Chapter 7 Investment Advice Advising Clients Risk Profile Investment Objectives and Strategy Investment Recommendations Review Wealth Management Charges Taxation Now Pynp This syllabus area will provide approximately 21 of the 100 examination questions.[Link] Clients 1.4. Client Categorization: A the start of the relationship, keep it under review. Categorization may be for all ofthe services offered by a firm or in relation to a specific trade, service or product. Different countries have diferent clients’ categories. Why Categorization? To set different rules and provide different levels of protection to clients. To protect ordinary investors who may not have adequate knowledge and experience, To adequately evaluate the suitability of a product and whether the product is consistent with their investment goals and financial situation. Availabilty of services and products To set if the client can be offered all products and services or spestfic. Retail Clients/investors Straightforward products Require the greatest protection than ‘non-etail ‘readily understood investors. suitable for most people 4 for those who do not have adequate knowledge and experi 4 for those not able to evaluate the suitability of a product Highly complex products 4 Designed for the use of experienced investors. 4 For those who are not in need of protection Non-retail Clients/Investors Experienced investors, institutional investors and financial frrns 1 Not be in need of greater protector = Higher risk and more complex products available only tothe non-real clients Re-categorization A Retail client may request to be re-categorized as a professional client, in that case: % They must meet the qualitative and quantitative requirements. % Client to meet regulatory standards ' Explain to the clients the implications of choosing another category. ‘Make sure they have the experience and skills necessary to understand the risks. + Carry out an ‘appropriateness test’ ‘Give a written warning of the regulatory protections they will lose. More knowledge and experience Less knowledge and experience get the least protection. get the most protection. - o = = eligible for complex and higher risk products not eligible for complex and higher risk products | 1.2 Client's Best Interest-definition could be: a-Seaaer Act in the utmost good faith for the client ‘Act honestly, fairly and professionally in accordance with the best interests of the client. Not to make profit from the trust placed in them. j Absolutely open, act with integrity, act ina manner consistent with the best interests. Selecting suitable investments Refrain from misusing confidential information for own advantage or third party. Examale: =e 6 In the US, Regulation Best Interest sets out a standard of conduct for broker-dealers. wi recommendations to a retail customer: ae ‘When making such a recommendation to a retail customer, you must act in the best interest at the time the recommendation is made, without placing your financial or other interest ahead of ¢! customer's interests. - Peeees A fiduciary duty owed to a principal, Page 2 of 32Fiduciary- The person who owes the duty to the beneficiary/principal Fiduciary relationships exist between: agent and principal, director and company, lawyer and client, banker and customer stockbroker and client, trustee and beneficiaries. Fiduciary Relationship is about the relationship of special trust, confidence, reliance, integrity, open and fair, best interest, honesty, professional, no conflicting advice, not to cause significant loss to the client, not putting your interest ahead of the retail client's interest. Acting in the client's best interest may take many forms. Ensuring that the financial adviser has sufficient information to be able to properly advise the client. Selecting suitable investments to meet the client's needs. Putting the interests of the client first and the demands of their firm and their own interests second. Prioritize the client's interests when providing advice to retail clients. Areqgulated financial adviser is a fiduciary, and his responsibilities must include: * loyalty, care, commitment, open and fair, utmost good faith, not make a profit, interest contflct + refrain from misusing confidential information, to act honestly, fairly and professionally. + Must provide appropriate and sufficient materials information. + Disclose the firm, its services, its charges and the basis of its recommendations. + Any recommendations made should be in the best interest of the client. + Must have sufficient information to be able to properly advise the client. + Putting the interests of the client first, increasing the professional standards of advisers + advisers maintain their professional competence-cor 19 professional development (CPD). + improving the level of qualifications + Provide material information such as charges, cancellation rights, early encashment penalties, risk warnings and any special or non-standard terms. ‘The sort of information that should be provided to the client includes details of: + the investments and proposed investment strategies, including appropriate guidance and warnings of any associated risks. any leverage that is involved, and its effects and the risk of losing the entire investment, the volatility of the price and any limitations any margin requirements the execution venue (market) that will be used financial planning reports and suitability reports simplified prospectuses for a mutual fund. + Key investor information documents (KIID) + evaluating and reporting performance, frequency and timing of the reports to be provided what benchmark their portfolio's performance will be assessed against A summary of the steps the firm has taken to protect the client's money/investments. That the investments/money may be held by a third party on the firm's behalf. What the firm's responsibilty is for any acts/omissions of that third party. + What would happen if the third party were to become insolvent? Page 3 of 324.3 Investment Advice Process (Factors to Consider When Providing Financial Advice) 1.3.4 At least Six di * Client Relationships Know Your Client (KYC) Client Information Information Disclosure Suitability Principles Monitoring and Review Unregulated Retail Products * See ee Investment Advice Process inct stages in financial planning process (as defined by Financial Planning Standard Board-FPSB) 1, Agree on goals and objectives-know the requirements of the client. 2. Gather data. 3. Analysing the client's financial position 4. Action Plan 5. Implementation 6. Review We can also look at the following as a part of financial planning steps: = Build relations Get details of financial position and requirements Determine the client's requirements. Formulate the strategy to meet the client's objectives Implement the strategy by selecting suitable products. Revisit the recommended investments to ensure they continue to meet the client’s needs. Periodically revisit the client's objectives and revise the strategy and products held, if needed, 1.3.2-Establishing Client Relationships-the first phase of financial planning process. ° Identify the needs of the client and determe whether these fall within the range of services offered by the firm and whether the adviser has the necessary skills, competencies, and authorisation. Explain the services that the firm can offer and an outline of the process, as well as the required regulatory disclosures. Determine whether the firm can meet the needs of the client and, if so, whether advice from other professionals (such as lawyers or tax experts) is required. # establishing a rapport with the client making clear early on what the purpose of a meeting is explaining that the information collection exercise is to ensure the quality of the advice that will be given. using a mixture of open and closed questions to establish the information needed. using everyday terminology and explaining jargon when it has to be used. checking understanding establishing priorities and getting the client to confirm their agreement. Quiding and controlling the pace of the interview 1.3.3 Know Your Customer (KYC) KYC-The process of gathering information is called fact-finding To establish all of the facts that are needed for the adviser to be able to make @ suitable recommendation. Before advising, the advisor should know about the clients (hence KYC requirement in many counties) Page 4 of 32Objectives and expectations Needs, preferences. Financial situation of the client Risk attitude. There is neither any quick nor single correct way of collecting required information. It may be face-to-face or at distance or electronic ways. Ensure the suitability of its advice and discretionary decisions. eeeeeee Similarly, a firm acting as_a_discretionary investment manager for a customer should: Ensure that it has sufficient [Link] enable it to put suitable investments into the customer's portfolio, When advisers are making their_recommendations to a clier tice, send the client a report on why the recommendation made is suitable. About The fact-find process Will need to go beyond just hard facts and elicit views and opinions from the client, > This will allow the adviser to assess the level of risk they are comfortable with and + This will help to understand the extent to which family values such as ethical or religious beliefs will affect investment decisions. 134 nt Information The purpose of gathering information about the client is so that financial plans can be devised, and appropriate recommendations are made. The information that the fact find will aim to collect will depend on the service and products under consideration, but will generally include: = Their assets and liabilities + Life assurance or protection products or arrangements that they may have in place. = Family and Dependents = Health Status = Future plans and expectations are equally important. = Details of Occupation, Earnings and Other Income Sources = Present and Anticipated Outgoings = Pension arrangements = Potential Inheritances Personal Details ‘Name and address will need to be verified to comply with AML requirements by inspecting photo ID plus official documents that prove the address, such as a utility bill. Date of birth to indicate the stage of life they have reached, which may have implications for any asset allocation strategy. It wll also. give an indication of their potential viewpoint on long-term investments. The client's age may also be relevant when looking at their assets. If they hold quoted investments that are showing substantial gains, then their age may be a relevant factor in considering the extent to which these should be sold and diversified into other investments. Place of birth- on their residency and domicile, which in turn may affect their tax liabilities. Residency and domicile (place of birth status > Establish whether the client is resident or not in their country for tax purposes and their domicile. » If the client maintains that they are not resident or domiciled, what evidence is Page 5 of 32available to substantiate this if challenged by the tax authorities. > These are required to understand the taxability of income and assets in different countries. Tax ID numbers: for any tax-free wrappers that may be selected and for any tax-reporting requirements that may have to be met. In addition, this could have a bearing on any future inheritance tax liabilities. HealthStatus Ifin good health or any serious medi ns that may influence their. investment obj (Client In good health Client net In good health May live longer May not live longer Need to be cautious Need not be cautious, Cautious client Plan for income well into retirement, (growing level lof income for many years) Is important Ni <4 more Immediate income Goal is short-term, low risk ay not prepared to take undue risk Goal Is long-term, high-risk approach Higher exposure to equity and growing dividend More cash and fixed- income jstream. securities in portfolio Low beta (<1) stocks Bul, if the client is insistent on pursuing a short-term but high-risk strategy which are contradictory, then document it Ifthe client has enough and he is ill, then they become adventurous in spending. Details of Family and Dependents If married and again if any ongoing divorce payments that might be relevant to the investment strategy. Young children- to assess the need to provide funds for school fees or university education, their financial needs must be catered first. Protection should be reviewed first along with capacity for loss — what would happen if the investment strategy did not work out as expected? Details of Occupation, Earnings and Other Income Sources Business and occupation and the income they earn and sources. The client's occupation or business will give a good indication of their experience in business matters, which may be relevant when judging the suitability of a particular type of investment that carries greater risk. Check if any issue with dealing in certain stocks if the client holds a senior position in a company. If a senior position is in the public spotlight-they often need to distance themselves from any investment decision-making so that there can be no accusation of them exploiting their position or knowledge. In such cases, it is often common to establish where all investment decisions are taken on a totally discretionary basis and where the client is deliberately kept unaware of trading decisions or their rationale. Estimates of Present and Anticipated Outgoings Their income, planning to meet certain liabilities or generating a specific income return. Understand the client's outgoings. Page 6 of 32Look at budgeting, planning to meet certain liabilities or generating a specific income return. Have some sort of reserve funds in case of volatility soon after investing. The general rule of thumb is that advisers should held by the client in reserves to avoid any short-term calls on the portfolio. ‘The adviser should satisfy themselves that, whatever amount is agreed with the client, it is suitable and commensurate with their personal circumstances. Assets and Lial > vvvy vv ies Full details of wealth (assets) and their source of income Check if the client has undertaken any dubious activity such as deliberately evading paying tax. Tax evasion and similar exercises are classed as financial crimes. The location of the assets and whether any investments are held in a nominee account. The tax treatment of each of the assets Whether any investments are held in a tax wrapper ‘Tax wrapper means Tax breaks that an investor can ‘wrap’ around their investment, so that they are sheltered from paying some or all tax on it) Any Capital Gain Tax liability Details of any early encashment penalties Regarding the Assets, take full information for each type of asset as per the format below. Asset Information needed | Accounttype and details Balance Bank and Branch where the account is held Savings Interest rate on the account, ‘Accounts ‘When interest is paid and whether there are any bonuses payable Any early encashment penalties Full ttle of each instrument Nominal amount of stock or shares held Quoted Dates of purchase. Investments Acquisition costs Where the stock is held and in what name itis registered Details of any pending corporate actions | and dividends Full title of each fund Number of units or shares held Investment Dates of purchase, Funds Acquisition costs Share Class Investment structure, fund type and tax status Whether the holding is certificated or uncertificated and in what name it is registered Any exit fees. Frequency of valuation points if fund redemptions are infrequent Page 7 of 32Account type and details Eligibility criteria for tax exemption Tax- Assets and cash held Exempt Whether further additions can be made in current tax year ‘Accounts Whether account can be transferred without loss of tax-exempt status Tax ID reference Type of product Details of sum payable and any guarantees Conditions to be met for payment. When purchased and cost Term and repayment date? Any early encashment penalties Whether quoted or unquoted Structured Products Policy type and details Policy conditions Life ‘Whether itis with-profits or unitlinked Assurance Details of unit-linked funds and number of units Bonds held When purchased and costs. Any encashment penalties Regarding the Liabilities, take full detai whether these are covered by any protection products if they are either large or require high interest payments. Pension Arrangements Any pension arrangement in place will have an impact on the investment strategy that is adopted both for retirement and other financial objectives. The availability of tax exemptions for pension contributions may influence the choice of investments and so clearly needs to be factored in at this stage. Potential Inheritances and any Estate Planning Arrangements. Ask the client if there are any potential inheritances he/she may receive. If he/she is a beneficiary of any trust. Any specific gifts of shares in their will, if one in place and, if so, whether this would prevent any sale of such a holding. Itis generally unwise to rely on inheritances in the planning process, as they are not guaranteed. Caution is particularly relevant when the anticipation of an inheritance might influence the chosen investment approach. Prioritization Process The facts that will be gathered during the fact find will identify those factors that influence the client's needs. Simply because a need has been established, however, does not mean that it can be addressed, Affordability will be a major constraint on a client's ability to invest and protect against alll of the risks that might arise. The adviser will, therefore, need to guide the client through @ planning and prioritisation process ‘The purpose of information is t % Devising financial plan + Appropriate recommendations Page 8 of 32| Information needed Why needed? Personal details- Name and address. Stage of life Health status lame and address: FFor verification with AML requirements. (Stage of life For assets allocation strategy hether to invest in long-term or short term [Explained earlier Details of family and dependents ‘Details of their occupation, [Required to understand: he clients’ objectives and attitude to risk If any immediate or future spending requirement like /edding, education ete: [This will be required to understand: The level of income to be generated. nings and other incom earings ard ter hear % Heloel ten tte ooe st > The client's experience in business matters > Ifthe client is experienced, he can also judge the suitabilty of any type of investment Estimates oftheir present > Budgeting - ani! ontipated catgoings > Planning to meet certain liabilities or > Generating a specific income return jeed to know: —e where assets are held > their tax treatment > acquisition costs and > details of any early encashment penalties. ‘Any pension arrangements [To develop retirement strategy Potential inheritances and any estate planning arrangements, such as a will > Amounts due to be inherited hether/how much client is going to inherit > Whether the client has left any specific gifts of shares in their will 1.3.5 Client's goals and objectives Agreeing the client's investment and financial objectives-at the outset Identifying any constraints Establishing the clients risk profile, and Collecting the quantitative and qualitative data needed Determine a client's goals and expectations at the outset. Understanding a client’s background is important, as a person's history always plays a dominant role in shaping individual attitudes. Individuals’ attitudes and beliefs about money based on their experiences and challenges they have faced Page 9 of 32An adviser should also try to elicit (to find out) what principles matter to a client. To know their views about where their money should, or should not be, invested, The level of risk they are prepared to take to achieve objectives. Their attitude to money, and principles and values which matter to them, will help the adviser understand what influences them, and this can be factored into recommendations. Question a client about how satisfied they are with their life. This could help in Indicating key priorities that need to be addressed. The degree to which investments need to be targeted at income production, wealth preservation/wealth creation. Understand the stage of life that a client has reached. To know the clients’ intentions, plans they have and challenges they face. Other information that should be gathered includ personal details — name, address, age, health, family and dependents financial details — income, outgoings, assets, liabilities, insurance and protection arrangements objectives — Growth, protecting real value of capital, Income, Protecting against future events. risk tolerance — cautious, balanced, adventurous. liquidity and time horizons ~ immediate needs, future liabilities, need for an emergency reserve expected investment time horizon (short or long) tax status — income, capital gains, inheritance tax (IHT), available allowances. investment preferences ~ restrictions, ethical considerations, A client's knowledge and experience in relation to the investment or service that will be considered for recommendation ~ this could cover a client's past financial investment products. The level of investment risk that the client can bear financially, capacity for loss. 1.4 Other Key Financial Planning Considerations 4.4.4 Information Disclosure For the client to make a full and informed decisionabout the suitability and recommendation. the firm needs to make certain disclosures about it Information about the firm Scope of the services that they offer. How it manages and safeguards investments Costs and charges that the client will incur. Cancellation rights Early encashment penalties Risk warnings. ‘Any special or non-standard terms In the case of providing ongoing services, how it will go about managing the client's money and the arrangements it will put in place for safeguarding the client's assets. The purpose of the disclosure is that the client has all the information needed to ensure that they are in a position to make a full and informed decision about the suitability of the recommendations being made. o be eeeoooe What constitutes ‘material information’? will depend upon: ‘The investments and products being recommended. ‘© Charges, cancellation rights, early encashment penalties, risk warnings and any special or non- standard terms. Page 10 of 321.4.2 Unregulated Retail Products ‘What is unregulated in one country is regulated in other countries. + Like cryptocurrency is banned in some countries and accepted in others 4 Disclose to the client if the product is unregulated and that there is no protection. Any advice that is out of a country’s regulatory principles, the firm may face disciplinary action. if the advice proves to not be successful and “the client complains. [Link] Profile Selection of a suitable product for the client depends upon the following factors. Risk profile, Risk exposure, Appetite for risk, Level of Wealth, Time scale, Commitments. Life cycle, Life goals, Investment objectives, Attitudes, Experiences, Knowledge Capacity for loss, And many other factors Level or attitude of investment risk which can be tolerated differs from investors to investors, because of 1) Individual differences in circumstances, 2) Experiences and 3) Psychological make-up. 3. components of risk profile 1) Risk tolerance 2) Risk perception, 3) Risk capacity. ‘These three elements along with relevant additional fact-find information should allow a risk classification oF profile to be determined that can be agreed with the client Risk toleranc Risk tolerance is a very personal subject and is dependent upon the emotional make-Up of a person. Awillingness to accept a certain level of fluctuation in the value of their investments without feeling an immediate need to sell Understanding their tolerance to risk as it is essential to choosing the right investment objectives. It is also objective as well, in that age will affect how much risk a client can assume. Degree of uncertainty that an investor can handle, with regard to a negative change in the value of their portfolio, It reflects the extent to which an investor is comfortable with the risk of losing money on an investment. Risk tolerance, a client's attitude towards risk depends upon the objective and subjective factors. A client may be financially able to invest in high-risk products, but if he is cautious, then go for lower-risk investments. Risk percepti Personal opinion on the risks associated with making an investment based on their prior knowledge and experience. Discussed details later. Based on one’s knowledge and experience, willingness and attitude Subjective judgments about the likelihood of negative occurrences like injury, disease, death etc. Highly personal process of decision-making, Based on an individual's frame of reference as developed over a lifetime Take shape with the increase in experience. vvvvyY ris ql : Subjective perceptions, Intuitive judgements, Inferences, Information Page 11 of 32Experts try to base their risk perceptions more on research findings and statistical evidence. 3k capacity. This is the client’s capacity/abilty to absorb any financial losses that might arise from making a particular investment. Risk capacity will play the most important role in determining the client's overall risk profile. The client's capacity for risk will also be affected by the level of investment being considered, Risk capacity will be greater when the amount at risk is a small fraction of available capital These 3 elements and additional fact-find information will help to decide on the risk classification or profile of the client. Risk assessment Process starts with: Investigation of attitudes Consideration of risk capacity Knowledge of the client's objectives Particular investments that are being considered vvvy Notably, people can have more than one attitude to risk at any given time. This is because they often have multiple pots of money earmarked for different purposes (eg, retirement, education funds, emergency savings or discretionary Spending), each of which may have a different investment horizon and objective. For example, a client may have @ conservative attitude towards risk when it comes to their retirement savings, preferring stable and low-risk investments to ensure the security of their nest egg, but a more aggressive attitude with a separate pot earmarked for discretionary spending. Attitudes toward risk can also vary over time due to changes in circumstances, experiences and financial goals, Factors such as life stage, financial objectives and market conditions can influence these shifts in attitude. 2.1 Components of Risk 2.1.1 Risk Tolerance (discussed earlier) isk tolerance also can be: 4) Little or no risk tolerance, 2) Greater Risk tolerance Little of no risk tolerance: If the client is unwiling to take the chance that an investment might drop in price Greater Risk tolerance If the client is willing to take some risk by making investments that fluctuate in value. Risk tolerance is measured in terms ‘Objective factors- the capacity for loss or ability to take on risk (objective) ‘Subjective factors/Soft facts = willinghi@8s to take on risk’, attitude, perception. Understanding Cautious/Moderate/Adventurous kinds of Risk Tolerance For example, a question might be, "What would you do if the stock market fell by 20 percent over the course of one year? You would a) Do nothing, b) Wait a few months to make a decision or c) Sell your stocks immediately.” An aggressive investor would likely answer "Do nothing.” A moderate investor might answer "Wail a few months...” A conservative investor might answer "Sell stocks immediately.” Page 12 of 32Objective Factors- to assess client's ability to take risks/risk tolerance, consid: + Timescale ~ the timescale over which a client may be able to invest will determine both what products are suitable and what risk can be adopted. + Family Commitments + Level of Wealth + Stage of life + Age of the client Subjective Factors/Soft facts-for assessing client's willingness to take risks- their ‘risk attitude.’ Subjective factors enable the advisor to try to establish a client's attitude to taking risks. When attempting to determine a client's willingness to take risks, areas that can be considered include: ‘¢Aclient’s level of financial knowledge 4 Aclient’s comfort level of risk A client's preferred investment choice 4A client's approach to bad decisions 2.1.2. Risk Perception (subjective)-discussed earlier 2.1.3 Risk Capacity- (objective-abilty to pay, a matter of fact)-discussed earlier 2.2 Risk Description Describe different types of investment attitudes to find out which is closest to the client's view. ‘There are a number of approaches that can be taken to establish the client's risk profile, as shown below. Psychometric risk profiling Assess the client's psychological risk tolerance or preference, rather than their objective financial capacity to take risks. These risk-profiling tools uses a questionnaire to generate a risk score that can be compared to other clients. Stochastic modelling The stochastic model forecasts a range of possible returns from different portfolios of investments. The model is making predictions about the future and is, therefore, reliant on its assumptions. With risk profiling, we can assess the investor risk appetites; examples of these are shown below. Investors’ Risk Appetite Low Risk, Low-Mid Risk, Mid Risk, Mid-High Risk, High Risk Low Risk Low-Mid Risk Mid-Risk Mid-High Risk High Risk Want captal safe Want capil safe Noteomfonableinequties someexposuretoequies Partofasetsineqtes _Nejtty inequities primary neues Wejrty of bonds and cash Nix of igh andl isk in Sur inaon sk Ser infationrsk Sur fom severeregret Suferfromreget Saffer tom eget Safer rom eget Donotsuferrom toomuh eget Himehorzon-I0yeesormore Timehorton-10yeasormore Tine hrzon-i0yeasormore Timehrizon-10yeasormore Tine horizon 10yearsormare Noexperince Noexperiense Same experience Esperoned Substantial experience Page 13 of 32[Link] Objectives and Strategy First, Collect core information Agree on the investment objectives Classify the needs Convert the needs to objectives Develop investment strategy to achieve the objectives Needs are classified as follows: Maximising future growth Protecting the real value of capital Generating an essential level of income Protecting against (provision for) future events Investment objective: > Income — higher level of current income at the expense of potential future growth of capital. > Income and growth — cortain amount of current income but also potential future growth in income and capital. > Growth —primary objective is capital appreciation. >) Out-right growth - maximum return through a broad range of investment strategies, a high level ofr K. Mere ascertaining investment objective/need is not enough. The fulfilment of the objectives depends uoon the client's ability to take risks and hence the advisor must guide the client through the planning process which are as follows: + listing the areas that need to be dealt with + quantifying the impact and likelihood of each + ranking them in order of importance + reviewing existing arrangements + assessing the cost of providing protection + identifying the extent and scope of protection that the olient can afford. + establishing a plan which will allow some, or all, of their needs to be addressed. + Also see the ‘protection side’, that the client has adequate life cover. In developing an investment strategy, consider the following: risk profile investment preferences liquidity requirements time horizons. tax status. vvvvy 3.1 Risk profile-discussed earlier 3.2 Investment Preferences An adviser will also need to establish whether the client has any specific investment preferences that need to be considered within the investment strategy. These preferences may take the form of restrictions or a requirement to follow a particular investment theme. Some investors may wish to impose restrictions on what should be bought and sold within their portfolio. For example, they may impose a restriction that a holding cannot be disposed of, or they may prefer to exclude certain investment sectors from their portfolios (eg, armaments). Alternatively, a client may want to concentrate solely on a particular investment theme, such as ethical, responsible Page 14 of 32and sustainable investment, or they may require the portfolio to be constructed in accordance with Islamic principles. Ethical, sustainable and responsible investing is covered in chapter 6, section 2.2 3.3 Liqui Liquidity: Amount of funds a client might need both in the short and long term, ity Requirements and time horizons Emergency cash reserve is put to one side that the client can access without having to disturb longer-term investments. Agree with the client how much of a cash reserve should be made. Ensuring that the portfolio will contain investments that are readily realisable in the event of an emergency. : Time Horizons and Stage of Life Time horizon refers to the period over which a client can consider investing their funds. Time horizon is very relevant when selecting the types of investment that may be suitable for a client. Short term = 1 to 4 years-Should not put much in Equities 4 Medium-term = 5 to 10 years-then only you invest in Equities Long term = 10 years or more-Then their stage of life will have an important effect on the investment strategy followed. The lower the client’s liquidity requirements and the longer their timescale, the greater will be the choice of assets available to meet the client's investment objective. 3.4 Tax Status The client's residence and domicile status may also impact upon how any investments are structured ‘The adviser will therefore need to establis! the client's residence and domicile position the client's income tax position how tax will affect any investment income any tax allowances which can be utilized. how capital gains tax will affect any gains or losses made. any capital gains tax allowances which can be utilised ability to invest in certain securities and mindful of inheritance tax laws on ‘sited assets’ eligibility for any tax-free accounts opportunities for and the desirability of deferring any tax due. Tax Mitigation Acceptable tax planning to minimize tax liabilities in ways that are expressly endorsed by tax legislation. Tax avoidance Taking steps to reduce the amount of tax within the law whilst making full disclosure of material information to the tax authorities. Tax Evasion ‘Attempt to evade paying tax by illegal means, 3.5 Considerations for other types of Clients. For some clients, wealth managers will also need to take account of additional factors when dealing with Page 15 of 32trusts and charities and when they need to take account of the ethical and religious beliefs of clients, Islamic Finance, Faith based Values, Trusts, Charities, Islamic Finance Islam sets out specific requirements in Islamic law (Shariah) with reaard to investment. To support their communities who follow these practices. Islamic finance refers to a system of banking or banking activity that is consistent with the principles of Islamic law. Overarching principle of Islamic finance is that all forms of interest are forbidden. Shariah prohibits. The payment of fees for the renting of money (riba, or usury) for specific terms. Investing in businesses that provide goods or services considered contrary to its principles (haraam, or forbidden). Main categories within Islamic finance are: jara, ljara-Wa-Iqtina, Mudaraba, Murahaba, Musharaka Ijara-a leasing agreement whereby the bank buys an item for a customer and then leases it back over a specific period, Ijara-wa-Iqtina is a similar arrangement, except that the customer is able to buy the item at the end of the contract. Mudaraba offers specialist investment by a financial expert in which the bank and the customer share any profits. Customers risk losing their money if the investment is unsuccessful, although the bank will not charge a handling fee unless it turns a profit. Murabaha is a form of credit which enables customers to make a purchase without having to take out an interest-bearing loan. The bank buys an item and then sells it on to the customer on a deferred basis. Musharaka is an investment partnership in which profit-sharing terms are agreed in advance, and losses are pegged to the amount invested. Faith-Based Values \s all about responsible, sustainable and ethical investing. Faith-based investing is often a combination of socially responsible investing plus the screening out of several other things germane (useful) to a particular religion. Avoiding the investments contradicting the values of the religious denomination, their views and opinions Trusts (detail cover in Ch 8 also) Trusts are a legal arrangemeni. Assets are placed under the control of trustees For the benefit of certain named beneficiaries or For a specified purpose. Investment managers regularly manage portfolios on behalf of trusts and a different set of considerations and obligations arise when doing so. Page 16 of 32Trusts are widely used to conirol the ownership of assets and to mitigate tax liabilities. In mani it iti nial { their various forms, operations and relevant rules. In order to carry out their obligations under the trusts’ Trustees have a range of powers and duties that are conferred by either trust or statute. Within a trust, there will always be assets or investments of various kinds and therefore the trustees need powers to invest, as otherwise they would be liable for any loss. Charities=Charities also invest their surplus funds. The charity can be established as a: Trust-run and managed by the board of trustees. Foundation. run and managed by a council. When investing in charitable funds (especially those which represent permanent endowment) The charity must seek to strike the right balance for their particular charity between the two objectives of: > Providing an income to help the charity carry out its purposes effectively in the short term, and > Maintaining (and, if possible, enhancing) the value of the funds invested In order to discharge the duty to adopt a prudent approach to the investment trustees or council members of the charity must > Know their investment powers. > Discharge their duties properly when they take decisions about investments. » Have proper arrangements in place for holding investments on behalf of the charity. > Follow certain legal requirements if they are going to use an institution to manage the charity's investments on their behalf. > Know what they can and cannot do if they are going to apply an ethical approach to the charity's investments. Investment Services, the Investment firms provide: 1. Advice 2. Management- discretionary and advisory 3. Execution only Financial Planning (ongoing) and Advice (one off recommendation) Process of developing strategies to help clients meet their goals and manage their finances. Process to help make sensible decisions about money that can help you achieve your goals in life. Itis not just about buying products like a “pension or an individual savings account (ISA). Being in control of your finances rather than letting your finances control you. Financial Planning depends upon goals in life, in the short, medium and long term. Prioritize the goals based on when you need money, cost involved. eeeee inancial Planning might be wolved. + Putting appropriate wills in place to protect your family 4 Involve financial advice, not necessarily involve product recommendations. 4 Thinking about how your family will manage without your income should you fall ill or die prematurely, spending money differently, but it involves. Rearrangement of the client's affairs Page 17 of 32[Link] Recommendations After determining a client's objectives and risk profile, the next stage is to Collate all of the data that has been collected. Analyze the client's financial position. Prioritize the areas where action is needed. To analyze the data, they must be in various forms as follows: Net assets statement. Cash flow statement. Tax analysis. Lifetime cash flow projections. After analyzing the client's current financial position and any constraints, the final stage of the investment advice process is the development of solutions that are suitable for the needs of the client. 4.1 Developing a Strategy Having established what the needs and objectives of the client are, and completed a thorough assessment of their existing financial position, the adviser can asses: > The affordability and suitability of the client's exist > What the client is aiming to achieve. > What should be the client's priorities. > Assessing where action is needed. > Prioritizing what should be addressed. > Identifying where action should be left until a later date. > Developing potential solutions to address the priorities for further investigation. 4.2 Assessing Existing Strategy Having determined a strategy to meet the client's needs, then chose products based on: > Determining the details of each product > Assessing whether they meet the client's needs. > Establishing any issues that may arise in moving these to alternative options. > Their relevance to the true needs of the client. > Whether they are affordable options. > The degree of risk associated with the product considered against the client's risk tolerance > The extent of any diversification, or lack thereof. > The liquidity (that is, the ease of selling it or otherwise converting it into cash). > The level of charges compared to comparabie products. > Whether it is income producing or more suitable for capital growth. > The tax treatment/efficiency. > Performance of investments, growth achieved and any taxation treatment on encashment. > How long any assets need to be retained to earn any bonuses. > Any encashment penalties » Which assets should be retained, and which should be disposed of. The ne to suitable ancie icts that can meet the client's requirements and to evaluate their features. Page 18 of 324.3 Investment Services and Solutions Consider the investment policy statement and select an investment proposition that is: Appropriate, Suitable, and capable of achieving the goals. An Investment Policy Statement (IPS) A document between a portfolio manager and a client that contains: Y General rules for the manager Y Strategies that the manager should employ to meet these objectives. Y General investment goals and objectives Y Asset allocation, risk tolerance, and liquidity requirements. Potential investment solutions for different types of clients include: A preferred fund panel For clients who want execution only services. A portfolio of low-cost mutual funds For clients with modest level of asset who require a low-cost ongoing service. A model portfolio service For clients with a higher level of assets and investment experience, where the ad appropriate. ional costs are Discretionary fund management For clients who require bespoke investment management solutions. Allthe investment solutions generally fall within two types of structure, 1. Investment funds. 2. Discretionary investment management 4.3.1 Types of Investment Services: Discretionary (Investment Manager decides) and Advisory (clients take decision) Management Investment Management of the portfolio can be conducted: ‘Either on an advisory basis or “On discretionary basis Advisory ‘An advisory management service. Decision making is with the client. The client wants to stay actively involved in their portfolio's management. An investment manager suggests changes to their client's portfolio and Explain why certain changes are needed, but The client then decides whether or not to accept the advice. The principle of utmost good faith does not apply. eee eoe iscretionary Management Service ‘The client gives discretion to the investment firm. Manager manages and makes changes to the portfolio without referring to the client, the constraints of the client's investment objectives and the strategy that has been agreed with the client. The principle of utmost good faith does not apply. The principle of utmost good faith applies to insurance contracts. This places an obligation on the person seeking insurance to disclose any material facts that may affect Page 19 of 32,how the insurance company may judge the risk of the contract they are entering into. Failure to disclose a material fact gives the insurance company the right to avoid paying out in the event of a claim. The principle of utmost good faith states that the insurer and insured both must be transparent and disclose all the essential information required before signing up for an insurance policy. Execution only The transaction is carried out on the instructions of the customer NO\AdVIEE is provided about the suitability of the course of action or product. Certain regulatory requirements do not apply. Fact find to establish full details about the customer is not required ( But, if the client asking whether the product or its features suitable for them, then it is no longer mere execution only service. So, go through the KYC process. Even if the transaction is to be conducted on an execution-only basis, though, advisers in some jurisdictions may be ‘expected fo provide some form of comment or warning if they believe that the trade that the customer is proposing may be unsuitable. This is particularly important in situations where the adviser has reason to believe that the customer may not fully understand the risks involved, or if they suspect that the customer may be making a decision that is not in their best interest. 4.3.2 Portfolio Solutions Discretionary and advisory portfolios can take a number of forms including: 4-Fund portfolios that are a portfolio of various mutual funds or multi-manager funds. This could include: 1-actively managed funds for clients seeking the potential for higher returns than an agreed benchmark. 2-a portfolio of low-cost mutual funds for clients with modest asset levels who require a low-cost ongoing service, or 3-a combination of the two 2-Managed portfolios Standardized portfolios and adjusted at the same time by the ary managers. Designed to appeal to a wider audience with relatively smaller funds to invest. 3-Bespoke' portfolio management The traditional service offered by private banks, wealth managers, stockbrokers and private client investment managers. This involves constructing and managing a portfolio around the specific needs of a client and Can be managed on a discretionary or advisory. Will utilize a range of asset types from traditional asset classes to alternatives. The minimum portfolio size for a bespoke service is quite high. The investment mandate is agreed with the client. With scope for increasing levels of customization for higher amounts. ‘An investment manager will be appointed to manage the portfolio, and the client will often have direct access to the investment manager as well as their relationship manager. Both traditional and alternative asset classes will be used. and existing assets can be incorporated into the portfolio and large holdings managed separately. Page 20 of 32Charges will usually be by negotiation and dependent on the level of service provided. Reporting will be sophisticated with detailed performance reporting and analysis. For clients who want execution-only services, a preferred fund panel may be provided Discretionary Investment Management Services Discretionary investment management services vary widely and range from managed portfolios at the lower value end of the market to bespoke portfolios that are tailored to the individual client at the other end. 4.3.3 Investment funds The essential characteristic of this type of investment service is the use of investment funds to access a diversified portfolio of assets. They may use mutual funds or any of the other types of investment fund such as closed-ended funds, absolute return funds or hedge funds. Examples of some general types are shown below 1. Return-focused portfolios. 2. Risk - targeted portfolios. 3. Model portfolios. focused portfolios. This kind of portfolio targets different investment These are regularly monitored and adjusted depending on market movements and fund manager changes. Aims to meet or exceed a benchmark target. Balanced investment objectives mean seeking a balance between capital preservation and growth. Risk-targeted portfolios. This kind of portfolio targets to maximize returns with a certain level of risk within predefined volatility bands. The fund's aim is to ensure the asset mix within the fund continues to meet the risk profile and does not simply aspire to beat a sector average performance. Constraints imposed on risk-targeted funds can make it difficult for the fund to outperform its benchmark and so significant outperformance should not be expected. Model portfolios. An investment firm may construct and manage model portfolios of funds itself or outsource the investment activity by using a fund of funds approach or multi-manager solution. + FoFs — assets are invested in other mutual funds to utlise the expertise of specialist managers in each asset class. A FoFs approach can be either fettered which means that it only invests in funds managed by the same group or unfettered where it may invest in any fund and fund management group it chooses. + Manager of manager (MoM) - assets are managed by specialist managers in each asset class on a segregated basis as mandated by the multimanager fund manager. + With multi-manager funds, many funds will invest only in traditional assets, whilst others will adopt a more multiasset approach, investing in commodities and hedge funds, for example. It is important that advisers understand the component parts of each fund as these could expose investors to different types of risk, ‘Which type of investment funds the client will invest in depends upon what type of portfolio it has and what are the features of the portfolio, Whether the portfolio is return focused, or risk targeted. Page 21 of 32In analysing such services, differentiating factors that should be analysed include whether: - The approach is return focused or risk targeted. = Itinvolves management of a portfolio or the use of a fund of funds or multi-manager type solution. - It uses only traditional asset classes or also includes alternative assets. -The level of asset and geographic diversification and whether the investment approach is active management, passive management or a blend of the two. ~The portfolio turnover ratio is appropriate. The portfolio turnover ratio is the rate at which assets in a fund are bought and sold by the fund manager. Higher turnover may be appropriate, but implies higher charges to cover the cost of trading a) Note that the ratio will depend on the investment type within the fund — eg, a fund of short-dated bonds will have a relatively high ratio, as the bonds mature and redemption proceeds reinvested. b) Additionally, the ratio can be impacted by the approach — for a core/satellite approach, the ‘core’ (buy- and-hold) element will have a lower ratio, but the ‘satellite’ a higher ratio. 4.4 Recommendations Objectives in terms of risk and return, that have been agreed with the client, after taking into account their liquidity, constraints and other needs. The plan should detail the following: + Document the client's existing position. + Identify the areas that require addressing and what the priorities are. + Detail the recommendations made and the reasons why they are suitable. + Document the areas where action has been deferred until a later date. {the recommended solution is to offer ongoing investment services, then, > Prepare an investment policy statement. > Select a suitable benchmark to monitor the performance of the investment portfolio, Linear relationship between risk and return. More simply, as risk taken in investment increases, return has to increase to compensate investors for the additional risk taken. The risk premium required is with the level of risk taken. The risk axis is split into zones and defined by three maior asset classes. Money market-lke instruments Bond-like instruments and Equity-lke instruments; and Risk increases from money market -like instruments through to equity-like instruments, 4.4.1 Investment Policy Statement (IPS), a summary of a client's investment objectives that capture their required returns, risk profile. Liquidity requirements Time horizon Tax position. Investment strategy that will be used to achieve the client’s goals. Asset allocation any constraints regat Benchmark vVvvVVVVVVY Page 22 of 324.4.2 Choice of Benchmark Realistic benchmark, to depend upon the precise asset split adopted. It should be compatible with the risk and expected return profile of the portfolio. 4.5 Presenting Recommendations, a written report Contains recommendations that have already been made orally in meetings with clients. Should be easier for the client to understand. ‘Acts as the proof of record of what is being recommended, and on what key information it is based, to avoid the potential for misunderstandings. Acts as a safeguard for the adviser in justifying their work. Acts as a document of record for the client. ‘The parts of a financial planning report /Contents to a client are normally as follows: A statement of the client's objectives. Asummary of the client's income and assets. Proposals for immediate action Longer-term suggestions to consider in the future. The reason behind why recommendations are felt to be suitable Any risks or inflexibility are inherent in the proposed solutions. Timescales for implementation. ‘Appendices, including any data that is best presented separately, if appropriate. vvvvVVy Product quotations, illustrations and brochures should be presented in an orderly way, possibly with an index listing the various items being sent to the client. The language in the report should be as concise and clear as possible. The language used should not include jargon, except when necessary to explain points being made. Following the preparation of a written report, itis often sensible to have a face-to-face meeting with the client, to give them an opportunity to clear up any misunderstandings that may have arisen with regard to their objectives, and to allow them to ask questions where needed. 4.6 Regulatory Considerations for Recommendations 4.6.1 Suitability Principles Firm to ensure its recommendations are suitable and appropriate. What is suitable and appropriate depend upon: ‘the needs and priorities of the customer ‘> the types of investment or service being offered and + the nature of the relationship between the firm and the customer 4.6.2 Conflicts of Interest Conflict of interest an its significance when A conflict of interest Conflict of interest can arise where, for example: > The adviser or firm may have an interest in a customer undertaking a transaction. > Where a firm is dealing on behalf of a client. > The firm may wish to place an order in the same security, and it may have orders from other clients for the same security. Page 23 of 32‘So, what to do? Place the orders in due tum so that it is not giving priority to any particular client. Refrain from placing its own orders if they may prejudice (harm) the client's trade. Acting in the client's best interest Requires advisers to not place themselves in a position where their own interests conflict with their duty to the client. CIS! standard principles says: Members to comply with the rules at all times. Members to support the underlying values of the Institute. CISI Code of Gonduct relating to principles relating to conficts of interest: Be alert to and actively manage fairly and effectively any personal or other conflicts of interest. Obey legisiation and comply with regulations to the best of your abil. Ensuring you are open and cooperative with all your regulators. Challenge and reporting unlawful or unethical behaviour.” All recommendations by the financial advisor should be dri the customer's needs and never by the potential to earn commission for the adviser or the firm, vvyvy In Europe, investment firms are required to have a documented ‘ No Inducements-A firm should not pay or accept any fee or commission, or provide or receive any non-monetary benefit, that would impact on its fiduciary duty to its clients. The receipt or payment of any such benefit should only be permissible only when: It is disclosed prior to the provision of the service to the client, with a clear explanation. Payments or receipts will not impair compliance with the firm's duty to act in the client's best interest and the amount is clearly disclosed to the client. “The best way to resolve potential conflicts of interest. Remove conflicts of interest. of any fees or commissions ¢ahlaid ramoval of this conflict. If not possible to remove the conflicts of interest? The firm or advisor should recognize the need to Conflicts of Interest Policy In Europe, investment firms are required to have a documented ‘conflicts of interest policy Firms under these obligations are required to: > Maintain and apply effective organisational and administrative arrangements designed to prevent conflicts of interest from adversely affecting the interests of their olients. > Have in place appropriate information controls and barriers to stop information about investment research activities from flowing to the rest of the firm's business. > Where a specific conflict cannot be managed away, ensure that the general or specific nature of it is disclosed (as appropriate to the circumstances). Note that disclosure should be used only as a last resort. > Prepare, maintain and implement an effective conflicts policy. > Provide retail clients and potential retail clients with a description of that policy. Page 24 of 32> Keep records of activities where a conflict has arisen. [Link] Financial planning is a cyclical process and needs regular reviews. A financial plan should, generally, be reviewed at é {2 Months, but ad hoc reviews may also be required if, for example, the client experiences a significant change in personal circumstances. Objective of each review 1. To tell the client whether they remain on track to meet their objectives, and, if not, 2. What additional actions may be required. 3. Rebalancing and assets reallocation it's plan can chan: % the environmental changes around them such as changes to tax laws etc. 4 The client's circumstances change like needs, wants and aspirations. ‘The review should look at a range of factors including: > Reviewing the previous advice in light of any changes to the client's circumstances and revising recommendations where necessary. > Changes to goals and objectives and the amounts targeted. > Reviewing and amending the assumptions used, where relevant, to take account of changing market conditions, investment retums and future inflation rates. > Net worth, income and expenditure. > Asset allocation and client risk profiles (including rebalancing portfolios). > Suitability of products and product wrappers held and revisiting the risk appetite and capacity for loss of the client. > Obtaining any documentation that may be required in the review meeting, > Checking existing terms of business documentation and preparing updated documents, where necessary me significant changes to one or more of the above May require that a new financial plan is drafted In others The existing plan may be amended and updated. wi ! circumstances m: ir needs, war aspirations, what are they actually? The client marries or divorces. Retiring from full-time employment Inheriting a sum of money or having a child. Not only will their financial needs change But their attitudes to finance may also alter and they may, for example, become more or less risk averse. Periodic Review should include: % the up-to-date value of the client's investments. + Value the investments on a basis which has already been agreed with the client. * When stocks and shares are involved, the valuation process should be consistent. ‘ Whether bid or mid prices are used and what exchange rate used for foreign assets ‘ Transactions undertaken over the period. ‘ Charges that have been deducted Page 25 of 32“Any additions to or withdrawals from the client's portfolio Periodic re just repeating the planning exercise, say a year later, doi nsure: -whether they are making progress towards the client's goals 2-whether they are drifting off target Sif rebalancing required The adviser should agree early on whether ongoing monitoring and review is going to fall within their remit (within the scope) ~ in many cases, this will be so. If so, the adviser should have advised the customer of how frequently they can expect to see an update of the plan and any new recommendations. In case full periodic review is carried ou + Re-verify the client's details, + Establish whether there have been any changes “Check if any changes are required to the plan. % Ifthe plan changes, make new recommendations. 6. Wealth Management Charges 1,5 Wealth Management Charges Wealth Management Services can be paid for by: Management fees Transaction charges “Financial planning advice ‘ Performance-based fees Means, the fee for the wealth management services can take various forms as above. ‘The fees charged for wealth management services depend on: the nature and frequency of the service being provided. and include fees for providing financial advice, any management fees involved or fees for managing client portfolios. Fi inancial advice is a time-intensive exercise. Charges can be either: + Fee based © Commission based, + Fee may be agreed in advance as on-off fee, Fee based means charged as an upfront commission or, ‘Commission based means, commission paid from the product during its lifespan, as % of the value of the fund. ‘Advance fee in cases of specialist advice in certain areas Types of Charges: Investment products such as life insurance or mutual funds may include charges: An initial charge for investment in the product or fund based on a % of the amount invested. # Ongoing charges for managing the underlying investment portfolio. Page 26 of 32‘> Performance fees may arise based on the performance of the fund, Exit charges. Investment portfolio, when managed on behalf of a client. * Annual management fee as a% of the portfolio value on management of investment portfolio Regulatory requirements: Disclosure of services and Fee. % Disclose to clients the nature of the services being provided. The fee and the basis on which charges will be paid, any product-related charges and any commissions it may receive from a product provider and will usually require this. disclosure in writing and before the firm conducts any business. isclosure about F The total price to be paid including all related fees, commissions, charges, expenses, and any taxes. + If these cannot be indicated at the time, the basis on which they will be calculated so that the client can verify them. + The commissions charged should be itemized separately. + If any costs or charges are payable in a Fx, what the currency is and the conversion rates and costs. + If other costs and taxes not imposed by the firm could be payable, how they will be paid or levied So eee [Link] ‘SDRT-Stamp Duty Reserve Tax, WHT-Withholding Tax, DTR-Double Taxation Relief Tax evasion: A financial crime and is illegal. Tax avoidance: LegalPlanning and organizing affairs within the rules so that you pay the least tax possible. Maximize the use of tax allowances, exemptions, and reliefs. Tax relief- when you do not have to pay tax on part of what you earn, especially because you use the money for @ particu'ar purpose. All income grossed up to calculate tax liability Gross payment is one that is made without any tax being deducted Net payment is one that has had tax deducted before payment ypes of Taxes 1. Business Tax, also Corporation Tax on total profit 2. Sales Tax 3. Financial Transaction Tax 4, Personal Tax = Income Tax, Capital Gains Tax, Estate Tax 5. Overseas Taxation 7.1 Business- Corporation tax on company’s total profit Pay tax for each ‘accounting period. It is a Direct tax, ability to pay. Companies submit tax returns at the end of the accounting period. Authorities will issue a tax assessment, showing the tax due. An accounting period starts when: > Acompany first becomes chargeable to corporation tax, or > The previous accounting period ends. So, Accounting period may not be a full year. Page 27 of 32An accounting period ends when the earliest of the following takes place: > ‘The company reaches its accounting date. > ILis 12 months since the start of the accounting period, > The company starts or stops trading. For tax purposes, the accounting period is never longer than 12 months. Sales Taxes > Indirect taxation, levied on consumption or expenditure, also referred to as consumption taxes. > This tax is same for all and are not based on the ‘abilty to pav’ principle. > Regressive Tax (the tax rate decreases as the amount subject to taxation increases) > Example VAT, GST (Goods and Sales Tax) 7.2 Financial Transaction Taxes On any sale, purchase, transfer or registration of a financial instrument They are generally ad valorem tax6s, based on the _markel value of the shares, Tax rates vary between 10 and 50 basis points. vvvy v No stock transactions tax US, Germany and Japan 7.3 Personal Tax- Income Tax-on Individuals On all income received during a financial year, those income come from sources like: “Salary, pensions, Interest, Dividend, Rental from property or other assets, capital gain “ The rates may vary from source to source. ‘The financial year may be a calendar year or start at some arbitrary point. ¢ Financial year also referred to as ‘assessment year’, meaning income in that year is taxed. “Individuals, who pay tax for a set fiscal year. The financial year ‘May be a calendar year or + Orstart at some other arbitrary point. @ It's a full year. ‘Tax rules and allowances will differ widely from one country to anather, but the following are a few core concepts that an adviser should be aware of. Residency Probably, the main concept is the residence of the individual, which will determine whether they are liable to tax and, if so, on what sources of income. Overseas Taxes Advisers should also be aware of any tax deducted from overseas dividends. Gross and Net > Agross means before tax deduction Net means after tax deduction, Grossing up simply involves converting a net return into a gross one. For example, if bond interest is paid net of tax at 20%, then the net amount represents 80% of the gross and to find out the gross amount simply divide by 80 and multiply by 100. vvv Page 28 of 32Bond washing: The practice of selling a bond just before it pays @ coupon payment and then buying it back once the coupon has been paid, Bond washing can result in tax-free capital gains because after the coupon has been paid, the bond will sell for less. Capital Gains Tax (CGT) > Tax on gain on disposal of assets, gain on sale of shares and on gift > Gains made on Govt stocks exempted > Gains made on individuals principal home exempted. Advisor also must understand whether short-term or long-term gains and how are they calculated. Tax wrapper. Accounts or schemes where the assets in those accounts and schemes are free of CGT. Examples of tax wrappers Pension plans, savings schemes, some venture capital investments Estate Taxes Levy on the estate of a person who has died, ‘Some countries have no estate or inheritance tax. Estate tax is due before estates can be transferred onto their family. Estate taxes are charged on: > What a person gives away > What a person leaves on death > What a person receives Levied on estates whose value exceeds an exclusion limit set by law. ‘Surviving spouses and descendants of the deceased rarely, if ever, pay this levy. Estate tax can be reduced by: Gifis during their lifetime to reduce the eventual size of their estate liable to tax. In most countries, such gifts need to be made a number of years before the client dies otherwise the tax advantage is lost, and so forward planning and taking action in plenty of time is, therefore, important. Can be reduced by allowances and exemptions. Awell drafted WILL and GIFT. Inheritance tax A tax paid by 2 person who inherits money or property of a person who has died. Inheritance tax is known in some countries as a “death duty" and is occasionally called "the last twist of the taxman's knife.” 7.4 Overseas Taxes Withholding tax Levied by national tax authorities on investment income earned by non-residents in their foreign investments in that country. Tax Deducted at source by the payer in overseas. If an investor receives a dividend from an overseas company that has had WHT deducted, it will still remain liable to income tax and that raises the risk of double taxation of the dividend or interest income. Therefore, governments have double taxation treaties/Double Tax Agreements or DTAs. Double taxation treaties (or Double Tax Agreements or DTAs) Page 29 of 32To avoid the same income from being taxed in two countries ‘Two governments agree on how any payments will be handled, what rate of tax will be withheld on any interest or dividend payment, ‘Tax deducted by the overseas payer can be dealt with in two ways. 1. Relief at source 2. Repayment claim Relief at source Under this method, itis possible for a reduced rate of WHT to be deducted, instead of the normal domestic rate, by making appropriate arrangements in that country and obtaining the necessary documentation. Investors to submit necessary forms and documentation required by the foreign tax authorities before the dividend payments. Repayment clai Where relief at source is not available, or The arrangements cannot be put in place in time before the dividend is paid. Relief can only be obtained by making a repayment claim in the issuer's country. Investors must file a repayment claim with the foreign tax authority to reclaim the withheld tax submitting various forms and proof of tax residency. 7.5 Residence and Domicile Residence and domicile are concepts that are central to systems of taxation as they determine. > Who is liable to tax and > What assets or income may be liable. In this regard, some countries adopt a citizenship test to determine liability to tax. Residency Residency status holds significant sway over an individual's tax obligations including their liabilities to income tax, CGT and inheritance tax. It also deteremines whether they have access to any tax allowances and deductions, which could potentially reduce their overall tax liability. Each country has its own rules which determine an individual's residency status, along with their liability to taxes. Most countries’ tax systems can be loosely categorised as either a worldwide or territorial-based system of taxation Most countries’ tax systems can be loosely categorized gs either: 1-Under a Residence-based worldwide system of taxation Residents taxed on their worldwide income and capital gains irespective of where the income or gains 2-Under a Citizenship-based worldwide system of taxation US citizens are subject to US taxation, wherever in the world they may reside. 3: Under a territorial system of taxation Arising outside of that country are not liable to tax. Residents are taxed only on income and capital gains arising in that country, and income or gains arising outside of that country are not liable to tax. Note: Some countries that adopt the territorial system, however, extend the tax base of residents to include Page 30 of 32overseas income and gains, but only if such income or gain is remitted to the country of residence. Definitions of residency vary from state to state. > For individuals, physical residency is the most important factor. > Other factors, such as property ownership or the availability of accommodation are also considered. > Inaddition, many countries assess physical residency by the number of days that an individual spends in the country and the regularity of their visits. Domicile Domicile is the country that a person treats as their: permanent home, or lives in and 4 has a substantial connection with Domicile is a deciding factor in the liability to estate taxes. Every person must have a domicile, and itis not possible at any time to have more than one domicile, There are three types of domiciles: 1) Domicile of origin, 2) Domicile of choice and 3) Domicile of dependency Domicile of origin Domicile that every person acquires at birth, A child born during the lifetime of his father =country in which the father is domiciled birth. Ifa child is born after his father’s death = country where their mother is domiciled at the time of birth. Domicile of Choice > Acountry, where residing with the intention of continuing to do so permanently or indefinitely. > Where a person abandons their domicile of choice in a particular country but does not acquire a new domicile elsewhere, their domicile of origin will revive and continue to govern their legal position until they acquire a new domicile of choice or of dependency. Domicile of dependency > Arises in respect of children, married women and mentally disordered persons, > Domicile of the person on whom they are deemed to be legally dependent. Domicile of a child of married parents during their minority. will depend on the domicile of the father during the father's lifetime and (in general) on that of the mother after the father's death, ‘The domicile of a child of unmarried parents during their minority. will (usually) depend on their mother’s domicile. ‘The domicile of a married woman is the same as, and changes with, that of her husband in some countries The concept of domicile is of considerable importance in a number of areas of law. It is the link between a person and the legal system or rules that will apply for matrimonial, legitimacy, succession and taxation issues. Domicile and its related concepts are important as they help to determine: > Who has a right to inherit assets on death. > The form of any will or testamentary dispositions that are permitted. > Who inherits if there is no will, as some countries such as France have very rigid rules on who can inherit Page 31 of 32> Domicile may also affect how much estate tax is payable and where. Location of Assets The liability to some form of estate taxes usually deper > the domicile of the individual and > the location of the assets they own. .-END OF THE CHAPTER. Page 32 of 32Chapter 8 Lifetime Financial Provision Retirement Planning Protection Planning Estate Planning, Trusts and Foundations This syllabus area will provide approximately 13 of the 100 examination questions.[Link] Planning 1.1 Introduction ‘Retirement planning refers to financial strategies of saving, investments, and ultimately distributing money meant to sustain oneself during retirement. About how much money is needed to lead a retired life and how much to start investing. Retirement planning means preparing for a steady stream of money after retirement. 4 Retirement planning involves determining retirement income goals and what's needed to achieve those goals. Worldwide, state pension benefits are equivalent to only about 40% of net average earnings. The main objective of investing in a pension is to provide an income in retirement. ‘A defined contribution and personal pension plans are also called A money purchase plan. ‘The retirement amount can be taken in lumpsum, or an annuity plan can be purchased for monthly income. ee + 1.2 Intended Retirement Age Retirement Planning depends upon the Intended Retirement age. Intended retirement age depends upon: Lifestyle, Health, Financial capability, Goal, Income, Age Pension arrangements How much funds one will receive on retirement depends upon: ‘When he wants to retire, after how many years. * How much is the saving per year ‘© The savings are at the end of each year or al the beginning of the year. ‘© Whats the growth rate, means interest. Pension arrangements can be. « Through employer pension plans «Through own arrangements Key points for an advisor-self read = Assess desired income. * Ensure that the client does not run out of money. * Tund at least 20 years of living and leisure expenses = Consider Level of risk = How much residual value to bequeath (property to the beneficiary by will) = The details of any scheme that a client is already part of or has the option to join. = Establish the availability of benefits from the arrangements. = Establish at what age the client can retire and take benefits. = Whether these benefits will be in the form of a tax-free lump sum, with the remainder as ‘an ongoing income or some other arrangement. = For the ongoing income, it should also be established whether there will be a continuing pension for the surviving spouse following the death of the investor. = Identify the extent of any death benefits which may be provided in the event of death before retirement. It is usual to provide for a lump sum to be paid by either a return of part of the fund or by life assurance. = Whether the pension scheme is sufficient, how any annual increases are calculated, and the long-term security of the pension fund Page 2 of 291.3 Retirement Planning Products + Occupational Pension Schemes o Defined benefit scheme © Defined contribution scheme. + Personal Pensions 1.3.1 Occupational Pension Schemes (OPS) Provided by an employer/corporate. Employer that sets up the scheme. Employers contribute to the overall cost. The amount of employee contribution will be for the employer to decide. Employers will decide eligibility conditions for joining, like minimum age and service conditions. If an employee contributes some % of earnings, the scheme called contributory pension schemes. Ifthe employer only contributes to the whole f un d , the employee does not, known as non-contributory schemes. The benefits payable depends upon: Whether it is a defined benefit scheme or a It is a defined contribution scheme + eee! Defined Benefit (DB) Schemes & Pension amount based on specified criteria. There are two types: Final salary schemes: pension calculated based on number of years of service and final salary; and Career-averaged schemes: pension calculated based on the average salary earned over the individual's career May be employer funded, or contributions may be made by both employer and employee. Risk lies with the employer; the employer must ensure the fund is well run and for defined benefit schemes must make up for any shortfall in funding. Ifitis a defined benefit scheme, then the expected arrount of income that will be payable, no need to worry about the investment performance of the fund. A DB scheme essentially promises a given level of income at retirement, expressed as a proportion of final earnings. The income under DB scheme that will be payable until death is based on Number of years worked Person's final salary or average career salary Sponsoring employer standing behind that promise e+ + #€ + Advantage of allowing retirement plans to be made in the knowledge of what income will be received, ++ Disadvantages- in the final years of working, the employee may not be earning as much as when they were at their peak eaming power. Due to the provision of a ‘guaranteed’ income throughout retirement, DB schemes are seen as the ‘gold standard’ by individuals and their financial dependents. However, over time, such schemes have become less popular with employers, 2s they have to cover any deficit between payments to members and how much is available in the pension fund. Many employers who offered DB schemes have therefore closed their schemes, in one of three ways: Hard freeze or termination — the scheme is closed to new workers, and existing members are no longer allowed to accrue benefits. Soft freeze — the scheme is only closed to new workers, while existing members can continue to Page 3 of 29accumulate benefits. Partial freeze - the scheme is frozen for some (but not all) members, Defined Contribution (DC) Schemes (also called money-purchased scheme) ‘+ The pension is based on the contributions made & investment performance achieved. + May be funded just by employee or contributions may be made by both. ‘+ Both the employer and the employee contribute + Contributions invested to build up a fund that can be used to purchase benefits at retirement. + At retirement, the client will be looking to use this fund to generate the pension, possibly by purchasing an annuity. + The pension provided is related to the contributions made and investment performance achieved. % Hence a final pension is down to how much money has been invested and how well the invested- in funds have done. + The employee will not know in advance the amount he will receive when he retires-disadvantage. + These funds will usually be held in a designated account for the employee, and this gives certainty that the funds will be available at retirement. + Risk lies with the employee; no set pension amount Is defined-this is a disadvantage. + Good for employer client will be looking at two options: = Use this fund to generate the pension, possibly by purchasing an ann — Access the capital of the fund. ‘The choice of options depends upon: 1) Expected life expectancy and 2) Health ‘[Link] in poor health with limited life expectancy may wieh to access the capital of the pension fund rather than having to take out an annuity. Investment performance during the life of the pension fund = Investment performance at the time when retirement takes place. Life styling is an approach to automatically switch to lower risk assels as the inlended reliremenl age approaches. The amount of pension that the client will receive on retirement, under the defined contribution scheme, will depend upon: the contributions made. ‘The size of the fund 4 investment performance of the pension fund prevailing interest rate at the time of retirement Similarity between both schemes The employer contributes to the overall cost - for both contribution and defined benefit scheme. Pension payments after retirement are taxable for both the schemes. Tax relief and rebates are available on pension contribution, for both the schemes. 1.3.2 Suitability-Which Scheme should be preferred? To know which scheme should be preferred, determine: Client's requirements > Risk Profile + Analysis of pension schemes Page 4 of 29* Client's life expectancy and health (if in poor health, better take capital of the fund, rather than taking annuity. ‘ Client's wealth and general financial condition “ Actuarial deductions if the retirement benefits are taken early. + How pension increases are calculated Some more factors to consider are: For DB schemes: Amount of retirement income that will be generated and any other benefits such as any pension payable at death to a surviving spouse/civil partner. For DC schemes: The options available are to use the accumulated pension fund to provide an income in retirement such as an annuity or an option to access the capital of the fund. Options to de-risk the portfolio as the intended retirement age approaches should be established and whether lifestyling is automatic or has to be initiated (lifestyling is an approach to automatically switch to lower risk assets as the intended retirement age approaches). 1.3.3 Personal Pensions Individual/self-employed who do not have access to occupational pension schemes. No employer contributions generally, but sometimes employers organize the scheme and contribute-advantage and disadvantage More expensive - disadvantage Reduced administration-advantage The individual can choose the provider and the funds that they are invested in-advantage tte ++ Assessing Existing Pension Plans To know if the existing retirement plans are suitable for their objectives, determi ‘+ What type of pension plan the client has and what retirement benefits it will generate. «The age at which benefits can be taken. + Any penalties, such as actuarial reductions, that may be made for taking retirement benefits early. The lump sum that can be taken at retirement. 1.4 Quantifying Needs in Retirement How much is needed for retirement? Depends upon Current financial position Aspirations for retirement How much income will be needed in retirement to fund their intended lifestyle. What capital will need to be available at retirement to fund their plans. Existing retirement plans along with their assets, liabilities and protection products. Developing an investment and protection strategy to meet their needs. Identifying appropriate solutions Implementing that strategy and keeping it under regular review. tee ee eee 1.4.1 Current Financial Position Information relevant to retirement that will be needed includes: ~ Personal information %& Dependents + Health ‘% Assets and any expected inheritance. Page 5 of 29+ Liabilities + Income and expenditure at present + Any existing protection policies + Expected lump sum payments from any existing pension arrangements. + Any large, expected costs. > nal ‘Anticipated retirement date ‘The amount of any stale pension that might be payable. What level of cash reserves the client will need for emergencies and the unexpected. An estimate of any lump sum needed at retirement to repay items such as mortgages. An estimate of the income they will need in retirement, taking into account inflation. Quantify what the client's aspirations and needs are. Determine the details of any scheme that a client is already part of or has the option to join. Establish the availabilty of benefits from the arrangements, Establish at what age the client can retire and take benefits and whether these will be in the form of a tax-free lump sum, with the remainder as an ongoing income or some other arrangement. For the ongoing income, establish whether there will be a continuing pension for the surviving spouse following the death of the investor Identify the extent of any death benefits which may be provided in the event of death before retirement. Itis usual to provide for a lump sum to be paid by either a return of part of the fund or by life assurance t + eH HEHE EEE 1.4.2 Aspirations and Needs People’s expectations of retirement have changed markedly since the 1980s, when DB schemes were more prevalent, and life expectancy was shorter; and the adviser will need to understand the changing factors that may affect a client's circumstances and their retirement aspirations After establishit client's intended retirement age, the next stage is to make an estimate of Long-term needs, as well as any immediate requirements Possible need for medical treatment and long-term care. Itis better to prepare an expenditure plan as folows to understand what income they will need from post-retirement. Page 6 of 29Rent or mortgage payments erro pera) Other loan repayments Credit card repayments Local taxes Food Clothing Power and water Schooling costs Tel connections lephone and internet Car costs inch Socialising ling fuel, | Establishing future expenditure (post-retirement), however, can be difficult. If the client is not in a position to make a realistic assessment, then, as a rule of thumb, take about three-quarters (75%) of their net income to maintain a similar lifestyle in retirement, ‘Once we arrive at the amount needed Check ‘how much is arranged by the existing pension (explained later) How much is the shortfall. Then, what capital will need to be available at retirement to fund such shortfall Solve the example in the textbock 14.3, Other Sources of Capital and Income in Retirement Hcostly house can be sold less expensive can be purchased, thus freeing up capital, ited out Rental Income, ifany from property which is rented out Own business and there may be the opportunity to sell this as a going concern. Retirement planning strategies. © Investment horizon © Attitude to risk + Life-styling ‘+ Asset allocation © Asset weighting 1.44 Assessing Existing Pension Plans Itis possible that itis required for extra contributions required for extra benefit, 7 It may be possible for the client to contribute additionally to the existing scheme for extra benefit. Ifitis not possible to the existing scheme, contributions can be made to a separate pension vehicle under the same pension scheme. This is called Additional Voluntary Contributions. + If arrangements are made with another product provider, then this is called Freestanding AVC. “Freestanding AVCs (FSAVCs) and give the individual a greater degree of choice of both provider and how they are invested. Page 7 of 29‘So, Topping-up contributions can be by. ~ Increase contributions into PPP - Additional voluntary contributions (AVCs) - Free-standing AVCs 1.5 Presenting Recommendations Report. ‘Written report, documented plan ‘Summary of the details obtained from the client. ‘Summary of the current position. Details of the objectives/goals and priorities that have been agreed Explain how the recommendations that are being made have been arrived at. ‘Why the advice and recommendations are suitable for clients Results of the analysis that have been undertaken, Existing arrangements- Anything in place at the moment and how it fs or does not fit in with the clients’ needs and goals. For pension, if additional pension contributions to be made. Whether existing pension arrangements suitable or to be switched Level of income needed in retirement, adjusted with inflation Proportion of income to be met from existing pension arrangements. The amount of additional income that will need to be generated in retirement over and above that received from state, company and personal pensions, Capital needed at retirement to generate additional income. ‘The growth rate that needs to be achieved to generate the lump sum needed. Protection-The extent of any existing protection policies that are in place to address areas such as mortgage protection, medical insurance and life cover that are relevant to the advice being provided. Essential gaps in protection cover that need to be dealt with. Restrictions or preferences agreed with the clients, Client's level of risk Fees and charges ‘Anything that has been discounted and what was not covered thee Fee HHH EE eee eee ‘The Recommendation report will be accompanied bi Any supporting product brochures, illustrations Key investor information documents (KIIDs) Note the action needed to implement the requirements Meet with the client to discuss the recommendations [Link] Planning In this section, we will consider some of the key features of a wide range of life and protection products. Such products are designed to provide financial protection in case certain risks occur, but it needs to be remembered that life is all about risk, and a judgment needs to be made as to which areas are in need _of protection. Just as it is not possible to eliminate risk entirely, it is not financially feasible for clients to insure against all events. Collect information to assess the need for protection plannin: + Personal information - age, marital status and employment information. + Dependents + Health- client's health, job and whether they engage in any potentially dangerous or hazardous activities + Assets - extent of assets and sufficient to cover the impact of loss of job, or illness + Liabiliies- what debts and how will be repaid in the event or illness or death. + Income after tax + Expenditure-regular expenditure, extent of disposable and ability to cover the cost of protection. 2.1 Main Areas in Need of Protection Page 8 of 29The table below gives some indication of the range of needs and protection products available. ner Reed aey eee) Perens) cen) Cia eae eae Life cover Income Household Key person protection cover protection Accident and Mortgage Shareholder sickness cover income protection Unemployment | protection Partnership cover protection Critical iliness cover Protection Life or earlier products critical illness cover | Neaatcowe | Long-term care Consider the client's personal_circumstances and make an assessment of whether taking out protection should be considered. + Family and personal - the main wage-eamer or another family member might suffer a serious illness. In some cases, illness may be critical. Without protection, the family could lose its main source of income and may have insufficient funds to live on. Additionally, there may be medical bills and care costs arising. Similarly, the main wage-earner could lose his or her job. The family will lose its main source of income and may have insufficient funds to live on. + Mortgage — job loss or illness suffered by the main wage-earer could result in difficulty in meeting mortgage payments. Furthermore, the main wage-earner might die before the mortgage is repaid, saddling the family with ongoing mortgage repayments. Protection policies could be used to address these issues. + Long-term care — if an individual suffers mental and/or physical incapacity, the cost of care could drain and perhaps exhaust the individual's savings, + Business protection — a key person within a business might die or suffer a serious illness. The business will no longer be able to generate sufficient profits without the key person's contribution. Alternatively, a substantial shareholder or partner within the business may die, and their shareholding or partnership stake may need to be bought out by the remaining shareholders/partners. 2.2. Assessing Protection Priorities Learning Objective Understand the need for assessing priorities in life and health protection — individual and_family priorities To assess the adviser exploring with the client what might happen and what the consequences might be. Although none of us can predict the future, it does not Prevent us considering future events and then assessing whether we are prepared for that possibiliy. This can be achieved by looking at each of the main areas in need of protection and asking what could happen and what would be the effect if it cid. The exploration of these points will reveal the extent of ‘the areas in which a client should consider taking action. Area of What could happen Potential impact ‘Your family loses your income and ‘You suffer from a fatal heart attack have insufficient funds tolive on You are diagnosed with a critical illness | You face major medical bills and care costs Life and ‘ou or someone in your family ‘You may want immediate access to a family needs surgery private hospital Page 9 of 29| You are unable to look after yourself and need full-time care You lose your main source of income The cost of care exhausts all of your savings Your savings are insufficient to maintain your lifestyle Lifestyle | You sutfer an accident or sickness _| Benefits from the state or your employer are and that prevents you from working insufficient income mm It takes a long time to find a new job and You lose your job you exhaust your savings Major expenditure to repair the damage Your home is flooded and buy new contents ~ [You are unable to meet your mortgage | Home | You lose your job repayigents contents | You die before your mortgage is repaid | Your family are saddled with ongoing morigagerepayments | - ‘The business can no longer generate | ‘Akey person in yourbusiness dies | its products or sales Business | Ashareholderdies Their shareholding needs to be bought out partners no longer able to work ‘Their share of the partnership needs to be bought out Having determined that protection needs to be considered, however, the adviser needs to move on to find out whether doing so is sufficiently important so that the client needs to prioritize it appropriately. 2.2.1 The Prioritization Process Learning Objective- Understand the requirement for prioritizing protection needs. Simply because a need has been established does not mean that it can be addressed. Affordability will be a major constraint on a client's ability to protect against all of the risks that might arise. The adviser will, therefore, need to quide the client through a planning and prioritization process. This will involve: “listing the areas that need to be dealt with -quantifying the impact and likelihood of each -ranking them in order of importance -reviewing existing arrangements -assessing the cost of providing protection identifying the extent and scope of protection that the client can afford. establishing a plan which will allow some of the needs to be addressed Pri need, may want to deal with all of them. The age of the client may also give some ion as to what to prioriti ing such decisions is not an easy process, especially as the client, having recognized the The below example gives the stages of a stereotypical 2.4 children’ family, but there are many variations — there are too many individualised situations to cover here, and each olient's unique needs must be addressed accordingly: Page 10 of 29+ If the client is in their 20s or 30s and is married with child-life sickness and redundancy cover high priority +f the client is in their 40s-life and mortgage cover may become less important, depending upon whether they have paid off the mortgage and the children have left home. Sickness cover remains important, however, as increasing age brings more risk of illness. + In their 50s-Life and redundancy cover may not be as important-Sickness cover remains important, and consideration of long-term care starts to appear on the planning horizon. + When the olient is in their 60s or older- the need for redundancy cover is usually no longer applicable. Life cover is even less relevant and, instead, clients will be thinking about preserving their wealth and how to reduce any inheritance tax liabilities. Health and sickness cover should be a particular concern as well as long-term care. The adviser also needs to explain the long-term nature of this process, namely that the prioritisation exercise can only identify the |. The Femainder still needs to be addressed at some stage when the client's circumstances allow, ie, they have been deferred not Abandoned, The process of prioritization will enable a plan to be established of what_needs doing and what will be considered later. This leads naturally to the realization that financial planning is an ongoing exercise and that the client and adviser will need to regularly review progress and reassess the plan in the light of changes to needs, circumstances and priorities. Clients should also be encouraged to maintain open communication with their adviser, should any changes arise in the interim. 2.3 Quantifying Protection Needs Learning Objective Understand how to quantify protection needs: So far, the adviser has collected information about the client: assessed which areas are in need of protection and, agreed an order of priority of what will be addressed. Before moving on any further, the adviser needs to quantify the ind level of protection needed for each of those areas. is simply about comparing the future position of the client with their current position and then assessing the shortfall. This can begin with producing an and expenditure plan that documents the client's current position. Outgoings Income Rent or mortgage payments Solary after tax Other loan repayments Other income ~ after tax Credit card repayments Local taxes Gas, electricity and water Schooling costs Page 11 of 29Telephone andintemetconnections | Carcosts including petrol, servicing and insurance Socializing Holidays and breaks Attitude to risk need not be covered in Morigage protection cover policy The client can then be asked how thls position might change in the event that they were no longer able to work, and the revised result will show what is at stake, This exercise can then be continued by considering what would happen if something happened to the client or their partner, seeking an understanding of what the impact would be on the family of the following: + Ifthe client or partner were to die + Ifthe client or partner became unable to work ‘Who would look after the home or the children if the client or partner were unable to? This may then indicate that it is necessary not just to replace lost income but also to generate additional income or a capital sum. Asa result, there are a number of other factors that should be considered, includina: + Determine whether the client will need capital or income, and whether this is best met by a lump sum payment or the generation of income, or a combination of both. Generally, a lump sum will be the best option, as it gives the client the flexibility to use the capital and either invest it for income or draw on itas necessary. + The amount of income that can be generated from a capital sum will depend on the level of interest tates at the time the funds are invested and will vary. This will introduce a level of uncertainty if the client will need a given level of income. As a result, any assumptions made need to be conservative. + The effect that inflation will have on the income flow should be established. The importance of this will depend on the length of time the income might be needed for. These factors will direct the adviser towards the consideration of a type of policy that is appropriate to the client’s need. This will also involve choosing between different types of policy that may be capable of addressing the needs of the olient. If a regular income is required, for example, this need could be met by an income protection policy, but also by a term assurance policy that would pay a lump sum that could be invested. This process can then be repeated in a similar fashion for all of the other areas that may be in need of protection. 2.3.1 Existing Protection Arrangements To determine if there are any gaps and make sure that all protection needs have been filled. Obtain details of the 1 icy, i ium, the term and the potential benefits thai may arise on death or maturity. Then measure the suitability of these against the client's current circumstances, consider the following: + their relevance to the prioritised needs of the client Page 12 of 29+ the extent of the cover provided and whether this is adequate given the client's current needs. + whether there is an option for the cover to be extended + whether they are affordable options or whether the client's circumstances have changed so that they can afford to increase what is paid + whether the original timescale is stil valid + the degree of risk associated with the product considered against the client's risk tolerance. + the extent of any diversification or lack of it + the level of charges compared to comparable products. * any encashment penalties. This is will then provide the basis for continuing the financial planning process. The results of the analysis will show the following: + Which protection products should be retained? + where the amount of cover should be increased or decreased + products that should be disposed of as they no longer meet the client's objectives. + protection gaps that need to be filled. The next steps are to identify suitable life assurance and client's requirements, and to evaluate their features. 2.4 Life Assurance Two types of life cover ‘@ Life assurance (covers the policyholder for their entire life) and Term assurance. that can meet the Note that in this industry, the term ‘assurance’ is often used interchangeably with ‘assurance’, although they are not the same thing: assurance usually covers the policyholder for their entire life, while insurance is designed to cover the policyholder for a specific term. 2.4.1 Basic Principles of Life Assurance-Key terms. Proposer: ‘The person who proposes to insure themselves or another person on whose life they have insurable interest. Life Assured: «The person on whose life the contract is. Although the person who owns the policy and the life assured are frequently the same person + A policy on the life of one person, but affected and owned by someone else, a ‘life of another’ policy. A policy effected by the life assured is called an ‘own life policy’ Single Life A single life policy pays out on your death or if some other insurable event ocours, such as if you are diagnosed with terminal illness and have critical illness cover. Joint Life-Cover is for two people. Benefits would be paid out following the death of either the firsi, or, if required for a specific reason, the second life assured. Insurable Interest When you have an interest in that person remaining alive or expect financial loss from that person’s death A whole-of-life policy-Permanent cover- Life assurance-claim whenever death occurs. Life insurance - Pay out only if death ocours within a particular period. We can say Whole-of a life policy assurance- payment, any time death Term life insurance- payment, if death occurs during the term, Page 13 of 29Remember, life insurance is not general insurance. 2.4.2 Whole-of-Life Assurance Reasons for this Unit-linked policy > To provide a lump sum in the event of death, which might be used to pay off the principal in a mortgage as a nart of a protection planning exercise or > To provide funds to assist with the payment of inheritance tax (IHT) They can serve two purposes, therefore: both |protection and investment ‘There is a wide range of variations on the basic life policy that is driven by: Mortality risk, investment, expenses and premium options These all impact on the structure of the policy itself Mortality risk deals with: > the expected life of the person insured, > whether any additional charges might be imposed, and > the level of risk borne by the life company, which can affect the cost of the cover provided The principle of utmost good faith Applies to insurance contracts. Places an obligation to disclose any material facts. Failure to disclose a material fact gives the insurance company the right to avoid paying out in the event o a olaim. Letter of acceptance Letter issued by the insurance company onea the proposal has been accepted and the first premium paid. Notification of cancellation The policyholder will have a right to cancel the policy within say, 1 for any premiums. After this period, they can still cancel but will not receive a refund for premiums paid. The principle of utmost good faith applies to insurance contracts. There are 3 types of whole-of-lfe policy described below in the table. 2.4.3 Term Assurance % Select the Cover amount and period when taking cover. % Lump sum, in/theleventiof death occurring within a specified period. % —_Insome policies, A lump sum is payable at that point ‘Other policies may pay out on diagnosis of a critical illness, which the individual can keep even if they recover. % There is no investmentie ° Pay premium during the specific term. USES of TERM INSURANCE: + Ensuring there are funds available to repay a mortgage in case someone dies * Providing a lump sum that can be used to generate income for a surviving parlier + Provide funds to pay the inheritance tax when a person dies. But this type of policy is not guaranteeing to repay a mortgage or loan Conversely, as term assurance has no investment element, then term assurance is not suitable for Page 14 of 29