6 - Characteristics, risks, behaviours and tax considerations of investment products. Part 2 - Other indirect investments including life assurance-based products Flashcards
What is an MVR on a with profits policy?
Market value reduction - usually applicable for surrenders or switches or in times of adverse market conditions
What are the two different types of unitised with profit policies?
Fixed price and variable price
Fixed - unit price is the same and number allocated through the year increases by a % of the annual bonus rate
Variable - unit price is increased through bonuses and guaranteed not to fall
What are the advantages of unitised with profits investments?
Bonus rate is declared annually in advance
It is easier to understand the value of the investment
Switches can be made to other unit-linked products (may be subject to MVR on switches)
The insurance company has less overall committment of reserves than traditional with profit funds
A final bonus may be payable on death or maturity
What are the characteristics of a conventional with profits policy?
Bonus declared annually in arrears
Investor can see the build up of funds by the bonus declaration
However, cannot easily calculate the current value of the policy
How do companies try to maintain a good balance in the free asset ratio?
Retain enough in good years to smooth out in poor
Provide each generation of policy holders with the appropriate returns
What are the advantages of with profit policies?
Provide access to equity markets for the risk averse
Bonus is not always linked to market performance - companies use reserves to cushion
They generally outstrip inflation
In some cases they allow investors to participate in company profits
Have ownership rights in the life office (and will benefit if demutulalised)
What are the disadvantages of with profits?
They lack transparency
Returns can be dependant on the companies subjective view of long term investments
They might be inflexible and give poor returns on early surrender or if MVR applies
What should policy holders consider if they have a closed with-profits policy?
Strength of the insurer Asset allocation (high fixed securities are likely to perform worse that equity funds) Current bonus rate Long term performance of the fund Surrender value Penalties such as MVR How long until the end of the policy
What are the consequences for an investor remaining in a closed fund?
Policy holders may incur no penalties to exit (such as MVR free anniversaries) taking their fair share of the fund, which weakens the overall fund
Investors need to weigh up the option of exiting and re-investing
What is the benefit of pound cost averaging to a policy holder looking to cash in their policy?
A saver will receive a better return if the fund has been at a low price during the term of the policy and rises just before encasement as they will have a greater number of units.
The units will have been bought on average at a lower cost than those who have had a steady increase.
Which types of funds are more unique to life assurance policies?
With profit funds
Guaranteed income and growth bonds
Property funds with asset holdings rather than property shares
Mixed or managed funds, providing a balance on investments
What is tha cap on MIP contributions (maximum investment fund)?
£3600
What is the guaranteed sum assured for a unit linked policy?
75% of the premiums paid over the life of the policy or up to the age 75 for whole of life
When are fixed term endowments generally most suitable?
When an investor can commit the funds for the full term of the policy
What are the characteristics of a high income bond?
Offer a high level of income but do not guarantee the return of the capital
Return of the capital will depend on the performance of one stock market index or an average of two or three
Provided it meets set targets, the capital will be returned, if not it may be less than the original investment
What is the benefit of an onshore unit linked bond to an investor in terms of tax paid?
Liability to basic rate tax is covered by the tax paid within the fund and the investor may take 5% without an immediate tax liability. (for 20 years or until the capital has been returned)
What does the ABI require of a distribution bond in terms of asset content?
max 60% equity
min 50% sterling based assets
yield at least 110% of FTSE all share index
How does a distribution bond operate differently to a untised bond?
There is a clear definition between income and capital
Income is taken in the form of payments direcrtly as a result of income from the bond - no units are cashed in
Unit prices will fall in line with pay out on distribution date
Taxation is the same as unit linked bondds - i.e. 5% allowance rules apply
Regarded as medium to long term as exit penalties are high
Appropriate for a cautious investor
What is the difference between a guaranteed equity and protected equity bond?
With protected equity bond the investor can choose at reguar intervals, how much of ther equity is protected, typicall between 95% and 100%
What is the tax advantage of holding bonds as investments for trustees?
The underlying life company would pay corporation tax on income at a lower rate tahn the trustees would pay on income.
What is the tax rate on trust income under £1,000 and over £1,000?
- 5% on dividends and 20% on other income under £1000
38. 1% income tax on dividends and 45% on other over £1000
When might there be a chargeable gain on an investment bond?
more than 5% withdrawn per year
full encasement
death of the life assured
How is a chargeable gain calculated for an offshore bond?
Number of days resident in the uk/number of days the policy has left to run
What are the two calculations that take place for encashement of an offshore bond?
The basic rate tax calculation is carried out at 20%
(subject to personal allowance and savers starting rate of £5000)
The higher or additional tax calculation is undertaken times the number of relevant years to determine the total higher rate payable on the gain (subject to top slicing)
How does top slicing differ for on shore and off shore bonds?
Offshore, it is always calculated back to the start date of the policy, onshore to the last chargeable event
Why are on shore bonds sometimes preferable to off shore?
Off shore bonds do not qualify for indexation relief and therefore taxed at 40 and 45% respectively
Some offshore income may be subject to witholding tax
Charges offshore are generally higher
An offshore bond has no tax to deduct the management expenses so reduces the gross roll up (onshore deductible from the fund for tax purposes)
An onshore bond for a higher rate payer 20% is charged on the net return vs 40% for offshore of the gross return
How does a friendly society benefit in terms of tax on income?
It does not pay any
What are the investment limits for tax exempt products within friendly societies?
£270 per year, or £25 per month for monthly/quarterly investments therefore £300
Parents and children can have their own policies
What are the genreal taxation rules for life assuance funds?
Dividends are exempt, uk or overseas
All other income is taxed at 20%
Capital gains are taxed at 20% after indexation allowance
What is the criteria for a qualifying life policy?
Term at least 10 years
premiums payable at least annually for least 10 years
Min life cover 75% of total premiums
premiums payable in one year must not be more than double in any other year
no premium more than one-eighth of the total premiums over the term
Limit of £3600 premiums per annum from 6/4/13
When would tax be payable on surrender?
If the surrender value exeeds the gross premiums, at the payers top rate minus basic rate
If the payer is basic rate, after top sliced gain, no tax liability
What tax is payable on a qualifying policy at maturity?
Free of any annual taxes provided:
It is in the hands of the original life assured
If it is surrendered after 10 years
What are the chargeable events for non -qualifying policies?
Death Maturity Surrender or final encasement Part surrenders Assignment for money
Can the 5% allowance for non-qualifying policies be carried forward to use in future years?
Yes it can
what are the 5 steps to calculate a taxable gain of a policy?
- Calculate the total taxable income for the year & ID how much falls into Starting rate for savings/personal savings allowance/nil, higher. additional rate bands
- Calculate the tax due across all bands, deduct the basic rate which is treated as already paid
- Calculate the liability to tax on the annual equivalent by dividing the gain by the number of years
- Calculate the liability to tax on the annual equivalent - deduct basic rate treated as paid and multiply by full policy years
- Deduct step 4 from step 2 to give the top slicing relief due
How could you use independant taxation to reduce tax liability?
Assign the bond to spouse before the surrender is made
An assignment is not a charegable event and is free of CGT and IHT (Uk domiciled)
If a person is claiming universal credit/child tax credit, what might be the implications if adjusted net income exceeds £50K?
It could reduce or eliminate the eligibility
When would there not be a chargeable gain on the sale of a qualifying life policy?
Is sold after 10 years
Would there be a CGT liability for the buyer at maturity of a qualifying policy?
yes, as they are not the original beneficial owner
