Question 39

Comment on the suitability for the couple of holding such a large amount of cash.

Answer 39

 The holdings are within the FSCS protection limit
 So fully protected in the event of the provider failing
 Interest may not be competitive and may be fairly low
 Meaning there is limited opportunity for growth
 Meaning there is little protection from inflation
 Meaning the real value of the cash will start to fall
 We do not know whether the interest rate is fixed or variable, nor
whether it is competitive
 Their ATR is medium
 Such a large cash holding is not in line with this

Question 40

Comment on the suitability for the couple of holding £100,000 in Premium Bonds.

Answer 40

 Treasury backed guarantee
 So fully protected in the event of the provider failing
 Prizes are tax free
 So investment is tax efficient
 Prizes are not guaranteed
 Meaning there is limited opportunity for growth
 Meaning there is little protection from inflation
 Meaning the real value of the holding will start to fall
 They do not appear to need access to such a large cash sum at
present
 Both ATRs are medium
 Such a large cash holding is not in line with this

Question 41

Outline the key factors that an adviser should consider when recommending a suitable strategy for Daniel and Sophia’s large cash holding.

Answer 41

 Objectives
 Diversification
 Timescale
 Emergency fund
 Ethical concerns / ESG
 ATR
 Performance and charges
 Willingness to use trusts
 Use of tax wrappers and allowances
 What they want to happen on 1st death
 Ongoing reviews

Question 42

Explain to Daniel and Sophia how and why they should consider drip-feeding some of their cash holdings into ISA wrapped actively managed UK and global funds.

Answer 42

 To use ISA allowance in future tax years
 So it is not wasted (use it or lose it)
 Potential for tax-free growth / hedge against inflation
 If require immediate income, choose high-yielding fund
 Additional tax-free income in retirement
 Provides greater diversification
 Benefit from fund manager expertise
 Asset and geographic diversification
 (Cash) Current cash is losing real value
 (Cash) Does not match their ATR, but can chose a fund that would
 Matches capacity for loss as have other assets
 Benefit from pound cost averaging

Question 43

Outline to Daniel and Sophia what would happen to their ISAs on death.

Answer 43

 On death, ISA becomes deceased’s ‘continuing ISA’
 Cannot add further funds
 Tax free until earlier of estate being administered, ISA closed or 3 years and one day from death
 The surviving partner can invest the higher of the value of the continuing ISA on death or on the date when the ISA wrapped investments are passed on to them as an APS
 This protects the ISA wrapper
 And is in addition to the surviving partner’s own ISA allowance
 The surviving partner must register the APS with a provider
 They can transfer the holdings ‘in specie’
 Or they can sell holdings and transfer cash to ISA up to value of APS
 APS can be used the later of up to 3 years from date of death
 Or up to 180 days after estate is wound up

Question 44

Identify the key benefits for Daniel and Sophia of investing some of their current cash holdings into a jointly held Onshore Investment Bond.

Answer 44

 They have excess cash holdings.
 Tax-deferred income available of up to 5% per annum of original
capital
 Cumulative withdrawals. (so can wait until retirement)
 Equivalent of Basic Rate Tax deducted within Bond/top slicing/no tax
due until chargeable event occurs.
 Tax-efficient income for Sophia as she is Higher Rate taxpayer.
 Can assign to Daniel as he is a Basic Rate taxpayer/no further tax
liability for Daniel.
 Wide choice of investments/diversification/fund switches.
 Growth potential/inflation protection.
 Matches attitude to risk/cash does not match attitude to risk.
 Jointly-held so Bond continues on first death/no tax on first death.
 Can assign segments/can set up in Trust.
 Not considered in long-term care assessments.

Question 45

Explain to Daniel how he could obtain a tax-efficient lump sum from an investment bond and access to capital in the future

Answer 45

 Take 5% tax deferred withdrawals
 Of original investment amount
 These are cumulative
 Daniel is a basic rate tax payer
 Providing encashments do not push him into high rates of tax
 There will be no income tax to pay
 Daniel can use top slicing relief
 Daniel can adjust income to meet his needs
 Can encash entire segments / policies if needed
 Depending on the size of the gain he may be able to encash the whole bond without further liability to tax if the top sliced gain falls within his basic rate tax band)
 Could use loan trust so growth is outside of Daniel’s estate
 Or discounted gift trust
 Bond usually exempt from long term care assessment

Question 46

Comment on the suitability of a purchased life annuity to meet Daniel and Sophia’s need for a tax-efficiency.

Answer 46

 Can buy with tax-free PCLS / deposit funds
 Tax is less than if had purchased lifetime annuity which is taxable in
full (rather than part tax-free, part taxable as savings income)
 Interest element may be slightly more than can be achieved on
deposit
 Starting rate and/or personal savings allowance can be used to offset
the tax, then remainder taxed at 20%/40%
 Provides a guaranteed income
 Giving the couple security of income
 Can be indexed
 To keep pace with inflation
 Though this will reduce the amount paid initially (and generally need
to survive 20 years for it to be worthwhile)
 Meaning less income
 Funds outside estate for IHT purposes (unless choose capital
protection)
 Reducing any potential IHT liability
 However, may not match their medium ATR
 Interest rates are relatively high meaning the annuity itself should
provide very a reasonable amount of additional income
 Inflexible as once set up cannot change

Question 47

Explain to Daniel and Sophia how a purchased life annuity is taxed.

Answer 47

 Split into capital and interest element
 Capital content return of capital and is fixed at outset
 Based on purchase price
 Calculated by dividing the purchase price by number of years
annuitant expected to live at outset
 Only interest element is taxable as savings income, usually deducted at source
 Interest element paid net of 20% basic rate tax
 Personal allowance, starting rate for savings income, personal
savings allowance can be used against the interest element, thereafter basic rate liability met at source, higher rate owe additional 20%, additional rate a further 25%
 Fill in form R89 if not liable to tax / reclaim
 No liability to capital gains tax
 Not usually included in the estate on death (unless capital protection
is chosen and the remaining fund is returned to the estate)
 Income from interest element cannot be used to fund gifts under
normal expenditure exemption

Question 48

Explain to Daniel and Sophia how a discounted gift trust works and how it could be used to mitigate IHT and boost their retirement income.
(Although Daniel and Sophia do not have an IHT liability at present, given they will have a lump sum to invest in addition to potentially moving their funds out of cash, there is the potential for growth to exceed the £1m limit in time therefore including a couple of questions on DGT and loan trust just in case.)

Answer 48

 Take out investment bond
 Ideally JL2D for most tax efficiency
 Daniel and Sophia to be trustees along with their daughter
 Assign bond to DGT (discretionary or bare)
 Calculate discount, meaning value for IHT is less than the amount
gifted
 Up to 5% income can be taken to boost retirement income
 Can defer income to begin with (to provide additional income later)
 CLT if discretionary trust, no immediate charge to tax if below NRB
 PET if bare trust, no immediate charge to tax
 Fall out of estate completely if survive 7 years

Question 49

Outline to Daniel and Sophia the potential benefits and drawbacks of using a discounted gift trust.

Answer 49

 Discount will reflect their good health
 Falls out of estate after 7 years
 Any growth outside their estate
 If use discretionary trust, no immediate charge to tax if kept under
NRB, no periodic/exit charges if kept under NRB
 Can act as trustee to retain element of control
 But, income is fixed from outset
 Once cumulative 5% used, no further income came be taken
 Irrevocable
 Lose access to capital
 May incur set up costs

Question 50

Explain to Daniel and Sophia how a loan trust operates and the benefits of such an arrangement for them.

Answer 50

 Establish discretionary trust
 Settlors should be trustees
 Retain control of capital
 Identify beneficiaries (surviving partner, children, grandchildren)
 Make capital loan to trustees
 Repayable on demand so remains in estate
 No immediate charge to IHT (as no IHT transfer has taken place)
 Growth immediately outside estate
 Can be held in Investment Bond
 Can take 5% withdrawals over 20 years
 Without immediate charge to tax
 Trust may suffer periodic / exit charge if value after deduction of loan
exceeds NRB, but this is unlikely

Question 51

Recommend and justify the recommendations you would make in respect of ensuring Daniel and Sophia’s financial arrangements are tax efficient.
(See Financial Aim 1 in relation to tax efficiency of pensions)

Answer 51

 Both to use their ISA allowances each year
 Maximising the funds held in tax-free environment
 That can then be used to supplement retirement income when
needed
 Easy access which may suit if their income and expenditure pattern
changes
 Consider moving excess cash to ISAs/UT/OEIC/onshore bond
 To reduce exposure to inflation risk and increase growth potential of
both capital and income
 Both of which will be tax free (ISA) / will enable them to use tax
allowances (UT/OEIC/onshore bond)
 Consider drip feeding lump sums over the years into ISAs from any new collective (Bed and ISAing)
 Future income and gains tax free
 Maximising performance
 Uses up CGT annual exempt amounts
 Saving further tax
 Transfer a larger proportion of the deposit account to Daniel
 To maximise use of allowances / reduce tax paid at the higher rate
 Consider moving some funds out of cash/fixed interest and investing in purchased life annuity / onshore bond
 To provide tax-efficient income in retirement (both)
 To provide a secure income in retirement (PLA only)
 Choose escalation option (PLA only)
 To protect against inflation (both)
 To protect against future IHT (PLA)
 To protect against future IHT (DGT/loan trust)

Question 52

Identify what should be covered in a review relating to Daniel and Sophia’s investment holdings.

Answer 52

 IHT liability
 Investment performance
 Suitability of fund choice
 Adequacy of income yield
 Asset allocation given their risk profile / rebalance?
 Asset allocation given investment performance (rebalance?)
 Fund charges
 Changes in economy / market conditions
 Changes in tax/legislation

Question 53

Explain in detail how downsizing relief could be used on the new property on the second death of Daniel and Sophia

Answer 53

*If the house is transferred to the survivor, he/she would inherit their spouse’s RNRB of £175,000.
*On second death the executors could claim £350,000 RNRB provided the house is left to their daughter(or grand children)
*RNRB is restricted to the value of the house so if less than £350K Down sizin grelief can be claimed.
*The amount of relief is the value at date of death/£350,000 (the maximum RNRBincluding transfer)
*The percentage is deducted from 100% and applied to £350,000
*This is the “Lost RNRB”
*This would be in addition to the normal NRB.
*It is available to pass assets other than the houseto their daughter without being subject to IHT

Question 54

Explain a Discounted Gift Trust

Answer 54

They would purchase a Joint Life second death Insurance Bond.
This would be underwritten and split into two parts.The majority (probably in this case due to their health and age) would be outside their estate.
*They could withdraw 5% of the original SA as an income. No tax would immediately be paid on this.
*Meets their need for sustainable income.
*The remainder would be placed into a discretionary trust.
*Their daughter and grandchildren could be potential beneficiaries.
This would be a CLT but no immediate tax as below NRBOutside estate after 7 years.
*And unlikelyto incur exit or periodic charges.

The downside is:
*They lose access to the capital
*Relies on investment growth to fund the 5% withdrawal
*They should be spending the incomeotherwise it increases theirestate