Technical questions Flashcards
Identify the main factors and assumptions that you should discuss with Dan and Tara when formulating a lifetime cash flow model.
(NB This question could also appear in relation to school fees planning so think about how you might adapt this answer to suit that topic)
Their ongoing health/ life expectancy/ potential long term care needs
Their intended retirement ages and expected longevity
Attitude to risk (this impacts potential investment strategies) and capacity
for loss
Any expected changes to their occupations/ incomes
How they intend to take their retirement benefits
Expectations of inflation
Any significant lump sum capital requirements
Likely expenditure needs now and in retirement
Pattern of expenditure throughout retirement
Current/ likely retirement tax rates
State pension age and NIC record
Any expected capital lump sums
Other non-pension assets, financial and non-financial
Provisions of their wills when made / intended lifetime gifting
Affordability – now and in the future
Expected growth rate for any investments
Use of tax efficient wrappers, e.g. ISAs, pensions
Explain briefly to Dan and Tara the risks of relying solely on cash flow modelling to meet their financial objectives (e.g. retirement planning or school fees planning).
Assumptions can turn out to be wrong
Figures are estimates only and will need regular reviews
The couple’s objectives or circumstances may change
Availability of tax wrappers and allowances may be withdrawn
It does not take into account market risk
It does not consider liquidity risk
State the process an adviser should follow when advising Dan and Tara on their pension arrangements.
Factfind
Risk and capacity for loss profile assessed
Client agreement and documents presented and signed
Obtain scheme details / analyse
Check for guaranteed benefits / transitional protection
Carry out research
Formulate a recommendation
Present recommendation
Review
Identify the factors a financial adviser should consider when reviewing Dan and Tara’s financial arrangements to determine an adequate level of income for their retirement.
Expenditure Debts Assets available to provide income State pension Tax status in retirement Use of tax allowances Need / preference for guaranteed / flexible income Current annuity rates Life expectancy Required rate of return Impact of death of either client
Outline the key factors that an adviser should consider when advising Dan and Tara on their strategy for funding retirement.
Planned target income State pension age Asset allocation Use of annual allowance / personal and employer contributions Use of allowances – ISA, CGT Charges Budget Use of other assets Sale of business Priority of objectives Ethical concerns / ESG ATR Willingness to use trusts What they want to happen on 1st death in terms of pension fund / protecting surviving partner
Explain to Dan and Tara how their State pension entitlement will be calculated and how to obtain a forecast of their benefits.
Their foundation amount was calculated as of 5 April 2016
This was the higher of their entitlement under the old multi-tier pension
system and the new flat rate state pension system
If an entitlement under the old system was greater than the starting level
for the new state pension, this additional amount was added to the new
state pension to make the foundation/starting amount
If it was less, then more new state pension can be built up
Under the new rules, they will need 35 qualifying years of NICs to get the
full weekly rate
i.e. years where they received or were treated as receiving earnings of at
least 52 x the weekly lower earnings limit for the year
Qualifying years can be accrued both pre and post 6 April 2016
A minimum of 10 qualifying years are needed to have an entitlement to the
new state pension
They can complete a form BR19
Or call the Future Pension Centre
Or apply for a forecast online
This will be provided in today’s money, but on the assumption that future
qualifying years are added to entitlement prior to retirement
Why might Tara have a gap her NIC record, what can she do about it and what are the benefits of doing so?
Depending on the couple’s previous income, Tara may not have claimed
child benefit after the twins were born to avoid the high income charge
She would not have automatically been credit with NICs for this period
While she was self-employed, there may have been times when her profits
were less than the small profits threshold and she chose not to pay Class 2
contributions
Tara can now make voluntary class 3 contributions
Can be paid up to 6 years after the tax years to which they relate
For 2020/21 they are due at £15.30 per week
Collected by HMRC quarterly demand or monthly DD
NSP represents good value for money
Benefits are guaranteed for Tara’s lifetime
Pension payments increase each year under ‘triple lock’
i.e. CPI / average earnings or 2.5%
She has limited pension benefits in her own name at present
Describe the process an adviser would use to ensure there are sufficient funds to provide an adequate income for the couple in retirement.
Dan and Tara have no defined benefit entitlement, preserved or
otherwise, and therefore revaluation would not be necessary;
Estimate the fund growth based on expected investment returns to
retirement date in line with Dan and Tara’s attitudes to risk;
Including planned future contributions;
Calculate estimated annual income requirement in retirement;
Allowing for inflation between forecast and retirement date;
Deduct expected benefits from the DC scheme, using a reasonable
annuity rate;
Or sustainable withdrawal rate should they have indicated a preference
for drawdown;
Allowing for any PCLS which may be taken at outset;
Obtain a state pension forecast;
Deduct estimated value of state pension;
This will highlight if there is an expected shortfall;
Calculate the funding requirement to achieve the target income amount
Ongoing reviews
Explain to the couple the potential benefits of the company making an employer pension contribution on their behalf.
The payment would be deductible as a business expense as long as it
is wholly and exclusively for the purposes of the business;
It is very rare that HMRC challenge a pension payment as not being
wholly and exclusively for business purposes;
Therefore, the payment would be deductible from the business’s
corporation tax bill;
It would increase the amount paid into their pensions;
This would be subject to compound investment returns and growth
over the period to their intended retirement date;
Therefore, it would increase the value of their retirement provision;
They would be entitled to a 25% PCLS from their pension funds;
This would mean that a quarter of the money paid could be withdrawn
free of any tax liability;
This is likely to prove tax efficient over the long-term;
Taking further dividends out of the business might not be as tax
efficient;
The majority of clients are basic rate taxpayers in retirement;
Therefore, it may save them income tax to draw the money at that
point if the success of the business moves them into the higher rate;
There will be no employer’s national insurance to pay on the pension
contribution;
Therefore, it is more tax efficient for the business than making a salary
payment.
Further to the above, why you would recommend that they make their pension contributions in this way rather than as a personal pension contribution?
Corporate pension contributions are deducted from the company’s pretax profit;
Therefore, the full amount is payable into the pension with no deductions
There is no employer’s national insurance due on the amount;
Personal contributions can only be paid from pensionable earnings;
This includes salary but not dividends;
Therefore, the net amount paid will have been subject to both employers’ and employees’ national insurance contributions;
It is therefore more tax efficient for the company to make the contributions
Evaluate the suitability of Dan and Tara’s current pension arrangements for their retirement planning.
Both are high risk investors
Dan’s pension is invested in a UK equity fund
This fund does not appear to align with his atr
Tara’s pension is invested in a Global equity fund
This does appear to be in line with her atr
We don’t know the retirement date of the funds
Nor when the couple intend to retire
They are making no contributions at present and so are not using the full annual allowance
They are potentially missing out on employer contributions by delaying the organisation of this with their new business
Both should consider further contributions due to relatively low fund values
Although personal contributions will be limited by their pensionable income / annual allowances
Keep pensions under review to confirm the likely future adequacy
Explain how carry forward works and how it could help Dan and Tara with their retirement plans.
Can carry forward unused allowance from previous 3 tax years
Up to £40,000 for 2017/18, 2018/19 and 2019/20
The £40,000 could be less if individual is subject to a tapered AA
Overriding limit – total contributions paid in current tax year (even if they relate to a previous tax year) cannot be more than 100% relevant UK earnings in current tax year to obtain tax relief
Neither Dan nor Tara appear to have used their full annual allowances in previous tax years and can therefore make up for that this year if they so wish / can afford to
Note dividends do not count as relevant earnings, if they keep their salaries at £12,500, this will be the limit on which they can claim tax relief on their own contribution
State the reasons Dan and Tara should consider making further contributions to their pensions / their employer’s pensions.
Tax relief PCLS Tax efficient fund Potential for growth Greater income in retirement Discipline / pound cost averaging Flexible options in retirement IHT efficiency Intended beneficiary can be nominated / flexible death benefits Fund choice can match ATR Salary sacrifice may be available (employer only) Lower charges (employer only) Deducted from salary (employer only)
Explain to Dan and Tara how ‘pound-cost-averaging’ from investing regular contributions could be used to assist them in generating an adequate retirement income.
NB This question could also be asked in relation to them create financial security for the future or school fees planning. Again, think about how you’d adapt the model answer.
Savings discipline
Benefit from volatility – more units are bought in a falling market
Avoids market timing risk, e.g. investing lump sum before a crash
Suitable for long-term investment
Contributions can be flexible in line with income from new business
Enables higher risk funds to be purchased
Average cost of purchase evens out
Identify the benefits and drawbacks of using each of the following to help Dan and Tara secure an adequate retirement income:
Option 1 – Pension plans
Option 1 - Pension
Benefits
Tax relief at highest rate on own contributions
Employer can claim as expense saving corporation tax
If salary sacrifice is available, save income tax and NICs
Fund grows in tax-free environment, 25% taken as PCLS
Contributions can reduce income tax payable / help avoid child
benefit tax charge
Access to professional fund management
Remaining 75% taxable withdrawals gives opportunity to use
personal allowance
And creates ‘income’ for ‘normal expenditure exemption’ under IHT
mitigation
Drawbacks
No access to benefits until 57
75% taxable as earned income
Annuity would not match ATR
FAD / UFPLS fund remains exposed to stock market
