Life Assurance Products

Question 1

How do with profits plans work?

Answer 1

The earliest such investments were with-profits plans. Investment performance is smoothed out by actuaries. Each year a proportion of the investment return is given as a bonus. Once added, this annual or reversionary bonus cannot be taken away. The remainder of the return achieved is kept in reserve to pay bonuses in later years when returns may not be as high. When a claim is made before a bonus becomes payable an interim bonus may be paid.

Question 2

How do MVR / MVA’s work?

Answer 2

Assume that the accumulated value of your investment is £107,000 made up of £70,000 investment and £37,000 of bonuses. These bonuses are guaranteed and will be paid to
you on a pre-set maturity date or on certain surrender points. If markets fall in value, the underlying assets that back this might not be worth as much as £107,000.

As long as surrender at full value only takes place on the pre-set or pre-agreed dates, this cash flow situation can be managed by the fund manager. However, if people seek to encash their investment simply because markets have fallen, this can lead to a run on the fund and leave those who remain in the fund worse off because a disproportionate percentage of the fund wealth has been taken by those who have gone. This is where an MVA/MVR
will be applied so that those leaving other than on the agreed points will have their values reduced to reflect the value of the underlying assets to which they are entitled.

Question 3

How do with-profits funds work?

Answer 3

The earliest such investments were with-profits plans. Investment performance is smoothed out by actuaries. Each year a proportion of the investment return is given as a bonus. Once added, this annual or reversionary bonus cannot be taken away. The remainder of the return achieved
is kept in reserve to pay bonuses in later years when returns may not be as high. When a claim is made before a bonus
becomes payable an interim bonus may be paid.

Question 4

What were traditional with profits contracts based on

Answer 4

Traditional with profits contracts were based on a guaranteed sum assured which then had bonuses added to it. Most modern contracts are now unitised – the policyholder has units in a with-profits fund and when bonuses are added either the unit price is increased (variable priced unitised with profits) or more units are added (fixed price unitised with profits).

Question 5

What are some disadvantages of with profit funds?

Answer 5

Whilst with profits contracts offer smoothing which reduces volatility (and so risk) over the long term performance may
be lower than an equivalent unit linked fund since the actuaries have to keep back reserves rather than passing them straight on to the investor. They are also criticised for lack of transparency.

Question 6

how we can measure whether a with profit fund is profitable

Answer 6

This opaque nature of with-profits investments means that the best measure of whether an investment is likely to be
profitable or not is the success of the life company itself. This can be gauged by assessing its assets against its liabilities – in other words, measuring the Free Asset Ratio
(FAR). The FAR along with fund performance and the asset allocation should be evaluated carefully before an investment is made.

Question 7

can money be moved within a life insurance product without constituting a disposal?

Answer 7

Some life contracts will also allow for investment in the funds of external fund managers. One of the big positives of
life assurance investments is that money can be moved from fund to fund within the wrapper, without constituting a disposal and without triggering a tax liability.

Question 8

what is one of the biggest problems with unit linked investments?

Answer 8

One of the big problems with unit linked investments is that the point at which you invest can be critical in the overall
return. As the unit price varies daily, investing on the wrong day can have a significant impact on returns. To counter
this, many people will invest over a period of months, drip feeding money into the fund and benefitting from ‘poundcost averaging’. This basically means that when unit prices are low, you buy more for your money, when prices are high you get less but over the period of, say, 12 months the
average price is achieved

Question 9

what are the two most common regular premium plans?

Answer 9

Regular premium plans are generally either whole of life (will run until the death of the life assured or earlier surrender) or endowment (set for a specified term or until the earlier death of the life assured).

Question 10

How are charges typically levied on regular premium life insurance contracts?

Answer 10

Charges are now typically levied
for the life assurance element of the contract and an annual management charge as well as a bid-offer spread. Older contracts often also have more punitive charges such as ‘initial units’ under which a higher annual management charge applies or a reduced allocation rate whereby only,
say, 95% of each premium is used to buy units.

Question 11

What are the main rules regarding regular premium contracts

Answer 11

These rules are broadly that the contract must be a regular premium and that premiums must be payable for at least 10
years or ¾ term if this is shorter. Premiums in any one year cannot be more than twice the premiums in any other year nor more than 1/8 of the total premiums due over the term of the contract.

Question 12

What is the contribution limit on qualifying policies?

Answer 12

Given the tax benefits associated with this qualifying status, such policies started to look like a good alternative to pensions
for those who were exceeding the ‘annual allowance’. To prevent this, the government introduced a limit of £3,600 per annum, per person on the contributions to qualifying policies. Where this is exceeded, the policy will lose its status and will be taxed under the harsher non-qualifying rules covered below.

Question 13

What is a guaranteed income bond?

Answer 13

guarantee to pay out a certain level of income over a certain period with return of
capital on maturity. This type of contract is generally issued in ‘tranches’ by insurers with each tranche being for a certain
overall investment. Once it is fully subscribed, the tranche comes to an end. This is often to limit the capital exposure of
the insurer.

Question 14

What is a guaranteed growth bond?

Answer 14

the same as guaranteed income bond, but with the guarantee being a set capital return
at maturity rather than an income.

Question 15

What are distribution bonds?

Answer 15

unlike ordinary unit linked funds,
these separate out income and capital allowing for the income return to be paid out to the investor annually and capital return retained in the fund. No unit encashments are required to
produce the income.

Question 16

What are Guaranteed / protected equity bonds / high income bonds

Answer 16

these are essentially a combination of a
high interest deposit and derivatives. A sufficient percentage of each investment is put into a high interest cash product such that at the end of the term, the capital
will be returned. The remainder is used to buy a derivative contract which secures a percentage of the rise in an index
such as the FTSE100. These are not very common at the moment since interest rates are very low, meaning that more of the money has to be kept in cash and less is
available to buy the derivative contract

Question 17

What is the tax situation within a onshore (UK) life contracts

Answer 17

Both qualifying and non-qualifying
UK policies hold investments in UK life funds. These funds will be managed by a fund manager who will be liable to corporation tax on income and capital gains.
Dividends (UK and Overseas) are tax free, other income is taxed at 20%. Gains are also taxed at 20% (with gains on gilts and corporate bonds being exempt).
Expenses of the fund can be offset against unfranked income so if expenses are greater than income then there could be no tax to pay which in turn could mean higher
returns for investors!
Importantly, there is no ability for a non-taxpayer to reclaim this whether the policy is qualifying or non-qualifying. This
means that non-taxpayers are the least likely to benefit from investment in this type of contract

Question 18

What is the tax situation on an investor investing in a qualifying policy?

Answer 18

An investor holding a qualifying policy, provided the qualifying rules are met, will be able to receive the benefits from the policy free of any further taxation at maturity - the tax paid by the fund manager is deemed to be sufficient.
There are, however, disadvantages such as the need to maintain premiums and the charges associated with the policy, including a minimum level of life assurance
necessary to maintain the tax treatment of the policy (for example, 75% of the premiums payable over the contract term or to age 75 for a qualifying endowment – (note: most policies are set up for a minimum of 10 years and must run
for a minimum of 75% of that to remain qualifying), so they aren’t for everyone. In addition, the £3,600 limit on contributions to such policies has significantly reduced the
attraction of their use for many.

Question 19

How are non qualifying policies taxed on the investor?

Answer 19

Non-qualifying policies work similarly in some ways but very differently in others! Just as qualifying policies, the fund
manager pays corporation tax on income and gains and this is deemed to be sufficient to satisfy a basic rate liability (20%). Again, non-taxpayers cannot reclaim
tax paid, but unlike qualifying policies, there is a further
liability to tax for higher and additional rate taxpayers.

you should note that where a non qualifying policy has joint owners, any gain and subsequent tax liability will be spread equally across them.

Question 20

How are partial withdrawals taxed on non qualifying policies?

Answer 20

This is done at the end of every policy year by adding all the withdrawals together.

Income tax is assessed in the tax year that the anniversary of the policy falls into.

5% of the original investment can be withdrawn without any tax liability on withdrawal.

The 5% is cumulative so if you don’t use it or don’t use all of it, the balance can be carried forward to the next year.

If the total withdrawals in the policy year are within the cumulative 5% then there is no chargeable event and no chargeable gain and therefore no tax to pay at that
time. If they exceed the cumulative 5% then a chargeable event occurs.

The chargeable gain on this chargeable event is the excess over the cumulative 5%.
It does not matter of the performance of the bond, however HMRC have said they will allow investors to apply to have the gain recalculated to account for it being disproportionate which incidentally in the end is HMRC’s decision

Question 21

is the 5% return of capital rule cumulative?

Answer 21

the 5% allowance is cumulative. If it is missed in year one, up to 10% can be taken in year two. Secondly, it is based on full or part years, so where someone has had a bond for 2 years and 3 months and has made no previous withdrawals, they would be allowed to take up to 15%. Finally, it is
important to remember that the 5% is based on the original investment NOT the current value

Question 22

Jim has a bond. He originally invested £100,000 into it and he has held it for 5 years and 7 months.
If he has made no previous withdrawals, how much can he take without there being an immediate charge to income tax?

Answer 22

He has held it for 5 full years and one partyear so this means that we round up to 6 years. He can take 5% of the original investment (£5000) for each of these years,
so he can take up to £30,000 this year.

Question 23

work out this example:
Mary has a bond into which she invests £100,000. In year one she makes no withdrawal but in year two she
withdraws £17,000. She surrenders it after 5 years having made no further withdrawals for a value of £120,000.

Answer 23

The £17,000 withdrawal will be partly taxable. Her allowance is 2 x £5000 and so she will be taxed on £7000 at the time.
Assuming she is a basic rate taxpayer she will actually escape further tax, if she is higher or additional rate she will pay an
extra 20/25%. When she later surrenders the bond, she receives £120,000. To this we add the £10,000 deferred element from her withdrawal to give £130,000 and deduct her
original investment of £100,000. This gives her a £30,000 chargeable gain which may be subject to tax depending on her tax status. The £7000 that has already been taxed is not brought back into the equation – this has been dealt with. She may be able to use her personal savings allowance and then top slicing may be used to establish what further tax may be due.

Question 24

If £100,000 was invested, in flat markets, 3 years later £30,000 withdrawn when the investment was still worth £100,000

What are the tax consequences when surrender one segment for the £30,000

Answer 24

single segment – cumulative 5% allowance
would be £15,000 (£5000 x 3 years), actual withdrawal £30,000 – chargeable gain £15,000. For a higher rate taxpayer assuming this was an onshore bond, there would be a tax charge of £15,000 x 20% or £3000 even though the bond has actually made no gain.

Question 25

100 segments. 30 segments surrendered If £100,000 invested, in flat markets, 3 years later £30,000 withdrawn when the investment was still worth £100,000,

Answer 25

segment surrender – 30 segments fully surrendered. Each segment originally had £1000 put into it. The value of each segment is still £1000. There has been no gain and as, on surrender, the chargeable gain is the actual gain – there is no tax to pay.

Question 26

Why might an investor not wish to surrender an endowment policy?

Answer 26

Many people with, particularly with-profits, endowments (qualifying policies) may no longer need the policy but may not want to surrender it because to do so would mean the loss of a potential bonus on maturity.

Question 27

How can a holder of an endowment policy release funds and what are the tax consequences

Answer 27

The original policyholder sells the policy to a third party who takes over responsibility for maintaining premiums and then claims at maturity (or on the death of the life assured). Provided the policy has been running for more than 10 years or ¾ of the term (the shorter) no tax will be due on the policyholder. If the sale takes place within this term, the policy is effectively classed as a non-qualifying policy and is potentially taxable on the difference between the sales proceeds and the premiums paid. The person buying the policy then falls due for capital gains tax rather than income tax on maturity using the purchase price paid as acquisition cost and allowing for the premiums paid after purchase as allowable deductions. This is the only time that a capital gains tax liability will arise on a life assurance product. In other instances, it will be income tax not capital gains tax that applies.

Question 28

What endowment polices do friendly societies sell?

Answer 28

Friendly Societies sell small, tax free endowments limited by the maximum premium size. The maximum premium level is £270 per year, £25 per month and £5 per week and applies to all policies owned by an individual.

Question 29

what are the main differences when comparing offshore bonds to onshore bonds?

Answer 29

Offshore policies are similar in structure and treatment to onshore bonds with the exception that they are generally established in jurisdictions with little or no taxation on the funds, such as the Isle of Man or Luxembourg, allowing for what is often called gross roll up of returns within the wrapper.

Question 30

What is the tax situation within offshore bonds?

Answer 30

Because no tax is paid within the fund, UK taxpayers are liable to their highest rate of taxation on gains when a chargeable event occurs. This can be beneficial to many policyholders, for example where they are higher rate taxpayers or additional rate taxpayers during their working lives but expect to be a basic rate taxpayer in retirement. By controlling the timing of the full liability they may be able to reduce their overall liability to taxation. Any gain which does arise can be top sliced to determine whether a 20 or 40% liability applies or to determine whether a 40% or 45% liability applies. It cannot be used to prevent a liability if the investor happens to be a non-taxpayer.

Question 31

What is Time apportionment relief

Answer 31

An allowance known as Time apportionment relief is given to reduce the chargeable gain. However, the formula can be written and applied in 2 different ways (but the answers are the same). .

Question 32

How is time apportionment relief calculated as a relief?

Answer 32

Use it as a relief, which means to reduce the chargeable gain on an offshore bond by the number of days the person was not UK resident. So Chargeable gain is reduced by the percentage from the following fraction: Number of days the policyholder was not resident in the UK Number of days the policy run

Question 33

What are personal portfolio bonds?

Answer 33

These are bonds where the policyholder effectively controls the underlying investments and the UK tax authorities have a clearly stated dislike for this type of policy. As a result of their view of these policies, a UK taxpayer with a personal portfolio bond will be taxed on a chargeable deemed gain of 15% a year regardless of the actual gain, along with other complex rules applicable to the deemed gain, such as, it's in addition to the tax charge from a part surrender and that although standard rules for chargeable gains apply, there is no top slicing relief allowed, However it can be deducted from the gain on termination of the bond. Because of this, these bonds are very unattractive for UK resident taxpayers.

Question 34

Are chargeable gains from a bond included in the adjusted net income calculation and does it take into account top slicing?

Answer 34

calculating adjusted net income, chargeable gains have to be included without top slicing along with the other sources of income. This essentially means that any partial withdrawals over the 5% allowance (remember this is cumulative) are treated as is the full gain on final surrender or encashment of the bond

Question 35

what are the main benefits of placing a bond in trust?

Answer 35

Bonds are very popular as trust investments. Because they don’t produce an income, there is no need for the trustees to complete a tax return on an annual basis. Trusts pay income tax at much higher rates with no 0% personal allowance. The first £1,000 (standard rate band) is taxed at 8.75% for dividends and 20% other income. Anything above this is taxed at the rates equal to those that additional rate taxpayers would pay i.e. 39.35% for dividends and 45% for other income. Equally, the bond can be assigned out of the trust to a beneficiary without a tax charge, who can ultimately surrender it as their own. If the beneficiary is a basic rate taxpayer this could result in no further tax on an onshore bond, whilst with an offshore bond a non-taxpayer could potentially avoid any tax at all.

Question 36

Can a bond be assigned out of a trust to a beneficiary without a tax charge?

Answer 36

The bond can be assigned out of the trust to a beneficiary without a tax charge, who can ultimately surrender it as their own. If the beneficiary is a basic rate taxpayer this could result in no further tax on an onshore bond, whilst with an offshore bond a non-taxpayer could potentially avoid any tax at all. Obviously the same 5% cumulative allowance applies, and a trustee can pay this out to the beneficiary every policy year without any tax liability at the time.

Question 37

How is the settlor taxed if a chargeable event occurs in a bond in trust?

Answer 37

► On the settlor (the person who created the trust) as part of their income if they were alive and UK resident immediately before the chargeable event. Tax paid by the trustees may be reclaimed.

Question 38

How are the trustee(s) taxed if a chargeable event occurs in a bond in trust?

Answer 38

► On the trustees if at least one of the trustees is a UK resident and the settlor is either dead or a non-UK resident immediately before the chargeable event. Top slicing cannot be used. The gain for a discretionary trust would be subject to the higher rates applicable to trusts. Remember UK policies are deemed to have paid 20% already so there would only be an additional 25% required to be paid by the trustees on income over the first £1,000. Beneficiaries cannot reclaim this tax even if they were non taxpayers.

Question 39

How are the beneficiary(s) taxed if a chargeable event occurs in a bond in trust?

Answer 39

► On the UK beneficiaries, tax accordingly (without top slicing) to the extent they benefit from the proceeds, where the trustees are non-UK resident. No basic rate credit (20%) is given either.

Question 40

What are ETFs

Answer 40

These are index tracking funds listed on stock exchanges. They are traded like a share with prices updated throughout the day. As they are shares the standard costs associated with share dealing will apply – though stamp duty will not apply. Typical management charges are 0.5%. ETFs CAN be held in ISAs.

Question 41

What are ETCs & ETNs

Answer 41

The equivalent of ETFs for tracking the performance of commodities are exchange traded commodities (ETC) and for niche markets exchange traded notes (ETN). An ETN is actually a form of bond issued by a bank – they have a maturity date but pay no interest. Instead the return comes from the movement in the index, less a fee.

Question 42

What are the key differences between ETFs & ETCs

Answer 42

The key difference between ETFs and ETNs is that ETNs don’t actually own anything – they simply use derivatives to track indices.

Question 43

how do Property Unit Trusts and Investment Trusts work?

Answer 43

Work similarly to other unit trusts and investment trusts. Like other unit trusts, property unit trusts cannot gear up while investment trusts can. Property funds can delay redemption payments to investors for up to 6 months if necessary to allow them time to sell property if needed. In reality most redemption payments are met by new money coming in to the fund.

Question 44

Briefly explain a PAIF

Answer 44

These are FCA authorised OEIC funds (they can only be OEICS), investing mainly in property (including investment in REITs ).

Question 45

How are PAIFs taxed?

Answer 45

They are able to elect for special tax treatment moving the taxation on to the investor for all rental profits and related income (as if they held the properties directly). Therefore, inside the fund, income relating to property investment (e.g rental profits) is tax exempt. Because a PAIF can invest in other areas any taxable Income that is not related to property is taxable under corporation tax at a rate of 20%. This essentially creates two businesses within a PAIF, a property investment business and one that isn’t property related.

Question 46

How are PAIFs taxed on the investor?

Answer 46

Income that is passed on to the investor as property income is paid out net of 20% and is taxable to the investor in the usually way (non-taxpayers can reclaim, basic rate don’t pay anymore and higher/additional have to make up the difference). It is paid gross if the PAIF is held in ISA or Pension. Any income paid out in the form of interest or dividends are paid gross and taxed accordingly in the hands of the investor based on their tax position.

Question 47

What are the qualifying rules for a PAIF?

Answer 47

The following 3 conditions must be met: 1. In the accounting period at least 60% of net income must come from the exempt part (i.e. income relating to property) 2. At least 60% of the total assets of the PAIF must come from the property investment business. 3. No corporate investor is allowed to hold 10% or more of the Net Asset Value (NAV) of the PAIF.

Question 48

what are the 3 main rules that a REIT must meet

Answer 48

UK resident A closed ended company Listed on a recognised stock exchange.

Question 49

How is a REIT structured

Answer 49

A REIT is split into two parts; a property letting business which is ring fenced and therefore exempt from corporation tax, the only time that it may not be is on the sale of property developments (see below) and the business that is not ring fenced which is essentially any other operation or activity of the REIT. A classic example would be property management services. Corporation tax is paid on the gains and profits from the non ring-fenced business.

Question 50

What are the qualifying rules for a REIT?

Answer 50

► At least 75% of total gross profits have to come from letting property (the ring-fenced bit) and at the start of every accounting period at least 75% of the total assets of the business must come from the ring fenced part. ► Interest on borrowing must be at least 125% covered by rental income.

Question 51

What is the taxation situation within a REIT?

Answer 51

Inside the REIT: At least 90% of rental profits (income) from the tax exempt part, must be paid to investors as a dividend within 12 months of the end of the accounting period. Property development can occur inside the ring-fenced business as long as it’s purpose is for rental income. If the developed property is not used for this purpose i.e. developed and then sold for a profit then the profit is taxable to corporation tax, unless the property sale happens 3 years or more from when it was developed, then the profit would be tax exempt.

Question 52

What is the tax situation on an investor investing in a REIT

Answer 52

A payment from the tax-exempt ‘pot’ to the investor will be treated as property income (paid out net of 20% unless the REIT is in an ISA or SIPP then it is paid gross) and is taxed in the normal way. Non-tax payers can reclaim it, basic rate taxpayers don’t pay anything extra as the 20% covers their liability and higher/additional rate taxpayers have to make up the difference of the gross amount to 40% and 45% respectively (so an additional 20% or 25%). A payment from the non-exempt ‘pot’ to the investor is by way of a dividend and taxed on the investor accordingly. (e.g. £1,000 dividend allowance, 8.75% for basic rate taxpayers, 33.75% for higher rate taxpayers and 39.35% for additional rate taxpayers) If an investor sells their shares in a REIT and they make a gain then this is taxable to CGT, following normal CGT principles.

Question 53

Can a REIT trade at a premium/ discount?

Answer 53

Just as with other investment trusts, the REIT can trade at a premium or a discount to NAV based on supply and demand. The same factors bringing about a narrowing or a widening of this premium / discount apply.

Question 54

What are Insurance company property funds?

Answer 54

These products work as per any unit-linked insurance company investment but the underlying assets are commercial property - this makes the investment far more liquid than direct property investment. There is no facility for the fund to be able to borrow to invest. An investor may take out a regular or single premium contract with the fund itself paying tax at 20%. The fund will fluctuate in value based on the value of the underlying commercial property

Question 55

What is an EIS

Answer 55

This is essentially an investment in a single, unlisted company. There are rules which must be met by the investment, covering aspects such as the size of the company and the assets held by the company but where these rules are met, the tax benefits can be significant.

Question 56

How much can be invested in an EIS and what are the tax benefits?

Answer 56

For EIS up to £1m may be invested and receive income tax relief of 30% as a deduction from your tax bill. It is possible to carry a contribution back to the previous year to be able to benefit from the maximum possible tax relief. The £1m limit is increased to £2m if the excess over £1m is invested into ‘knowledge intensive companies’, broadly defined as one that spends 10% or more of its operating costs on research and development, innovating intellectual property and / or has skilled full-time staff.

Question 57

are EIS disposals subject to CGT?

Answer 57

Disposals are generally free of Capital Gains Tax provided the shares have been held for three years but sale within this three-year period might not only result in a charge to CGT but also the withdrawal of the 30% income tax relief previously paid so this should definitely be seen as an investment for at least three years.

Question 58

Can investors defer a gain when investing in EIS?

Answer 58

Investors can also defer gains on other investments by investing in EIS shares. This means that where an investor sells a second property, for instance, and realises a gain of £100,000 it is possible to roll over the tax due on this gain by reinvesting it into EIS. Tax relief at 30% would essentially be given on money that would otherwise belong to the taxman! When the EIS is eventually sold, the original CGT liability must be paid but any extra profit made on the rolled over tax is tax free as long as they are held for 3 years

Question 59

Is business relief available when investing in an EIS

Answer 59

100% Business Relief (formerly called Business Property Relief) for IHT purposes is available if shares are held for at least 2 years.

Question 60

what are the rules that must apply for an EIS

Answer 60

The company may have no more than 250 full-time employees on the date on which the shares were issued (500 for knowledge intensive companies) No tax relief is given if more than 30% of the capital is acquired – though CGT deferral may still be claimed Gross assets of the company must not exceed £15m immediately before the issue of the shares nor £16m immediately afterwards The company must not have raised more than £5m under all venture capital schemes in the 12 months ending on the date of the investment (£10m for knowledge intensive companies) and no more than £12m in the companies lifetime (£20m for knowledge intensive companies). Investment must be made within seven years of the companies first "commercial sale" (ten for knowledge intensive firms). unless the investment is for more than 50% of the last 5 years average turnover. Subsidised energy companies are not acceptable from 6th April 2015.

Question 61

Do EIS pay dividends?

Answer 61

EIS do not generally pay dividends since dividends would be subject to tax whereas profits retained can add to the value of the company and can therefore be paid out in the form of a capital gain tax free when the investment is realised.

Question 62

What is a SEIS

Answer 62

This is a relatively new initiative designed to take the EIS model one step further and encourage investment into even smaller companies. Since the companies are smaller and the risk of failure greater, the tax breaks are also bigger

Question 63

How much can be invested into a SEIS

Answer 63

Up to £200,000 per annum may be invested each year and receive tax relief of 50% provided there is sufficient tax due against which the relief can be offset.

Question 64

Can you roll CGT gains into a SEIS?

Answer 64

CGT gains rolled into an SEIS are eligible for total relief at 50%. Unlike with EIS where the tax is deferred, here half of the tax due is written off entirely.

Question 65

Is IHT relief available when investing in an SEIS

Answer 65

IHT Business Relief is available after two years

Question 66

when investing in an SEIS, how long does the investment need to be kept for in order for the relief to be ‘locked-in’ and any gains to be free of CGT.

Answer 66

3 years

Question 67

When investing in an SEIS, what rules which must be met in order for the relief to apply

Answer 67

► The company must be an unquoted (not listed on the stock exchange) company at the time the shares are issued ► The company cannot employ more than 25 Full Time Equivalent (FTE) staff ► The company should be no more than 3 years old and have assets of less than £350,000 before the investment is made. ► To qualify, the company cannot be engaged in a precluded trade – the list of these includes financial services, property development and dealing in commodities.

Question 68

What is a VCT

Answer 68

A VCT is effectively a collective investment in smaller companies. With VCT, investors cash is combined and invested in a number of smaller companies providing diversification and reducing risk. This reduction in risk results in a reduced tax relief benefit, though it is still extremely generous.

Question 69

What are the investment limits and tax benefits when investing in a VCT

Answer 69

With a VCT it is possible to invest up to £200,000 per annum and receive income tax relief of 30% and this is clawed back if sold within 5 years. Again, there is no Capital Gains tax on disposal but unlike EIS schemes, there is no minimum period that the shares have to be held in order to benefit from the CGT treatment. It is not possible to roll over other gains and avoid tax, unlike EIS and SEIS.

Question 70

Are dividend subject to tax when investing in an VCT?

Answer 70

No tax is due on dividends from VCT – this being about the only time that you might be asked about dividends when the taxation is different to the standard.

Question 71

What rules must a VCT adhere to in order to qualify

Answer 71

► Must be listed on the stock exchange ► All money raised must be employed within 2 years ► Any company invested into may have no more than 250 full-time employees on the date on which the shares were issued ► The company must not have raised more than £5m under all venture capital schemes in the 12 months ending on the date of the investment (£10m for knowledge intensive companies). ► The VCT must not retain more than 15% of the income it makes

Question 72

EIS Investment limits

Answer 72

£2m (excess over £1m must be in knowledge intensive companies)

Question 73

VCT Investments limits

Answer 73

£200,000

Question 74

SEIS Investment limits

Answer 74

£200,000

Question 75

EIS Tax relief on investment

Answer 75

30% income tax reducer, but shares must be held for 3 years.

Question 76

VCT Tax relief on investment

Answer 76

30% income tax reducer, but shares must be held for 5 years.

Question 77

SEIS Tax relief on investment

Answer 77

50% income tax reducer, but shares must be held for 3 years

Question 78

EIS & SEIS taxation position on dividends?

Answer 78

Dividends subject to income tax (after use of £1,000 dividend allowance) (0%, 8.75%, 33.75%, 39.35%)

Question 79

VCT taxation position on dividends?

Answer 79

Dividends paid tax free

Question 80

CGT Deferral option with EIS

Answer 80

Gains made on other assets can be deferred by re-investing in an EIS (must be done within one year prior or three years after the gain is made).

Question 81

CGT Deferral option with SEIS

Answer 81

CGT deferral not available (However, reinvestment relief applies – which allows the individual to treat a maximum of 50% of the gain from any asset as exempt from CGT if proceeds are reinvested into a SEIS)

Question 82

CGT Deferral position with VCTs

Answer 82

N/A

Question 83

what are the qualifying conditions for an EIS

Answer 83

Gross assets not more than £15m before and £16m after investment. Must carry out a qualifying trade. Company must have a permanent establishment in the UK. Must be unlisted at time of investment. Fewer than 250 full time employees. Have raised no more than £5m under other EIS/SEIS/VCT in the 12 months ending on date of subscription. No more than £12m raised in the company’s lifetime. Subscription must be for new shares.

Question 84

What are the qualifying conditions for SEIS

Answer 84

Must be unquoted – although AIM and PLUS Quoted companies do qualify Must be independent Must have gross assets of less than £350,000 before the SEIS share issue Must have less than 25 employees Must raise no more than £250,000 per group in any three year period Must carry on a genuine new trade – though certain types of trade are prohibited. Must not have raised any money under the EIS or VCT schemes.

Question 85

What are the qualifying conditions for a VCT

Answer 85

Company must not be a close company. Must be listed on an European Economic Area exchange. Its income must be derived mainly from shares or securities. At least 80% of investments must be in qualifying trading companies (meaning a maximum of 20% can be invested in shares listed on the LSE) No more than 15% can be in any one group. At least 10% of investment in any company must be held in ordinary shares. At least 70% of investments by value must be in ordinary shares. Company must have gross assets not more than £15m before and £16m after investment. Qualifying company must have fewer than 250 employees

Question 86

EIS & SEIS IHT treatment

Answer 86

Qualify for Business Relief, meaning that the investment can pass on death free of IHT, as long as the shares are held for at least two years – note: this is generally the position for AIM shares.

Question 87

VCT IHT treatment

Answer 87

Business Relief not available, so on death the VCT shares will form part of the investor’s estate and be potentially liable to IHT.

Question 88

What are absolute return funds?

Answer 88

These funds simply rely on the skills of the manager to try to achieve a positive return in all market conditions within the fund’s risk profile. This can be achieved through a wide variety of means according to the fund manager in question.

Question 89

What are hedge funds?

Answer 89

Hedge funds are a specialist type of investment under which a fund manager will use a range of techniques including the use of derivatives and buying stock which he believes to be undervalued with the objective of achieving an absolute return. He is unlikely to be constrained by a benchmark, instead just looking to make this absolute return with relatively low volatility. These methods often mean that the funds have little or no correlation to the wider market and can achieve positive returns in falling markets and vice versa. Hedge funds can gear-up.

Question 90

Describe long/short fund investment strategy within a hedge fund?

Answer 90

Involves combining the following strategies Buying a stock in the expectation that it’s value will increase ( taking a long position) Selling a stock in the expectation that it will fall in value and can re-purchased at the lower pr ice ( taking a short position)

Question 91

Describe absolute return fund investment strategy within a hedge fund?

Answer 91

Involves using long/short strategies to achieve a positive return in all market conditions.

Question 92

Describe relative value investment strategy within a hedge fund?

Answer 92

Involves identifying and exploiting price anomalies between combinations of investments to generate profits for investors).

Question 93

Describe event driven investment strategy within a hedge fund?

Answer 93

Involves using pr ice movements from anticipated corporate events to achieve high returns. Examples of such events are mergers/acquisitions, restructuring and takeovers.

Question 94

Describe tactical trading investment strategy within a hedge fund?

Answer 94

Involves investing across a wide range of asset classes (including currencies and commodities) and adopting different sub-strategies (such as long/short) to achieve high returns.

Question 95

How can derivatives be used to hedge for a future purchase

Answer 95

if a fund manager is expecting lots of new money – for example a massive pension fund transfer, they could use derivatives to protect the current market prices if they believe the market will rise before cash is received

Question 96

How can derivatives be used to hedge a portfolio

Answer 96

where a fund manager expects a market to fall they could sell the assets of the portfolio or they could use derivatives to protect the portfolio assets against the downturn.

Question 97

How can derivatives be used to achieve different asset allocation in the short term without having to physically sell assets

Answer 97

by selling futures on your equity content and buying futures on gilts…

Question 98

for individual investors, are profits on derivatives chargeable to CGT

Answer 98

For individual investors, profits on derivatives are chargeable to Capital Gains Tax unless they are classed as "traders" where profits will be taxed as income. There is no CGT for individual investors in relation to gilts or qualifying corporate bond derivatives.

Question 98

What is a over the counter transaction?

Answer 98

Where the contract is agreed directly between two parties, this is known as over-the-counter (OTC) whereas this type of contract can also be purchased through the markets and would then be known as exchange traded.

Question 99

What are futures?

Answer 99

This is a legally binding agreement for one party to sell something to another party on a set future date for a set price. The buyer of a future is said to have a ‘long position’ while the seller is said to have a ‘short position’. The buyer of the future has the obligation to buy the asset and the seller of the future has the obligation to sell it.

Question 100

Do futures involve physical transfer of assets?

Answer 100

Most futures do not actually involve the physical transfer of the assets, simply the margin – making them a little like a bet. The seller believes that prices will fall and so is happy to sell at a certain price. The buyer believes they will rise and he will make a profit on that rise. If the assets are physically transferred, this is achieved by the seller (the short side) delivering the asset and then payment by the buyer (the long side) to the seller. This is known as the Exchange Delivery Settlement Price (EDSP).

Question 101

What is an option

Answer 101

Where a future is a binding agreement to buy and sell, the option is, as it sounds, an option for the buyer of the option to buy or sell the asset at a set price (strike price) on or before a certain date. A call option is a right to buy (call on) the asset and put option is a right to sell (put on to someone else), the asset. It is important to remember these terms so pause here and make sure you have embedded them before moving on. An option that can only be exercised on a certain date is described as ‘European-style’ one that can be exercised at any point in its lifetime is known as ‘American-style’.

Question 102

Who pays commission in the transaction for an option?

Answer 102

Both sides pay commission but the buyer of the option then only has to pay the premium on top of this, not margin payments. The seller has to pay margin payments

Question 103

What are the options available to an buyer of an option

Answer 103

► Exercise the option – call on the right to buy or sell the asset ► Sell the option before the expiry date – on the market to someone else ► Let it expire – if, for example, the right is to sell the asset for £2 per unit but the market prices hit £4, the buyer of the option may simply leave it to expire worthless. The only cost would be the premium paid to buy the option.

Question 104

Briefly describe a Lifetime ISA

Answer 104

A new form of ISA introduced in April 2017 available to those aged 18 and over but under 40 at outset. The maximum that may be contributed is £4000 per annum up to age 50. The government will apply a bonus of 25% to any money invested. Meaning that a bonus of £1000 will be added to the account of those making the maximum £4000 contribution. The resulting fund may be used to fund a first home purchase (as with the help to buy ISA) or accessed in full as cash from the age of 60. A penalty of 25% applies on withdrawals that are not used to pay deposit on first home / taken before age 60 and not terminally ill.

Question 105

What is a innovative ISA

Answer 105

In 2015 the then Chancellor, George Osborne, announced the introduction of a new type of ISA with effect from April 2016. This ‘innovative finance’ form of ISA is a ‘third way’ along with cash and stocks and shares and it allows investment in peer to peer lending and crowdlending.

Question 106

What are the main differences of an Innovative ISA

Answer 106

► The minimum age for subscription is 18 (not 16 as with cash) ► Returns are typically much higher than cash ISAs (around twice the rate) but whilst this is partly due to the removal of the ‘middle man’ in the form of the bank, it is also partly a function of the higher risk nature of this type of loan (not all peer to peer loans would pass bank scrutiny). ► Peer to peer lending is not covered by the FSCS Importantly, no equity participation is allowed within IF ISAs. Up to the full level of ISA allowance (£20,000 in 2023/24) may be subscribed to an IF ISA.

Question 107

What is a child trust fund?

Answer 107

Child trust funds were first introduced in 2002 as a means of encouraging parents to save for their children’s futures. The government kick-started the plan, with an initial contribution of £250 for children born after 31/8/2002. In May 2010, the new government announced plans to scrap CTFs and for children born after 31/7/2010 the initial contribution was dropped to £50 until CTFs were totally replaced by JISAs and no governmental contribution is now received. After the initial contribution, it is possible for anyone to top up a CTF up to the same limits as JISA (£9000 in the current year). No tax relief is paid on this contribution but importantly the fund benefits from a similar tax treatment to an ISA

Question 108

What is the process of an ISA on death

Answer 108

When an individual dies their ISA holding will form part of their estate. However, the spouse or civil partner of the deceased will be able to make an additional subscription to an ISA arrangement that is equivalent to the value of the ISA holding in the estate. This is on top of their permitted £20,000 per annum.

Question 109

what is a Scientific/ theoretical approach

Answer 109

This approach uses mathematical analysis to find the optimum balance of assets to achieve the best return for a client given their attitude to risk – indeed the most popular theoretical approach is known as ‘optimisation’. The extent to which it is really scientific depends upon your perception of the scientific validity of the Modern Portfolio Theory set out in week two, since this is the basis for this approach. Whatever the name, this approach takes the view that a portfolio should aim to sit on the ‘efficient frontier’ at a point set by the level of risk the client is prepared to take

Question 110

What are the drawbacks of a theoretical approach

Answer 110

Critics of this approach would argue that the mathematical approach works well when the world is ‘normal’ but that the world is seldom normal – especially in relation to correlation! Too many external factors will have an impact on returns and it is not possible to construct a portfolio that covers all of the potential outcomes. In addition, given the reliance on standard deviation as a measure of risk, critics would argue that this approach relies too heavily on past data which we know doesn’t represent a good guide to future performance.

Question 111

What is a pragmatic approach

Answer 111

The second approach ignores all of the mathematical theoretical constructs which underpin MPT and combines analysis of what has happened in the past with the judgement of the adviser as to what is likely to happen in the future. Combining the two, the adviser aims to construct a portfolio based on a rational analysis of the past, taking into account the changing world.

Question 112

Give an example of pragmatic approach

Answer 112

the adviser might look at the past returns on a given sector such as UK equities but then take into account the uncertainty presented by the UKs departure from the EU or the possible impact of the Covid-19 crisis. This could result in an ultimate decision to be underweight in UK equities, despite the strong returns previously demonstrated in this sector. On the other hand, the adviser might make judgement that another sector which has historically underperformed actually has stronger prospects for the future and decide to adopt an overweight position in this area. In this sense, the negative aspects of reliance on past performance are dampened by combining the raw data with a forward looking approach.

Question 113

What are the drawbacks of an pragmatic approach

Answer 113

Critics of this model would argue that it places too much reliance on the subjective judgement of the adviser / fund manager. Where the right judgement calls are made, the returns will follow, but a poor judgement can lead to significant loss for the investor

Question 114

What is stochastic modelling?

Answer 114

This technique uses complex mathematics, modelled by actuaries, to establish the ‘likely’ returns from a given asset allocation as a spread. This would suggest, for example, that one portfolio would be likely to deliver returns somewhere between 5% and 15% return over 10 years whilst another might vary between -5% and +20%. As you might expect, this is based on a range of extremely complex and sensitive assumptions used to establish probability

Question 115

what does strategic asset allocation argue?

Answer 115

Strategic asset allocation argues for an asset allocation to be set and then remain in place unless there are very good reasons for changing.

Question 116

What does tactical asset allocation argue?

Answer 116

. A tactical asset allocation, on the other hand, says that the portfolio manager should have the ability to vary allocation within agreed parameters. This might mean having a band for UK equities, for instance, that runs between 10% and 15%. The manager would be free to vary the asset allocation to be overweight or underweight within these parameters as the market conditions suggest.

Question 117

What are the main differences between strategic and tactical asset allocation?

Answer 117

strategic asset allocation is more about the long term whereas tactical asset allocation is more about the short term. The sport-minded among you might remember this as having ‘a strategy for a season and tactics for a match’.

Question 118

What is a core satellite management approach?

Answer 118

One approach uses passive investments at the core of a portfolio and some active funds to attain higher returns this is known as Core-satellite management.

Question 119

What is the top down method?

Answer 119

Start with the asset allocation e.g. 35% Equities, then look at the geographical split e.g. 15% UK equities, European equities 20% . Next look at the sectors e.g. banking 5% etc and finally pick the stocks…

Question 120

what are the two main approaches within stock selection?

Answer 120

Fundamental analysis – a detailed analysis of the company concerned and the related industry. Technical analysis – share price and trend analysis. This approach is focused on analysis of ‘charts’ and uses mechanical trading rules.

Question 121

What is the bottom up approach?

Answer 121

simply picking the stocks that the fund manager believes are the best stocks to make up the portfolio given the asset allocation.

Question 122

What is a value investor

Answer 122

looking for good stock and holding it for the long term. Taking the view that the market is likely to be subject to short term influences but a good company remains a good company in the long term… if you bought the share for a reason, you ought to keep it

Question 123

Explain GARP investment style

Answer 123

Growth at a Reasonable Price (GARP) – this style involves looking for companies with strong fundamentals and good future prospects for growth, even where this means paying a premium.

Question 124

Explain Contrarianism

Answer 124

looking to find what the market has missed. Looking for the opportunities that the market hasn’t seen and using the opportunities to achieve strong growth.

Question 125

What does a Momentum investor look for

Answer 125

looking for trends that are likely to persist, for example looking for companies that are likely to do well at certain points in an economic cycle

Question 126

Points to consider when choosing a fund manager

Answer 126

Objective of the fund – what is the fund set out to achieve and how consistent this is with the aims of the individual. Costs and charges The fund management groups – looking at how strong and safe the group is… does it have a good track record? Are there any concerns? This is essentially a matter of due diligence. The fund manager – what is the fund manager’s track record? How long has the manager been managing the fund? The type of fund and its risk – highly geared investment trusts will be higher risk than a comparable OEIC for instance Performance – Consideration to passive management – remember that in MPT, the market operates efficiently and there should be no benefit from stock selection. If you follow MPT, there may be an argument for simply selecting passive funds rather than active funds. We will come back to this shortly.

Question 127

in regards to ESG, what are the environmental concerns?

Answer 127

waste, pollution, climate change etc

Question 128

in regards to ESG, what is Social criteria

Answer 128

diversity of employee base, interaction with local communities etc

Question 129

in regards to ESG, what is Governance –

Answer 129

board structure, record on corruption and bribery etc

Question 130

What is negative screening?

Answer 130

Negative screening is the process of ruling out companies that engage in activities deemed inappropriate for the investor based on the specific ESG criteria – examples often include trade in tobacco, guns or animal rights.

Question 131

What is positive screening

Answer 131

Positive screening involves focusing on investment in companies that actively try to ‘do good’ both internally within the business but also to the outside world and environmental impact. An example could be investing in companies that focus on alternative energy or those that are leaders in the way they treat their staff.

Question 132

What does passive investment management argue?

Answer 132

Passive management argues that the best thing to do is simply use funds that follow a given market. This can be achieved by tracker funds or via exchange traded funds (ETFs) that also track an index. These are cheaper than actively managed funds since they don’t require the same level of management.

Question 133

do tracker funds actually buy the stock?

Answer 133

One thing that is certainly worth considering is that many tracker funds don’t actually buy the stock but rather use derivatives to track the index in question. Where this is the case, the investor will not benefit from any dividends paid by the stocks, and this can represent a large proportion of the overall return.

Question 134

What are the draw backs and benefits of investing in a pension

Answer 134

whilst incredibly tax efficient offering tax relief on contributions and highly tax favorable growth, the lack of access to funds prior to 55 will be a problem for those requiring earlier access. This said, the new freedom in terms of how benefits may be drawn after 55 have increased the appeal for those who have this kind of time horizon.

Question 135

What are the draw backs and benefits of investing in a ISA

Answer 135

again very tax efficient in the main, though for a non taxpayer, there would be little benefit from investing in an equity ISA. Also, the limit on contributions will be a problem for those seeking to make larger investments

Question 136

What are the draw backs and benefits of investing in a collective funds

Answer 136

allow the use of the CGT allowance to offset against gains. Since few people use their CGT allowance on a regular basis, this could be a major advantage. Gains above the allowance will only be taxed at 10 or 20% compared to up to 45% income tax on other products. This said, those seeking to make regular changes to a portfolio would have to buy and sell funds, each time representing a disposal for tax. Equally, income is taxed in the year it is earned even if reinvesting. For those people likely to be a lower rate taxpayer in the future, a fund allowing for roll-up of income (such as a bond) might be better.

Question 137

What are the draw backs and benefits of investing in a onshore bonds?

Answer 137

Eventual gains are taxed at up to 45% (20% deemed within the fund and a further 25% on maturity for an additional rate taxpayer). Non-taxpayers cannot reclaim any tax paid by the fund manager. Switches are not disposals. Up to 5% of the original capital can be withdrawn per annum for 20 years without immediate tax consequences. Non-income producing so less administration for trustees. Personal Savings Allowance can be offset against gains.

Question 138

What are the draw backs and benefits of investing in a offshore bonds?

Answer 138

Much of the same advantages of onshore bonds with the added advantage of offering gross roll-up and having no tax deducted within the fund. Non-taxpayers can largely escape tax. Charges may be higher than for an onshore bond

Question 139

What are the draw backs and benefits of investing in VCTs, EIS & SEIS

Answer 139

all offer highly tax efficient investment. Tax relief on investment and the opportunity to take money out at the other end free of CGT. The downside is that they tend to be higher risk since both involve investing in smaller start-up companies. Where this type of investment is right for the client, it is a tax efficient investment but care needs to be taken not to allow the tax-tail to wag the investment dog!

Question 140

what are wrap accounts

Answer 140

Wrap accounts allow an investor to hold money in a range of different funds and a range of different wrappers, all held on one platform. Typically, the investor could hold an ISA, a Pension and an onshore bond on the one platform and would be able to hold an asset allocation across all the wrappers. One consolidated statement would show all the investments in all of the wrappers and valuations are easily and readily available online. Each year the investor can also receive a single consolidated tax statement making it easy to handle the administration of tax. Charges under a wrap can be taken as a single admin fee either with commission rebated (open architecture) or as a separate charge with fund manager charges taken on top.

Question 141

define ATR

Answer 141

This is how the client FEELS about risk. How much risk they are comfortable taking and the extent to which they are prepared to accept downside risk in return for the potential for higher upside gains.

Question 142

Define CFL

Answer 142

this is the extent to which the client could reasonably AFFORD to lose money.

Question 143

What does the sharpe ratio measure

Answer 143

This measures the excess return over the ‘risk free’ return for each unit of risk taken. In other words, was it worth taking a risk? If the return achieved by taking a risk was no better than could have been achieved with the ‘risk-free’ return, the investor has exposed themselves to risk for no benefit. Risk in this context is once again measured by the standard deviation of the fund. In other words, the excess return over the risk-free return divided by the number of units of risk taken. This effectively gives us an extra return (a risk premium) for each unit of risk.

Question 144

What does the information ratio measure?

Answer 144

This is a more general form of the Sharpe Ratio which simply looks at the consistency of performance against a benchmark. It deducts the market return from the actual return received and then adjusts for the risk taken, this time using ‘tracking error’ against a benchmark. The resulting number shows the effect of fund management over and above passive funds. A high score is a good thing, indicating that the manager is adding value. A low number suggests that the investor might have been better to stick with a passive approach through tracker funds or ETFs. So, achieved return less benchmark return (the added value of the fund manager) divided by the tracking error (the risk element).

Question 145

What does Alpha measure

Answer 145

The Alpha of an investment is the difference between the return that would be expected for a given investment based on its Beta (market risk) and the return actually achieved. If you remember from week 2, the Beta of an investment is a measure of its sensitivity to movement in the market as a whole. Given the Beta of an investment, we know what SHOULD happen to in response to any movement in the market. The Alpha looks at this and then establishes whether this ACTUALLY happens. Any extra return over what we would expect given the Beta can be put down to the successful performance of the fund manager.

Question 146

What are the benefits are benchmarking

Answer 146

One of the most important tools in analysing performance is to consider the performance of a fund manager against a benchmark. This allows you to see how a fund manager is performing compared to a mock portfolio representing the same asset allocation, but using the appropriate indices for each sector. For instance, where the fund manager invests 20% in UK equities, the return on this part of his portfolio would be measured against the return on an index such as the FTSE All-share Index. The difference between the benchmark return and the manager’s return shows the outperformance or underperformance of the manager.

Question 147

What are the limitations of using a benchmark

Answer 147

Many indices only reflect movement in capital values There is no accounting for any cash balances Weighting by market cap can cause distortions

Question 148

What factors should you consider when selecting a fund manager?

Answer 148

► Experience of the manager ► The structure & style of investment (often considered the paramount factor in the selection process) ► The size of the fund – larger funds may be able to benefit from economies of scale and withstand downturns better, but smaller funds often deliver strong returns in early years as they are growing ► Staff turnover – how long do staff within the fund stay in role? ► Charges ► Past performance – whilst not a good guide to the future, there is some evidence that poor performance suggests a stronger likelihood of poor future performance

Question 149

What should a fund managers policy statement take into account?

Answer 149

► Changes in taxation ► Changes in regulation ► Changes in the market ► Where the statement is drawn up at client level, client circumstances

Question 150

Regular reports that are sent to client should include within them

Answer 150

► Portfolio valuation ► Details of holdings ► Any relevant commentary on the market and funds ► Performance against benchmark ► Any recommended changes in strategy