Annuity – An annuity is a contract between an insurance company and a pension scheme investor, where the investor uses some or all of their pension savings to purchase a regular and guaranteed income for the rest of their life, or for a predetermined number of years. The factors that determine the amount of income you can expect to receive include your age, state of health, postcode, prevailing annuity rates, type of annuity bought and the size of the pension pot. An annuity provides a regular and secure income for life, and can be tailored to meet specific individual needs and circumstances.
National Employment Savings Trust (NEST) – A defined contribution workplace pension scheme, set up by the UK government to facilitate auto enrolment. As a ‘qualifying’ scheme, NEST can be used by any UK employer to make pension contributions. Workers earning more each year than the government determined lower level, will be enrolled automatically in NEST if the employer doesn’t have their own pension scheme. Lower earners can join, but must choose to opt in.
Occupational Pension – The employer will make all the arrangements for the employee. Every payday, a percentage of the employee’s pay is deducted from their salary and invested into the scheme. The employer also contributes to the scheme on behalf of the employee, as does the government in the form of tax relief. There are two types of scheme – a ‘defined contribution scheme’ where the employee’s retirement income is based on the contributions made, investment returns and annuity rates, and a ‘defined benefit scheme’ where the employee’s pension income is based on the salary and length of service.
Pension Drawdown – This facility currently allows anyone over age 55 with a defined contribution pension to take income directly from their pension fund without needing to buy an annuity. As the bulk of your pension remains invested the fund is still able to benefit from any growth in the value of its investments. Although you can withdraw up to 25% of your pension fund tax-free, anything else you withdraw from your pension pot will be taxed at your highest marginal rate of income tax.
Personal Pension (PP) – Many investors will have these in some form. These schemes may have limited or wide fund ranges and high or low charges – it really depends on the individual plan. Likewise benefits and options may be limited on death or retirement. These schemes should be assessed to ensure they remain suitable.
Retirement Annuity Contract (RAC) - An old style of personal pension which is often invested in a with profits fund. These schemes may have integral benefits such as a guaranteed annuity rate or guaranteed minimum pension fund at retirement, however death benefits may not match the full fund value and the options on death or retirement may be limited. These schemes should be assessed to ensure they remain suitable.
Self Invested Personal Pension (SIPP) – SIPPs are designed for investors who want maximum control over their pension and a wide choice of investment funds. The charges may, but not always be, higher than for a personal pension or a stakeholder pension – an assessment of these will ensure you are not paying too much. A SIPP holder has a much wider choice of assets to invest in, each of which can be selected to meet the individual’s personal circumstances and requirements. You choose the pension provider and make the arrangements for paying the contributions – it is important to start contributing as early as possible and to keep making contributions for as long as possible in order to build up the pension pot.
Stakeholder Pension Schemes – A Stakeholder Pension is a type of Personal Pension designed to provide an optional lump sum and income in retirement. Stakeholder Pensions are available to any UK resident under the age of 75, even if you have a workplace pension, or if you’re self-employed and don’t have a workplace pension. Generally they provide the full value in the event of death, but due to their basic set up do not allow the full options available on death or retirement. These schemes should be assessed to ensure they remain suitable.
State Pension – The basic State Pension is paid by the Government when you reach State Pension age. This age is currently due to rise to 67 between 2026 and 2028, with further proposed changes expected to increase it to 68 in the future. The amount you receive is based on the number of National Insurance contributions made during your working life. The State Pension is expected to increase annually.
Collective Investments – Collective investments are also known as unit trusts, investment trusts and OEICs. With a collective investment, your money is pooled, along with that of other investors, to create a large capital sum. This is then used by fund managers to build up a large portfolio of investments. A collective investment allows you to indirectly hold a wide range of stocks and shares in a way which would not be practical for an individual investor, whilst minimising the effects on your capital to fluctuations of individual share values. You have access to expert full time investment management, reducing the risk and complexities of direct investment into equities.
Endowment Policies – Regular premiums are paid, and when the term of endowment expires a lump sum is paid out, which may be used to repay a mortgage. However to achieve this, the investment performance needs to be sufficient to build up the required capital and this performance cannot be guaranteed. Most endowments have protection that if the policyholder should die then a lump sum becomes payable. As these are fixed term savings vehicles they are now less popular due to the ability to invest flexibly via collectives.
Equities – Investing in equities means buying stocks and shares in companies listed on the stock exchange. This can bring greater rewards than investing in bank accounts and bonds as you have the possibility of gaining not only a dividend, but also a capital appreciation. If the price of the shares goes up after you buy them then you have made a capital gain. The value of the shares can go down as well as up, which means you risk losing your investment if the price of the shares falls.
Fixed Interest Investments – Fixed interest investments can provide a comparatively save haven during tough times. Investments can be made directly into corporate bonds or UK Government Stock (Gilts) however the majority of investors will invest via a fund to gain additional diversification. While considered to be lower risk than equities there is still a degree of risk since capital values can fall in value.
Individual Savings Account (ISA) – An ISA is a tax-efficient place for cash savings and investments in equities, bonds and collectives. An ISA is available to all UK residents over the age of 16 for cash ISAs and over the age of 18 for stocks and shares ISAs. There is usually a low level of minimum subscription and no minimum period of investment however you can only contribute up to your annual allowance and stocks & shares investments are recommended to be over at least 5 years. An ISA allows you to gather savings in a tax efficient way as all gains are tax free, making them particularly attractive to higher rate taxpayers. The Government introduced a new, simpler system known as the New ISA or NISA from 1 July 2014.
Investment Bonds – Designed to give capital growth and/or income over medium to long term with access to the fund by taking regular or one off withdrawals. In the past, if you cash in your investment within the first 5 years you were likely to be charged an early-surrender penalty, however this is less likely these days. Bonds can be either onshore or offshore to take advantage of tax concessions – this decision will depend on your personal tax situations. There are no maximum limits to invest, however the start-up figure can be higher than other investments. In some bonds the capital can be protected from stock market fall; however this will come at a cost. These bonds have management charges which vary greatly and should be assessed to see if they remain suitable for your objectives.
Investment Trust – Investment trusts provide a way of pooling your money with other investors. It is publicly listed companies whose shares are traded on the London Stock Exchange. The prices of shares in Investment Trusts will differ depending on investment demand and changes in the value of their underlying assets. The investment trust company may borrow to finance further investment, which is likely to lead to increased volatility in the Net Asset Value. This means that a small movement in the value of the company assets will result in a larger movement in the same direction of that Net Asset Value. A particular Investment Trust may invest in companies that are not listed on a stock exchange; these can be more volatile in their price fluctuations and more difficult to sell than listed shares.
Junior ISA – A long-term, tax-free savings account for children who are under 18, UK resident, are not entitled to a Child Trust Fund account. Investments can be made into a Junior Cash ISA or a Junior Stocks and Shares ISA. A child can have one or both types but will be limited to the annual allowance. If the child is under 16 the account must be opened by someone with parental responsibility, who then becomes the ‘registered contact’ and the only one who can change the account or provider. Anyone can put money into the account but only the child can take it out and only when they are 18.
National Savings Products – Investments offered by National Savings are the least risky investments. Although investment returns are not massive and some involve tying your money up for a long period of time, they are a stable option and in some cases can be paid tax free or paid without deduction of tax, which is beneficial if you are a non-taxpayer. These savings and Investment products are backed by H.M Treasury, which makes them the most secure cash products available in the UK.
Open Ended Investment Companies (OEICS) – OEICs are collective investment vehicles legally constituted as a limited company. OEICs are not trusts and do not therefore have a trustee, they instead have a depository which holds the securities. Most OEICs operate as umbrella funds which means that the OEIC is authorised and then can set up sub-funds without having individual authorisation for sub-funds. Each sub-fund has different investment aims, e.g. a sub-fund may specialise in the shares of a small company, or in a particular country. Most OEICs only have one unit price, where the initial charge is then added on as an extra.
Unit Trusts – Unit Trusts are a collective investment vehicles controlled by trustees with the aim of gaining capital appreciation and/or income. Unit trusts are made up of ‘units’, each of which will have a buying and a selling price. Units are created every time money is put into the fund, and liquidated when they withdraw money, meaning the fund can react to demand and continually grow through peak times. However, during periods of poorer performance, the fund may need to sell assets to enable investors to withdraw the money, so the fund size will be reduced.
With-Profits – In a With-Profits fund returns do not directly reflect the returns of the underlying assets of the fund. Instead the fund actuary allocates profits to investors with the aim of smoothing the good and bad years. These funds were popular in the past and were frequently recommended by the life offices tied sales forces but have now fallen out of favour due to their often opaque charging and market value reduction factors during market downturns. Some providers are now declaring minimal bonuses. The with-profits endowment policy is also a means of regular long-term saving and has the potential for a good return, but there is no guarantee of the final value of the policy. When choosing insurance products for investments, it is important to be aware of charges, fees or commission that may be added, and when profits and bonuses are added to the policies. These plans should be assessed to see if they remain suitable for your objectives.
We class a speculative investment as an investment without an income stream and therefore fully reliant on selling for a higher price that you bought at. In essence this aligns with “greater fool” theory in that you are dependent on someone buying the investment for more than you did.
Commodities – Raw materials that fall into two broad categories: Hard commodities – products of mining and other extractive processes, including gold, silver, crude oil and natural gas, and soft commodities – typically grown rather than mined, including coffee, cocoa, sugar, wheat, and livestock. As an asset class, commodities can appeal to investors as part of an overall strategy of spreading risk, because their prices tend not to move in tandem with equity or bond prices. Commodity investment is risky because the markets are dominated by interested traders, such as large metal businesses, who are more likely than private individuals to learn the latest information likely to move prices.
Works of Art and Collectables – Items that may appeal to an investor in this area include paintings, antique furniture, rare books, stamps, coins, limited edition plates, diamonds, gold and cars. Restoration, storage and insurance can all add to the cost and risk of this type of investments. It can be difficult to diversify and specialist knowledge on the collectable is needed to buy successfully.
Convertible Term - Contains an option at the end of the term to either convert it into an endowment or whole of life policy without the need for a medical assessment, this option must be exercised before the plan ends.
Decreasing Term - The level of benefit decreases as the term of the policy runs, however the premiums do not reduce. Premiums are fixed throughout the policy term, and the premium level is lower than that of Level Term Assurance as a result of the decreasing benefit. This type of life assurance is commonly used to protect Capital and Repayment mortgage debt. If you die within the term of the policy, it will pay out a lump sum to help clear whatever is outstanding on your debt but there is no guarantee that the lump sum paid will clear the debt in full.
Endowment Policies - Long-term investment plans, typically lasting between 10-25 years, with life insurance attached. Often linked with mortgages and will pay out any returns at the end of the policy term or a lump sum when the policyholder dies. They can be used as a tax efficient savings plan to build a sum of money for any purpose, or they can be used to repay an interest-only mortgage, which is often a requirement of the mortgage provider. Endowments can be unit linked which means that you can buy units in a fund or invest in a with-profits fund. An endowment policy is designed to return a specified sum of money at the end of the term; however, if the life assured dies during the term, a specified lump sum benefit would be paid.
Family Income Benefit - In the event of death the amount of protected income chosen at outset will be paid for the remainder of the term – often until your youngest child is 18 or 21. Family Income Benefit is one of the least expensive forms of life insurance and differs from most other types in that it is designed to pay the benefit as an income rather than a lump sum. This type of policy can also include Critical Illness Insurance. Family Income Benefit is a low cost, tax efficient solution to Family Protection.
Income Protection - Should you suffer ill health these plans provide a replacement income until you are either fit to return to work or retirement age, whichever comes first. At outset you select among other options the amount of income required, a waiting period during which no income is paid in the event of a claim (normally 4-52 weeks) and the term which normally coincides with your retirement date. In the event of ill health the plan allows you to maintain your lifestyle without being forced to sell assets. With the low level of state benefits, these plans should be seriously considered as they can be tailored to your needs and budget.
Increasing Term Assurance - This type of cover protects you for a given term for an increased level of benefit. The amount of life cover chosen at outset rises annually, usually by RPI. However, the premium price will also increase, but by selecting this option you are protecting the purchasing power of your selected benefit. This type of policy is worth considering if you are insuring over a long term.
Investment Linked Assurance - With term assurance policies, lower premiums make them an affordable way of helping to protect your family in the event of death within the policy term, but there is no guarantee of a pay out. However, some life insurance policies can be effectively used as an investment. Investment linked insurance allows the flexibility to choose your own level of protection and investment, as well as giving the ability to vary the amount of premium payments, based on your own personal financial situation.
Level Term Assurance - This type of cover provides a lump sum on either death or diagnosis of terminal illness, with the level of cover remaining the same throughout the full policy term. The policy will pay out if you die during the term of the policy, and may also pay out if, before the last say 12-18 months of the term, you are diagnosed with a terminal illness. If the policy pays out because of terminal illness claim, the policy and cover will end and therefore there will be no further payment on death. This type of protection may be suitable for family protection and interest only mortgage debt, where the level of debt does not decrease as the years progress.
Renewable Term - This type of policy gives you the option to extend the policy at the end of the term. The premium paid is based on your health at the time you took out the original policy, even if your health has deteriorated substantially since then. This type of protection is useful for dealing with unexpected events, such as a child staying in full time education for longer than originally anticipated. This could also be a good option if you cannot currently afford the level of cover you need for the period you require – cover can be taken out for a shorter period, and at the end of the period you could take up your option for a further period. This would make premiums higher because you would be older, but there would be no additional charge on health changes.
Trusts - When you are putting protection in place it is important to also consider if the new plan should be written under trust. A trust is often said to 'put money in the right hands at the right time', and you should remember that without a trust the payment may fall into your estate and not be accessible until the estate is settled (possibly 12 months!). A trust can also provide for minor children and ensure that the sum assured does not fall into your estate for inheritance tax.
Whole of Life - These plans pay out the sum assured on your death whenever it may occur and are therefore more expensive than plans which only provide cover for a limited term, therefore they may not pay out at all. Modern plans may simply provide a fixed sum assured in exchange for your premium but others may provide cover based on expected investment returns and may therefore need premiums increased if the returns are less than expected.
Inheritance Tax Products
Inheritance tax can reduce the amount left to your loved ones on your death by thousands of pounds and needs to be paid before they receive their share of your estate. It is often said that inheritance tax is an optional tax as you don’t need to pay it. A financial adviser can help you avoid paying inheritance tax, but this requires effective and thorough planning.
Investing into a pension fund can be very effective for inheritance tax planning. In short you can access the fund as and when you need it if you are over age 55, and it remains out with the scope of inheritance tax on your death. Pensions can be used to pass wealth down the generations by utilising the nomination of beneficiaries form. It is important to establish the death benefit options available for all your schemes and obtain advice to make sure you have accounted for all the specifics of your scheme and completed all relevant forms correctly.
2. Removing capital from your estate
Investments made in trust are often invested into some sort of investment bond to eliminate the need for the trust to complete an annual tax return. Investment bonds can be set up as either onshore or offshore, life assurance versions ending on the death of the last life assured or capital redemption bond versions which run for say 99 years. Investment Bonds are written with multiple segments, which allow them to be split among the beneficiaries of the trust. This means that the beneficiaries can receive their share of the investment as a separate investment which they can hold and draw capital from in line with their own tax position.
Trusts are used to give the settlors (the people placing the money in trust) some control and perhaps some access to the capital during their lifetimes whilst removing or reducing its value in their estate for inheritance tax calculations.
The most commonly used trusts are a ‘bare trust’ where the beneficiaries are named at outset or a ‘discretionary trust’ where the trustees can choose who should benefit at the time of distributing the trust assets.
Where a discretionary trust is used a ‘letter of wishes’ should accompany it to guide the surviving trustees as to whom should receive the trust assets.
There are various types of trust giving the settlors different level of access to the trust fund:
Gift in trust – Investing a lump sum with no access - The settlors have no access to the fund. The gift is offset against the settlors available nil-rate band until it falls out of the estate after seven years. When the last settlor dies the remaining trustees pass the assets to the beneficiaries.
Loan trust – Lending the trust a lump sum with full access to it - repaid either as a regular payment (giving you an income stream), or on death. When the settlor dies, only the outstanding amount needs to be paid back into the estate, with any growth amount being free from inheritance tax.
Discounted gift trust – Investing a lump sum while retaining the right to a fixed income stream until the investment is exhausted, or your death - whichever happens first. This allows you to retain income from a proportion of your capital, while the other proportion is gifted. The proportion that you are taking is free from inheritance tax, and the rest becomes free of inheritance tax after seven years.
Independent Financial Advisers are well placed to assist and advise on:
The set up of the trust
The management of the underlying investments until death
The transfer of the assets to the chosen beneficiaries
How and when the beneficiaries draw the money with maximum tax efficiency