BIA0044 Personal Financial Planning
Personal Financial Planning
Question 1 – Compulsory Question
This is being written in December 2017 when there is still considerable uncertainty about the impact of Brexit. This answer will need to be updated in June when the students sit the exam. This answer is based on several papers produced by international law firms synthesised together. There is a great deal of relevant material accessible online. Marks will be awarded for any relevant comments, so have not been allocated to individual points, however to gain a high mark the student must consider issues under the headings below (or similar described differently). Whilst the question gives no mark allocation, it is expected that the weighting of the 2 areas will be approximately equal.
Significance of the financial services sector to the UK economy
In 2016, financial and insurance services contributed £124.2 billion in gross value added (GVA) to the UK economy, 7.2% of the UK’s total GVA. London accounted for 51% of the total financial and insurance sector GVA in the UK in 2015.4 Apr 2017(Parliamentary briefing report)
A report by PwC in December 2016 found that the FS sector contributed £71.4 billion in tax payments in the year to March 2016 – the highest since the survey began in 2007. This amounts to 11.5% of the UK Government’s total tax receipts, 0.5 percentage points more than in 2015.
(If the students find this report there is a lot more useful information about contribution to the economy)
In October 2017 the LSE was ranked 6th in the world in terms of market capitalisation and 5th in terms of numbers of trade. Until recently London was ranked ahead of Shanghai, Japan (now 3rd and 4th) and the Euronext (now ranked ahead of London in market cap.) Whilst this reflects the increased significance of the Far Eastern markets as a result of the development of the Chinese economy, there is also evidence that the LSE is losing its status as the most significant financial centre in Europe.
The Swift Institute published a report in late 2017 which suggested that the decision to leave the EU would result in an initial loss of 10,500 jobs in the UK as banks and other large organisations switched their head office operations to Europe. It is anticipated that Frankfurt and Dublin are expected to benefit most, although Paris has been offering incentives for relocation.
In October 2017 the BBC reported that the Bank of England believed that Brexit could lead to the loss of 75,000 jobs in financial services.
However it must be clear that until the terms of any negotiations about the ongoing trading arrangements between the EU and UK are finalised this remains largely speculative.
In marking this section I will be looking for an answer that refers to the above, or similar points, whilst emphasising the uncertainty at this stage.
Possible implications for the financial services industry.
Passporting (Any answer which does not refer to this area will be awarded a maximum of 30 marks)
This would seem to be the area where there is most serious risk to the FS industry. At the moment a range of authorised businesses, such as banks, insurance companies and asset managers, are able to operate across the EU as long as they have a base in the UK. This is called “passporting”.
Passporting means that a British bank can provide services across the EU from its UK home. Importantly, it also means that a Swiss or an American bank can do the same from a subsidiary established in the UK. Goldman Sachs and JPMorgan both gave evidence to the Parliamentary Commission on Banking Standards before the referendum, flagging up the importance of the UK’s EU membership in providing a base from which non-EU businesses can passport across the EU.
There could possibly be a period of significant confusion as overseas financial services firms which use a London subsidiary would need to decide how to restructure themselves and decide how much of their operation to transfer elsewhere in the EU. BBA announcement in November 2016 that many banks were already looking to move their headquarters overseas
Passporting into the EU from the UK will not be possible following a Brexit unless a special arrangement can be negotiated. Financial services businesses wanting to continue to provide services across the EU may well have to establish subsidiaries in mainland Europe (to the extent that they do not already have them).
There is an argument that the significance of London as global centre for FS will mean that in the short to medium term at least, firms will find some way of operating that will continue to enjoy access to the EU markets. However there will be pressure, particularly from Paris and Frankfurt.
Continuing the UK’s relationship with the EU
Various models have been proposed for how the UK and the remaining Member States of the EU might manage their relationship following a Brexit. Could the UK be the new Norway (by becoming a member of the EEA and EFTA)? Or Switzerland (accessing the EU by way of bilateral agreements)? Or Turkey (which has a customs union with the EU)?
No doubt plenty will be said about the advantages and disadvantages of these and other options in coming weeks and months as the alternatives are assessed in more detail. Focussing solely on the financial services perspective, however, it is only the Norway model which is appealing for the sector, but it is unlikely to be politically appealing.
Switzerland’s 120+ bilateral agreements with the EU require constant renegotiation. None of these agreements allows Switzerland full access to the EU’s internal market for financial services. As a result, Switzerland tends to do banking business by passporting – often from the UK.
Turkey’s customs union is limited to trade in goods. It does not extend to trade in services (financial or otherwise) and is intended as a pre-cursor to EU membership, not an alternative to it.
It is likely therefore that the UK will now be looking to set up a bespoke arrangement going forward.
Financial services is a highly regulated industry. Although much of this regulation emanates from Brussels, it is unlikely that regulation is going to lessen following a Brexit. While there are some examples of financial regulatory requirements which have been resisted by the UK (e.g. the bonus tax and banking levy) much of the EU-derived requirements reflect the perceived need in the UK. It is therefore unlikely that the UK will repeal or amend significant parts of the financial regulatory law. Where the requirements have had direct effect in the UK, through Regulations, then the UK would need to decide whether to adopt these requirements or allow them to lapse on a Brexit.
If the UK wants to continue to do business with the remaining EU Member States following a Brexit, it will almost certainly need to comply with EU regulations in order to meet an equivalence assessment – but unfortunately without the ability that it previously had to negotiate, influence or challenge those regulations. Banks may also be faced with having to comply with UK as well as EU legislation, which may well diverge over time or at minimum be applied inconsistently.
The UK’s legal system has become tightly enmeshed with that of the EU over a period of forty years. The unravelling process is likely to be a long and expensive one. Which European legislation and regulation does the UK like or need and therefore want to keep? What should be replaced? Where are the gaps? New UK legislation might also be incompatible with EU legislation. Over time, it is almost inevitable that the two banking environments would drift apart.
There may also be an impact on contracts as time goes by. For example, contractual parties will be asking:
Will a contractual requirement to comply with a particular piece of EU legislation still be binding following a Brexit?
What principles of EU law will still influence English courts?
How will a judgment from an EU Member State now be enforced in the UK?
How will a choice of English law be interpreted if EU law was part of English law at the time the contract was made but not by the time of performance?
As UK will still be negotiating its exit when MiFID II / MiFIR apply on 3 January 2018 one assumes this legislation will be enacted in full. Even after the UK withdraws from the EU, the third country provisions in MiFIR will be important and the equivalence of the UK regime will be a crucial factor. It is also important to note that many EU initiatives stem from international commitments coming from the G20 (for example OTC derivatives reform) and the Basel Committee on Banking Supervision (capital requirements) which the UK remains a party to. Therefore it is highly unlikely that financial services regulation with radically change under Brexit. It is worth noting the UK Financial Conduct Authority’s press statement on the day the referendum result was announced advising that “firms must continue to abide by their obligations under UK law, including those derived from EU law and continue with implementation plans for legislation that is still to come into effect.
Regulation of Banks
The regulation of banks in the UK rests on three pillars – the capital requirements contained in Capital Requirements Directive IV1 and the Capital Requirements Regulation2 (together CRD IV), the stabilisation, recovery and resolution provisions contained in the Banking Act 2009 and the Bank Resolution and Recovery Directive3 (BRRD) and the structural reforms in the Financial Services (Banking Reform) Act 2013 (BRA). The BRRD and CRD IV are the consequence of EU legislation. Parliament will need to consider how much of the legislation to retain. The CRD IV largely implements the requirements of Basel III, which the UK would still be committed to. However, there are provisions within the CRD IV (such as the limits on the payment of bankers’ bonuses) which are not Basel III related and could be abolished or amended. Assuming that Parliament decides it wishes to maintain the current regulatory structure and achieve mutual recognition between the British and European regulatory authorities, it will be necessary to consider how much the BRRD, the BRA and the PRA Rulebook need to be amended to maintain equivalence. Parliament will also have an opportunity to reconsider the burden of the regulatory compliance matrices imposed on banks by the CRD IV and BRRD. The larger retail banks are subject to the ring fencing of the BRA. Whilst this is an entirely UK regime, Brexit will impact the legislation application of the EEA branches and subsidiaries. With regard to the application of the Regulation on Banking Structural Reform (the BSR Regulation) the latest Council text already contemplated recognition for national legislation requiring core retail activities to be ring-fenced. However, the importance of recognition of the UK’s own ring-fencing legislation may become moot if the BSR Regulation has not been implemented at the time of Brexit.
The UK’s decision to leave the EU raises significant uncertainty for the financial services sector. For this sector, continued access to the single market is a priority. On the one hand, UK institutions, which are heavily reliant on the EU as the destination for UK exports of financial services, will be seeking to support and influence the UK Government in the important exit negotiations. On the other hand, these institutions will be seeking to implement their contingency plans to achieve continuity of access to the single market.
Total 40 marks
5,500- 5,000 (div all)
|Income tax – 32,000 x 20%||6,400|
|Extend BR band by
2,400 x100/80= 3,000
13,755 x 40%
|500 x 32.5%||162|
|Bank deposit interest||1,020|
All covered by dividend allowance
|Non savings – x 20%||4,158|
|Savings 1,000 x 0% (BR tax payer)
20 x 20%
|Less deducted at source||(4,100)|
ISA interest is tax free in both cases
Basic rate relief is given for the personal pension contribution at source and higher rate relief is given by extending the basic rate band by the gross contribution.
The basic rate relief for the gift aid donation is also given at source. As Sadia is a basic rate taxpayer no additional adjustment is needed.
Total 30 marks
IHT q – Xiaoyu
|Gift||Gift after exemptions||CYAE||PYAE||PET||CLT|
|Sept 2015||Gift to cousin 7,000
marriage exemption 1,000
|Sept 2015||Gift to charity – exempt|
|Feb 2016||Gift to sister||8,000||–||–||8,000|
|Mar 2016||Gift to Yan250
Gift to Fan 100
Exempt as small gifts
|Gift to uncle||2,500||(2,500)||–|
|Gift to trust||120,000||(500)||115,000|
|Total chargeable lifetime gifts PETs||8,000|
|Chargeable lifetime transfers||115,000|
|Nil rate band at death||325,000|
|Less lifetime transfers||(123,000)|
|Estate at death||750,000|
|Tax due @ 40%||£219,200|
- The balance of Li’s wife’s NRB would be available to him – i.e. 325,000 – 160,000 = £165,000
This would reduce the tax liability on Li’s death by £165,000 x 40% = £66,000
His liability would be £153,200
- An occupational scheme is a registered pension scheme set up by an employer with insurance or Pension Company for benefit of employers.
- It is owned and run by the employer and if the employee leaves this employment he will either freeze the fund or obtain a transfer value.
- Both employee and employer may contribute
- It can be a final salary or money purchase scheme.
- Limits on contributions attracting tax relief greater of 100% of UK earnings chargeable to tax and £3,600, up to upper limit currently £40,000
- Employer will get tax relief against CT on contribution.
- Payment is not taxable for employee
- Normal pension age is 55
- Benefits are based on value of fund at retirement or final salary
- An individual sets up the pension directly with a pension or insurance company
- The scheme is owned by the employee and is portable between employments
- Either party may contribute
- The value of the pension will be based on the value of the fund at retirement.
Total a) 10 marks
- b) Every employer with at least one member of staff now must put those who meet certain criteria into a workplace pension scheme and contribute towards it.
This is called automatic enrolment. It’s called this because it’s automatic for staff
A workplace pension is a saving scheme for retirement organised through an employer. The employer may have their own scheme, offer one from a specialist pension provider, or use a government-backed scheme.
Under the new system, those who work in the UK, are aged over 22 and under the state pension age, are not already in a scheme, and earn more than £8,105 a year will automatically be enrolled.
Must opt out if they do not wish to be included
Staff will be given a letter about the scheme when it starts at their workplace. This will explain who the pension provider is. Workers can ask this provider for an opt-out form.
If they fill it in within a month, then their involvement will be cancelled.
Those who opt out will also be enrolled again every three years by an employer, or after three months at a new job, at which point they will need to complete the opt-out process again.
The system will be introduced gradually over six years.
The first wave has begun, with the largest businesses – with more than 120,000 staff – starting first. As time goes on, smaller firms will start enrolling staff.
At first, an employee will only see a minimum of 0.8% of their earnings going to their workplace pension. Their employer will be obliged to add a contribution that is the equivalent of 1% of the worker’s earnings. Tax relief adds another 0.2%.
However, these amounts will increase to a minimum of a 4% contribution from the employee, 3% from the employer, and 1% in tax relief from October 2018.
c)There are very few defined benefit (otherwise known as final salary) pension schemes still open to new members, most of these are in the public sector
Key characteristics are that the benefits under these schemes are a fraction of salary for each year employed by the employer and a tax free lump sum
The fraction of salary varies but is usually between 1/60 and 1/80 of pensionable salary – this may be a career average of best 3 of last 10 years salary depending on the terms of the policy and a 25% lump sum, although it is usually possible to take a larger lump sum and a reduced pension.
The advantage for the employee is certainty around their pension entitlement. However these schemes are not beneficial for alll employees – particularly younger staff who expect to have a number of different employers during their working life and may benefit from a portable personal pension. Transfer values out of occupational pensions may not represent a realistic value of the funds invested.
However for the employer these schemes are expensive as they have to be funded by transfers from profits. Full actuarial valuations need to be made regularly, and adjustments made which affect cash, profit and potentially share prices. Funding must be disclosed in financial statements and any shortfall reported.
Marks in this question will be allocated for all relevant points made up to the limit specified
Simon and Joanne
Analysis of current position
Income is relatively low and no savings
Low pension provision
Family house has low mortgage which will be paid off shortly so effectively asset of £250,000
Children are likely to stay living with them, for at least 5 years so assume house cannot be sold to provide a lump sum
Inheritance from the mother will provide a lump sum.
When the house is sold they will receive cash after inheritance tax of
500,000 – 325,000 = 175,000 x 40% = 70,000
Cash will be £500,000 – 70,000 = 430,000 (subject to funeral and estate costs)
Attitude to risk known, liquidity and ethics to be determined
As they have little savings they need to provide an income for their retirement.
May also wish to preserve capital for children to inherit.
One option would be to use unused pension relief to top up pensions. However this could not be drawn until they reach retirement age which makes it relatively inflexible
They could consider paying off their mortgage
Contrast interest rate paid with investment rate. If mortgage is charging interest at a higher rate than they could get on investments then it may be sensible to repay it.
Divide their options into short term, medium term and long term goals
Some cash should be kept in liquid form to meet unexpected bills – say 10%.
Maximise the use of NISA’s, may save £15,000 each tax free
Consider longer term investments in income bonds – cash is on term deposit but return is likely to 5%+
If less risk averse consider gilts or collective investments schemes
Should spread risk and avoid single equity investment
Marks will be awarded for any sensible suggestions fully justified
- The financial adviser will be paid on a fee basis.
The basis of charging will be set out in a client agreement that must be signed before any work is commenced
It is no longer possible for the advisor to receive commission instead of a fee.
Total 30 marks