Case Study 1 - Key Notes Flashcards
State the additional information you would require in order to advise David and Ruby on their financial aim of ensuring they have sustainable income throughout retirement.
14 marks
Tips:
Think about the below for when alive, on death and how much:
- Need (what they want)
- Got (what they got)
- Fill (general extra info)
Need (what they want)
Income requirements / any specific future capital needs.
What the couple mean by ‘sustainable’ income in retirement.
Breakdown between essential and discretionary expenditure.
Any long term care requirements.
Life expectancy for both / family health history / how Ruby’s heart condition affects her life expectancy.
Views on gifting any money or assets to the children or grandchildren in their lifetime, or on death.
Views on inflation rates going forward.
Got (what they got)
David’s pension:
- performance of fund
- desire for David to continue managing
- costs of current plan
- David’s view of continuing to withdraw £20k
- availability of pension freedoms
Rubys pension:
- Available amount of PCLS from Rubys pension
- performance of fund
- costs of plans
- views on level of income required
- availability of pension freedoms
Fill (General)
- likelihood of inheritance
- view on equity release
- plan to move?
- capacity for loss and tolerance to risk
- pension nomination forms
Identify the additional information a financial adviser would require in relation to the level of income David is currently taking from his FAD pension scheme before giving advice on ensuring the couple have sustainable income in retirement.
8 marks
Tips:
Focus on what we know and go from there
- how can it be taken?
- what has been taken to date?
- inflation?
- potential death?
- investment performance?
- find choice?
- views on future?
FAD income - additional information
How long has he been taking the £20,000 annual income from the FAD.
Use of PCLS when he retired.
Rationale for £20,000 per annum figure / has this altered since David retired.
Existence of an up to date nomination form / who benefits from the funds remaining on David’s death.
Desired income / capital levels for Ruby should David pre-decease her.
Thought around continuing to manage investment funds himself.
Alternative funds available / switching options.
Fund charges / impact on returns.
David’s willingness to use other investments in order to generate retirement income.
David’s views on guarantees versus flexible benefits.
David’s views of inflation / its impact on the amount of income he needs annually going forward.
Any long term care concerns that may need a higher level of income in future years.
Describe the process an adviser would take David and Ruby through when giving them advice on how to obtain a stable and sufficient income throughout their retirement.
12 marks
Tips:
- Follow the advice process and make it pension specific
Establish / define relationship / confirm scope of service and fees.
Fact find to obtain their goals and objectives.
Establish their income and capital requirements / requirement on first death / essential and discretionary income requirements.
Establish their views on inflation.
Allow for the use of existing assets / ISA and unit trust investments / property equity that can be allocated to the objective.
Confirm the couple’s attitude to risk (currently low to medium) and capacity for loss.
Calculate current pension income from all pension / non pension sources.
Calculate any shortfall in the pension income required.
Analyse the current situation / consider options available.
Present the financial plan and recommendations and discuss.
Provide key information documents and suitability report.
Implement plan / obtain client agreement.
Monitor and review.
David and Ruby wish to ensure they have stable and sufficient income throughout their retirement.
Comment on the couple’s current pension situation in relation to their current financial arrangements, in light of what they are trying to achieve.
20 marks
Tips:
- methodically work through the factfind
- Comment’ means that you should note down;
what you do know
what you do not know
the implications
- literally taking facts from the case study and commenting on them in your answers.
General comments
The couple are have been retired for the last five years, both are past SPA.
We do not know their required income levels and capital requirements.
They have a low to medium attitude to risk.
They have two adult children and six grandchildren.
They have a mortgage-free property valued at £450,000, no apparent debts, as well as other savings and investments.
David has NS&I income bonds that provide guaranteed income annually / highly secure as underwritten by government / 3.59% x £200,000 = £7,180 secured annual income.
The couple have investments in unit trusts and a BTL that could help to provide annual income / invested in real assets.
S&S ISAs are invested into UK fixed interest securities and UK gilts. Gilts are highly secure.
State Pension
Both are in receipt of their Single Tier State Pension.
Both are receiving £11,120 gross annually; this suggests a full entitlement plus a protected payment.
Escalation of their Single Tier State Pension will be in line with the Triple Lock / protected payments in line with CPI.
The Triple Lock; so the higher of 2.5%, CPI and NAEI changes, gives the couple valuable inflation proofing (10.1% increase in April 2023 and 8.5 projected for April 2024).
The protected payment element will only benefit from escalation in line with CPI.
This is the couple’s only source of guaranteed and inflation-proofed income currently.
Both protect the couple from longevity risk as they are paid for life.
State Pension deferral is an option for both, even though payments have started.
David’s FAD
David is taking £20,000 gross annually as income from his FAD / no idea if it has been at this level for the last five years.
With the level of market volatility experienced in the last couple of years, sequencing risk and pound cost ravaging could be real risks for David’s FAD funds.
Appears to have taken full PCLS / no idea of usage.
Also exposed to investment risk /nothing stable about this retirement income source / longevity risk.
Growth potential to balance the many risks involved / help with sufficient income in the longer terms if good growth achieved.
Could purchase a secured income at any time if stability is a key area / rates will be better as David is already five years older than when he commenced FAD.
Ruby’s personal pension plan
Currently still uncrystallised, Ruby has the full choice of pension freedom options.
25% will be tax free (£30,000?) the remainder taxable at her marginal rate.
Ruby’s mild heart condition could affect her life expectancy / make her eligible for an enhanced annuity boosting the couple’s stable, guaranteed income stream.
Escalation could be built in to help income last in real terms in the longer-term.
Identify the key factors that a financial adviser should consider when reviewing David and Ruby’s financial arrangements before giving advice on their aim to have a stable and sufficient income throughout their retirement.
15 marks
tips:
- Think about what types of considerations would affect this area of advice
- is something you would take into account, so you will still potentially get marks for listing something that you already know.
Key factors
Income and capital needs, essential / discretionary income requirements.
Life expectancy / estimated period retirement income required.
Assets available / current and future inheritances.
State pension escalation / combination of Triple Lock and solely CPI on any protected payments.
The couple’s views on State Pension deferral.
Single Tier State Pension only current source of guaranteed escalated income.
Unaffected by longevity or investment risk.
Tax status.
Personal preferences; guarantees versus flexible income.
Economic conditions / inflation expectations.
Required / expected rate of return on the couple’s FAD / PPP / investments (ISAs/unit trust).
Yield projections on couple’s investments.
BTL potential net yield if retained and rented out.
Attitude to risk / tolerance of risk / capacity for loss.
Desire to leave funds to children and grandchildren on death, and an idea of when and how much to be given.
Willingness to use other assets / downsize / use property equity.
Views on equity-release / home reversion plans.
Ruby’s likely qualification for enhanced annuity / higher guaranteed income levels.
Outline to David and Ruby the key issues that may result in the couple failing in their objective of having a stable and sufficient income throughout their retirement.
10 marks
tips:
- make a list of where the couple’s retirement income could potentially come from and what issues could come from these?
The one current source of guaranteed income is their Single Tier State Pension/ no death benefits passed on first death / this income dies with them.
FAD subject to many risks including longevity / investment / sequencing / fund erosion / pound cost ravaging.
David manages his FAD funds / lack of experience may result in lower gains.
Fixed interest funds have no equity content / likely to be more susceptible to inflation risk.
Relatively modest pension funds - £420,000 between them.
Ruby’s heart condition; may end up needing care resulting in higher capital and income requirements than expected.
David is in good health / greater longevity will put a higher strain on the couple’s pensions and assets.
Low to medium ATRs; less likely to take investment risk, investment returns likely to be lower as a result.
High level of FAD withdrawals in relation to fund size / could already have eroded fund if same withdrawals made over each of the last five retirement years.
ISA funds selected are cautious / no equity content - will limit real returns.
Considering selling BTL property, which is a real asset capable of returns above inflation via rental income.
Selling the BTL property would realise a £150,000 gross capital gain (£125,000 after allowing for £25,000 costs) / higher CGT at a 18% /28% rate.
Unit trust commercial property fund has no diversification / highly illiquid / possible six month wait for any encashments.
Outline to David the key factors in relation to his flexi-access drawdown that could affect the couple’s desire to have a stable and sufficient income in retirement.
10 marks
tips:
- Think of all the negatives associated with FAD
Relatively modest fund value of £300,000.
Equity funds subject to investment risk / fixed-interest exposure subject to inflation risk.
Effects of sequencing risk and pound cost ravaging due to withdrawals in early retirement years and market / fund volatility.
Funds managed by David himself / levels of fund management experience unlikely to be high.
Costs and charges higher / impact on overall net returns.
David currently taking withdrawals that represent 6.66% of his FAD fund value / sustainability at this level.
Higher equity content required with FAD to combat mortality drag / more volatility and susceptible to market fluctuations.
No / little protections against longevity risk / easier for David to erode his FAD fund / run out of monies.
If fund value drops, FAD withdrawals should be reduced / affecting the couple’s retirement income levels negatively.
If withdrawals are not reduced, further exposure to pound cost ravaging / does not bode well for this income source lasting for the couple’s retirement.
David and Ruby have concerns around providing themselves with a sustainable income throughout their retirement. As a result, they have asked you to carry out some cash flow modelling with them.
Explain the process you will take them through in order to carry out this exercise.
10 marks
tips:
- cash flow modelling in 3 main stages:
1. What they want & need
2. What they will have
3. where income in retirement can come from
Cash flow modelling process
Establish with David and Ruby their current and likely future expenditure in retirement.
Regular expenditure is broken down into two groups:
Fixed: costs such as food, utility bills, and other household bills.
Discretionary: e.g. eating out, holidays, gifts.
Capital expenditure must also be discussed and accounted for
Such as;
Future lump sums, required.
Potential gifts to children / grandchildren.
Also consider health / life expectancy - reduced for Ruby / longer for David?
Potential long term care costs (regular or lump sums) could also be included.
The next step is to consider the income that David and Ruby will have. This will include:
Income from their Single Tier State Pensions.
David’s FAD withdrawals.
Income from Ruby’s PPP - possible enhanced annuity / FAD.
Any other income, such as from their ISAs, Ruby’s BTL and joint unit trust.
Any future inheritances likely that could help.
Assumptions must be agreed with David and Ruby, including:
Inflation.
Investment returns.
Costs and charges.
Life expectancy.
A cash flow modelling computer system will then look at the couple’s income and capital situation on a projected annual basis.
It is possible to then apply a series of ‘what if’ scenarios, such as what if interest rates rise, gilt yields fall, annuity rates decrease, ill health occurs, they live longer than expected, etc.
This will highlight any situations where surpluses or deficits may arise.
Plans can then be put in place to take advantage of any surpluses or mitigate the impact of any deficits.
Outline the main benefits of using cash flow modelling to analyse whether David and Ruby are likely to have a sustainable income throughout their retirement.
8 marks
tips:
- work through CFM step by step and apply to CS
Highlights periods where income or capital is in deficit / surplus.
Allows David and Ruby to take any required actions now to either prevent a deficit or to maximise opportunities.
Can help the couple achieve their aim of obtaining a stable and sustainable income throughout their retirement.
Analyses different scenarios such as living too long, running out of monies, not having enough for a comfortable retirement.
Can demonstrate the impact of increased inflation on income and capital.
And the effects different scenarios have on levels and requirements.
Pinpoints areas of finance where costs can be cut, or additional investments made.
Identifies potential issues or opportunities.
Gives David and Ruby the opportunity to discuss with an adviser how to plan for and / or overcome potential shortfalls.
State the reasons for not solely relying on cash flow modelling to ensure David and Ruby have a stable and sustainable income throughout their retirement.
8 marks
tips:
- state means list
The couple may live longer than expected (even with Ruby’s heart condition).
The process uses many assumptions; it is an estimate only.
Inflation assumptions may be incorrect.
The investment growth assumptions may not be met; these are not guaranteed and there may be adverse market conditions.
the impact of high FAD withdrawals may be more significant than expected.
The couple’s personal circumstances may change.
Taxation rules / legislation may change (lets face it, pension rules change every year!)
ATR / CFL may change.
Charges and fees may be higher than expected.
The process provides a snapshot at one point in time; in practice, regular reviews will be required.
There could be input errors / human error / misunderstanding of information by David and Ruby or by their adviser.
David is currently using flexi-access drawdown to provide some of his retirement income.
Explain to David why he may wish to stop taking FAD withdrawals in the short term.
10 marks
tips:
- think of all the drawbacks of FAD, and how stopping withdrawals may help
Reasons for suspending FAD withdrawals short term:
£20,000 withdrawals exceed David’s personal allowance / FAD income is taxable at his basic marginal rate.
He is exceeding the current recommended safe withdrawal rate of 6% / making funds more susceptible to erosion and pound cost ravaging.
He will retain more within his tax efficient pension wrapper - income and capital gains tax efficient (saves 20% / 10% in these taxes).
Leave more in the pension wrapper that will be IHT free / the couple already have an IHT liability.
FAD value may have decreased already due to market volatility / high initial withdrawals.
Can adjust investment strategy / use a professional fund manager rather than David to boost growth.
Greater tax free pot to pass to Ruby / children / grandchildren pre age 75.
Greater growth potential / more likely FAD funds will last for longer-term retirement needs.
Income available from other assets that have fewer tax benefits such as unit trust / income bonds / BTL and S&S ISAs.
ISA will provide source of tax free income / ISAs are not IHT efficient like his FAD fund.
Explain to David why it is important for him to regularly review the level of income that he draws from his flexi-access drawdown arrangement.
10 marks
tips:
- think of all the drawbacks of FAD
The couple’s income needs may change / may reduce as they get older or increase if Ruby’s health means she needs greater care.
Review investment fund performance.
Tax efficiency / maximise use of tax allowances.
Market conditions / volatility.
Sequencing risk / pound cost ravaging / safe withdrawal rate.
Income / capital available from other sources the couple have.
IHT planning for children / grandchildren.
Annuity rate changes / could a higher income be obtained via a secured income / rates have been rising recently.
ATR / CFL changes.
Health / life expectancy changes / reviews.
Taking account of any government / legislation changes.
Explain to David what a safe withdrawal rate is, and why it is important for him to keep this reviewed at least annually in relation to his FAD funds and withdrawals.
8 marks
tips:
- what is it?
- why its important to review it annually.
This is the maximum % of withdrawals David can make from his FAD funds;
over a period of 30 years; with a 95% probability that he will not run out of funds.
David and Ruby want a sustainable retirement; reviewing the SWR at least annually will help with this.
They will minimise their chances of running out of monies in retirement.
This will reduce the chances of pound cost ravaging and fund erosion.
This will help protect David’s FAD fund, with all its tax benefits including providing higher death benefits for Ruby / IHT efficiency.
It will give them greater peace of mind in terms of their retirement funds and income.
Explain in detail to David and Ruby why they may wish to purchase an annuity using some of their personal pension funds to meet some of their retirement income needs in terms of a stable and sustainable income in the longer-term.
12 marks
tips:
- key word is some so consider benefit of using funds and benefits of not using some
- think of all of annuity features and how they’re a benefit
This would provide them with a guaranteed income source with no longevity risk.
The income would therefore last them in the longer-term.
They could use their annuity income to meet their essential expenditure needs.
This is a simpler solution / gives them peace of mind / no worries for David in terms of investment management.
This solution is more consistent with the couple’s low to medium ATR.
Escalation can be built in to inflation-proof this income source.
The couple can build in a spouse’s pension for each other on first death.
Capital guarantees can be built in, in case of shorter than expected life expectancy.
Investment growth potential on their non annuity funds / David’s remaining FAD funds.
Lower costs / less adviser time required / no need for annuity annual reviews.
Annuity rates have recently significantly improved / couple are also older, so greater benefits from mortality gain.
Ruby may qualify for an enhanced / impaired life annuity, boosting income levels further.
Further annuities can be purchased if rates continue to ruse / Ruby’s health deteriorates.
Invested pension funds remain within tax-exempt wrapper with income, capital gains tax and inheritance tax benefits.
David and Ruby require a stable and sustainable income for their longer-term retirement needs. Explain how a purchased life annuity could help achieve these aims.
10 marks
tips:
- list all PLA features and then which ones relate to casestudy
This would provide a guaranteed income for their lifetime, achieving the stability and sustainability they require / avoiding longevity risk.
There would be no investment element / more of a match for the low end of their ATRs / avoiding any investment management for David.
Part of their income payments would be classed as capital and would be paid tax free / boosting their net income levels / saving 20% income tax.
This element is calculated using life expectancy / Ruby’s possible lower life expectancy could make this element larger / again leading to higher income levels.
The other part of their annuity payments would be classed as savings income / this could mop up both their £1,000 PSA allowances if unused / part may be taxable at 0% for Ruby using her savings starter rate / maximising tax efficiency / saving 20% income tax.
Escalation could be built in to the PLA, inflation proofing this income stream.
Death benefits could be built in for each other on first death / providing some sustainability in to longer-term retirement, which is one of their aims.
A guaranteed period could be built in, to ensure a minimum return on premature death.
The solution is simpler / peace of mind for our couple.
Lower costs and charges / no need for adviser annual reviews with the PLA.
David and Ruby require a stable and sustainable income for their longer-term retain needs. Explain the death benefits that could be paid from both their pension schemes, and how they would be taxed.
10 marks
tips:
- think of all possibilities relating to age
David is currently in FAD / on his death there would be a variety of options.
These would include taking crystallised funds as a lump sum, continuing in FAD, buying an annuity with the fund, or a combination of these.
FAD recognises all classes of beneficiary, so dependents (Ruby) and nominees and successors (children and grandchildren).
In theory Ruby, his children and grandchildren would therefore all have options.
Ruby currently has an uncrystallised personal pension / on her death there would be a variety of options.
These would include taking uncrystallised funds as a lump sum, moving in to FAD, buying an annuity with the fund, or a combination of these.
Death benefit taxation
If David dies pre age 75, however benefits are taken these will be tax free to his beneficiaries. They are not classed as BCEs and there will be no LTA test.
OR
If David dies age 75 and above, however benefits are taken these will be taxable at the marginal rate of the beneficiaries.
If Ruby dies pre age 75, taking her PPP as cash is classed as a BCE and there will be a LTA test (LTA still exists / just the lifetime allowance charge has been abolished in the current tax year). As this is within Ruby’s LTA there will be no income tax charge.
OR
If Ruby dies pre age 75, using her PPP for FAD or annuity purchase would not be a BCE so there would be no LTA test and no tax charge.
OR
If Ruby dies age 75 and above, however benefits are taken these will be taxable at the marginal rate of the beneficiaries.
David is concerned that withdrawing £20,000 annually from his personal pension has caused a fall in his current fund value.
Explain what pound cost ravaging (or reverse pound cost averaging) and sequencing risk are, and how these may have played a part in the decline of David’s FAD fund value.
10 marks
tips:
- explain and link back to casestudy
Pound cost ravaging works in the opposite way to pound cost averaging.
It considers the implications of taking regular withdrawals during times of market volatility.
When withdrawals are taken from a fund during market downturns:
more units will need to be sold to provide the money for David’s £20,000 a year withdrawals from his FAD arrangement;
this can lead to a rapid reduction in the value of the fund;
this adversely exaggerates the effect of volatility.
Sequencing risk
This risk occurs where higher fund withdrawals are taken in the early years of taking income from a fund, such as in retirement, in an environment of poor market returns and volatility (as we have experienced over the last few years).
This creates an early drag on the investment growth received, which can mean that the fund value will struggle to recover.
Where a fund has good growth in the early years, the investment has a chance to grow before the withdrawals have a detrimental effect on the fund value.
With the market volatility over the last few years, which has coincided with their recent retirement, this will have contributed to his withdrawals having an impact on the fund value.
The concern over this could have lead to David wanting to ensure that he will have sustainable income throughout retirement as, at the current rate of withdrawal and assuming no growth, he would only have 15 years of income within the fund: £20,000 x 15 = £300,000.
Outline how the couple can use their existing ISA and unit trust investments to help provide a sustainable retirement standard of living whilst maximising tax-efficiency and suitability.
8 marks
tips:
- how do they do this now?
- what else could they do?
The couple currently have between them stocks and shares ISAs and a jointly held unit trust.
All these investments are all relatively liquid.
They can access the ISA investments without CGT implications, currently saving 10% in CGT above their annual exemptions.
They are over the IHT thresholds currently. Using their investments for income and capital needs can help to reduce any IHT due on second death, as they will be depleting these assets, not their IHT-efficient pension funds.
Some of their ISA and unit trust investments could be in funds that do not align with the couple’s low to medium ATR (such as their Commercial Property fund).
As a result, using these will start to balance their overall portfolio to the low to medium ATR they are more comfortable with.
They could move the funds in their S&S ISA and the couple’s joint unit trust to ones that distribute income by switching to distributing funds.
By encashing the unit trust over a few years, the couple can use each tax year’s CGT exemption, although the exemption amount is reducing in future tax years.
David and Ruby have a number of different investment funds.
Outline the reasons why David and Ruby’s current pension and investment fund choices may not be suitable to achieve their aim of providing a stable and sustainable retirement income for the longer-term.
8 marks
tips:
- what do they have?
- what are their features and drawbacks?
- think of their tax statuses and allowances
ISA UK Gilt and fixed interest funds.
Limited growth potential.
Value likely to be eroded by inflation in the medium to long term, as inflation rates are currently much higher than interest-based returns.
Subject to interest rate risk.
Charges may exceed returns, leading to fund erosion.
Wasted ISA allowances for both David and Ruby using interest-bearing funds.
Unit Trust commercial property fund
Does not match their low to medium risk ATR (UK Commercial Property fund).
Relatively illiquid / withdrawals could be delayed by up to six months.
Dividends above the couple’s £1,000 DAs will be taxed at 20%.
David’s FAD fixed-interest funds
Will not help to combat mortality drag / no idea what percentage of his fund is in this fund type.
David’s FAD equity funds
Details unknown, so may not be appropriate for achieving goal of stable and sustainable income.
Comment on David and Ruby’s current investment portfolio and fund choices, in relation to their aim to provide a sustainable income in retirement.
20 marks
tips:
- Take each of their holdings one by one and comment on how it will help with their retirement needs.
- Think about the sustainability;
- will it be regular?
- how will it be affected by inflation?
- is it accessible when they want it?
- There is also the taxation angle.
NS&I Income Bonds
This provides a competitive rate of interest that is variable so will increase if general rates increase.
It is likely to pay interest at a rate below inflation.
There is no possibility of a capital gain.
This will mean that its real value will be eroded over time.
The funds are liquid so can support any ad hoc needs for capital.
The funds are fully protected via HM Treasury.
It is currently paying at a rate of 3.59%, so is generating £7,180
This is only in David’s name, with income over his £1,000 PSA being taxed at 20%.
It is not able to utilise Ruby’s PSA or 0% starting rate band.
Stocks and Shares ISAs - UK Fixed interest and UK Gilt funds
These funds are very liquid allowing not just the income but also capital to be withdrawn free of income tax.
Growth within the funds is also exempt from CGT.
They can get the natural income paid out of these funds to support their income needs.
They can continue to top up the funds each tax year using the £20,000 contribution limits.
On first death, the tax efficiency can be maintained using APS rules.
If they take the income from the funds, there is likely to be minimal capital growth, eroding the value over time.
Unit Trust - UK Commercial Property Fund.
They will be able to take income from the fund and utilise some or all of their Dividend allowance.
It is held jointly so both of their allowances are available.
The fund can be illiquid as invested in property, so there may be restrictions imposed on capital withdrawals in difficult market conditions.
They can utilise their CGT exemption each year to switch the value over time into ISAs for increased tax efficiency.
Dividend payments are variable, so will not provide a stable regular income.
Buy to Let property
This is in Ruby’s sole name.
The property is a tangible asset which may be easier to understand than pensions or other collective investments.
It can generate rental income to help meet their retirement income needs.
They have no mortgage on the rental property so, after expenses and taxation, they will have access to most of the rental income.
There is however a lack of diversification with only one property held.
There may be void periods when no rental income is received.
Ruby is concerned with the administrational burden.
Using this to provide income would mean continuing with this, or appointing a property management company at a cost.
Property is illiquid, and may be difficult to sell if they need to access the capital.
There is a significant CGT bill payable on sale of the property.
David and Ruby want a stable and sustainable income throughout their retirement.
Explain to the couple the inflation protection they currently have in place and the options they could consider to improve both inflation protection and sustainability of income throughout their retirement.
14 marks
tips:
- This question has three parts to it. Breakdown each asset:
1. current inflation protection;
2. options to improve inflation protection;
3. help with their financial aim of sustainable income throughout retirement.
Sustainable retirement income - current inflation protection
Both are in receipt of their Single Tier State Pensions.
Both appear to have the full entitlement, plus a protected payment.
State Pensions are protected by the Triple Lock. From April 2023, they increased by the September 2022 CPI increase of 10.1%. The projected increase for April 2024 is 8.5%.
The couple’s protected payments will rise in line with CPI only, though was still 10.1% last April and will be 8.5% in April 2024.
The couple have a joint unit trust, invested into a Commercial Property fund; this is invested in real assets and should provide a hedge against inflation.
The couple own their £450,000 property outright / Ruby inherited a BTL property from her mother.
Property as an asset class has historically performed well in terms of value increases and a real return (in excess of inflation).
Options to improve inflation protection and ensure a sustainable retirement income
David has £200,000 in NS&I income bonds with a 3.59% rate of return.
Reducing this holding and investing more into equity-based assets would help provide a greater inflation hedge.
Any remaining holding could be shared with Ruby to maximise allowances and tax efficiency.
The couple should continue to use their ISA allowances, investing in in equities, multi asset and property funds as these provide both a hedge against inflation and real growth potential. As long as they are within their low to medium risk ATRs.
Bed and ISA their unit trust to maximise the use of their CGT annual allowances. This avoids 10% CGT on any gains and moves monies where they can grow and provide income in an income and capital gains tax free environment.
The couple should consider switching out of their fixed-interest and UK Gilt funds in ISAs and David’s FAD. These are likely to provide returns below inflation and are not invested in real assets.
Ruby’s BTL property could be rented out via a management company. This would provide a source of retirement income for Ruby plus retain monies in a real asset. It would also avoid the stresses of administration requirements.
David and Ruby want a stable and sustainable income throughout their retirement. They have both reached State Pension Age and are in receipt of their State Pensions.
Explain to the couple how their State Pensions helps with inflation protection and the sustainability of their income throughout retirement.
8 marks
tips:
- breakdown each source of pension income
The Single Tier State Pension is inflation-proofed via the Triple Lock.
The State Pension provides a guaranteed, escalating income for life.
David appears to have normal life expectancy / Ruby maybe not / State Pension will be paid however long or short their retirement lifespan is.
It is not subject to longevity or investment risk.
The inflation-proofing built in will help maintain the purchasing power of their State Pension incomes in the long term.
David and Ruby want a stable and sustainable income throughout their retirement. They have both reached State Pension Age and are in receipt of their State Pensions.
The couple are considering deferring their State Pensions. Explain how deferral would work, and how this could help with their retirement goals.
10 marks
tips:
- This question has two parts to it:
1. the mechanics of State Pension deferral
2. how it could help our couple with their retirement goals - stability and sustainability
The Single Tier State Pension can only be deferred once / either on reaching SPA or once in payment.
The minimum deferral period is nine weeks / no maximum.
Since 6th April 2016, only an increased income in payment is available / no lump sum option.
Their income will be increased by 1% for each whole 9 week deferral period / capped at 5.8% per whole deferral year.
Once in payment, the increased Sate Pension income will be paid gross but taxable.
State Pension deferral - help with sustainability / stability
The State Pension provides a guaranteed, escalating income for life.
The inflation-proofing built in will help maintain the purchasing power of their State Pension incomes in the long term.
David and Ruby could live off their investments / ISAs / BTL income, saving the State pension for later in their retirement.
An increased payment in the future would help with their sustainability aim / guaranteed payments help with stability of income.
As long as they deferred for at least 9 weeks, they could select a deferment period that suits their needs, it does not have to be years and years.
David and Ruby wish to ensure they have a stable and sustainable income throughout their retirement.
(a) List the two main generic options the couple could explore which involve using their main residence to help with this financial aim.
2 marks
(b) Explain to David and Ruby how each of these options could be use to provide them with income throughout their retirement.
12 marks
tips:
- resi. property options
1. How would this help the couple with their aims of a stable and sustainable retirement income?
2. Are there any tax implications?
- Downsize their property to release some of the equity.
- Consider equity release to access capital whilst remaining in the home.
Option explanations - downsize
David and Ruby could move into a smaller home and release some of the equity from their £450,000 mortgage-free home.
They could then use this money to invest to provide an income.
They could use the money released to buy an inflation-linked purchased life annuity (PLA) / some other form of income-generating investment.
This could provide them with a guaranteed inflation-linked income for life (if they built in index-linking) helping with their concerns around sustainable and stable income in retirement.
A PLA would generate higher income levels than a conventional annuity, as the capital element of the income would be tax-free.
Option explanations- Equity release
They could release capital from their home via a lifetime mortgage or home reversion plan.
Both options would generate a capital lump sum for the couple whilst allowing them to remain in their home.
This capital could be used to purchase a PLA or invested to produce an income (index-linked bonds / Gilts), helping with their financial aim of sufficient income throughout retirement.
They would be able to remain in their home until both of them had died or had both gone in to care.
They may not need to pay any interest, and may benefit from a no negative equity guarantee with a lifetime mortgage.
The amount that they could release would depend on their age and health.
The lifetime mortgage loan would be repaid on death or when the property is sold.
The home reversion portion would revert back to the provider on death or when the property is sold.
Both options would also help with inheritance tax, as the couple’s estate is currently above £1 million.
Recommend and justify a range of actions that David and Ruby can take to improve the long-term sustainability and stability of their retirement income.
16 marks
- Agree emergency fund monies required / keep these on deposit in joint names.
Easily accessible to David / Ruby in case of any capital needs.
Avoid cashing in investments during poor market conditions.
Interest may be tax free within the couple’s PSAs / Ruby’s available 0% savings starter rate, saving 20% income tax.
- Bed / ISA monies from unit trust.
Can provide additional source of tax free income to boost retirement needs / tax free growth potential.
Avoids paying CGT on gains from the unit trust holdings, providing more funds for David and Ruby.
Higher yield funds can be selected in line with low to medium ATRs.
- Buy a purchased life annuity with cash, for example from Ruby’s PPP PCLS.
Part of income tax free / boosted if Ruby has shorter life expectancy.
Other part classed as savings income / helps use up couple’s £1,000 PSAs / Ruby’s 0% savings starter rate.
- Guaranteed income giving stability and sustainability / no longevity or investment risk.
- Buy an enhanced / impaired life annuity with Ruby’s personal pension fund.
Ruby will receive a higher rate due to a lower life expectancy (if she qualifies).
Guaranteed income for life.
Death benefits can be built in for David / guarantee period.
- Move part of NS&I income bonds into Ruby’s name.
Helps mop up both David / Ruby’s £1,000 PSAs and Ruby’s available 0% savings starter rate.
- Interspousal transfer so no tax implications.
- Make pension contributions of £3,600 gross annually for next five years, until reach age 75.
Recycling monies out of other investments such as NS&I Income bonds.
Will receive 20% tax relief on contributions.
- Building up another tax efficient fund / IHT free on death saving 40% tax.
Transfer the BTL property into joint names / rent it out via a management agent.
Sheltered gain can use both of the couple’s annual CGT exemptions / saving 10% CGT on disposal.
Interspousal transfer, so no immediate taxation.
Rental income can provide additional income for retirement needs.
Property is a real asset which provides a hedge against inflation / growth potential.
