Practice Test 1 - Peter & Katie

Question 1

Describe to Peter and Katie the taxation treatment of their investment bond both now and in the future.

Answer 1

Investment Bond
• Underlying fund subject to Corporation Tax.
• Income Tax may be payable on chargeable event.
• 5% per annum tax deferred of the original investment.
• Basic rate (Income) Tax deemed paid within the fund.
• Higher-rate taxpayers pay additional 20%.
• If basic-rate taxpayer there is no further liability.
• Unless the gain takes her into a higher rate of tax.
• Top slicing relief may apply.
• May impact on age allowance.

Question 2

Explain how their investments could be made more tax-efficient.

Answer 2

• Transfer investments into Katie’s name as she is a basic rate taxpayer.
• Deposit funds to cash ISA and OEIC/investments to stocks and shares ISA.
• Use of CGT allowance.
• Take withdrawals from investment bond.

Question 3

List the arrangements that may be available to Katie as methods of taking her pension income.

Answer 3

• A scheme pension/secured pension.
• A lifetime annuity.
• Phased retirement.
• Short term annuity.
• Flexi-access drawdown.
• Uncrystallised Fund Pension Lump Sum.

Question 4

Describe the tax treatment of the rental income within Peter’s self-invested personal pension (SIPP), both when it is received by the SIPP and when it is paid out to him.

Answer 4

• Rental income free of Income Tax in self-invested personal pension.
• Subject to Income Tax/earned income at his highest marginal rate.

Question 5

State the factors that Katie should consider regarding her proposed Alternative Investment Market (AIM) investment.

Answer 5

• Prospects for the company/company solvency.
• What is the amount of the investment?
• What is her attitude to risk/capacity for loss?
• Transaction costs/discount/bonus shares.
• How will it be funded/encashment of existing investment?
• Lack of diversification/liquidity.

Question 6

Describe to Katie the nature of the AIM including any tax advantages that may apply to her.

Answer 6

• They are investments in small/new companies.
• AIM investments can offer high returns/losses/high risk/higher volatility.
• They are usually illiquid.
• Business Property Relief/Inheritance Tax relief if held for more than two years.
• Any capital losses can be offset against income.

Question 7

Recommend in detail, using the appropriate amounts, how the structure of Peter and Katie’s proposed gift of £700,000 can provide them with maximum control without incurring any immediate charge to Inheritance Tax.

Answer 7

• £650,000 into a discretionary trust in respect of each of their Nil Rate Bands.
• Plus a further £12,000.
• Balance (£38,000) into a bare/absolute trust.
• Trustees to be Peter, Katie/must exclude son-in-law.
• Beneficiaries of bare trust to be the grandchildren.

Question 8

Explain how the structure described in (d)(i) above meets Peter and Katie’s objectives.

Answer 8

• The money placed into discretionary trust is protected from the son-in-law.
• The fund will be used to benefit their grandchildren/can add further grandchildren to discretionary trust.
• Provided the gift into discretionary trust is within the available Nil Rate Band/gift allowances, there is no immediate charge to IHT.

Question 9

State four drawbacks of the arrangement.

Answer 9

• They can never benefit from the money themselves.
• There may be periodic/exit charges.
• The bare trust may be wound up by the beneficiaries.
• A bare/absolute trust is irrevocable/inflexible.
• Complexity/costs.

Question 10

Describe to Peter and Katie the taxation treatment of their open-ended investment company (OEIC) both now and in the future.

Answer 10

OEIC
Income Tax
• Dividends paid gross;
• on which Peter must pay an additional 32.5% on his share above his £5,000 Dividend Allowance;
• and Katie will pay an additional 7.5% on her share above her £5,000 Dividend Allowance
• May be subject to Inheritance Tax.

Capital Gains Tax
• Gains subject to Capital Gains Tax.
• Peter’s chargeable gains will be taxed at 20% if he is still a higher rate taxpayer at the time of encashment.
• Katie’s chargeable gains will be taxed at 10%.
• May be subject to Inheritance Tax.

Question 11

Describe in detail the recommendations you would make to cover their liability with appropriate life assurance. (IHT)

Answer 11

• Whole of life.
• Joint life second death.
• Sum assured to cover the Inheritance Tax liability.
• Indexation/regularly review sum assured.
• Gift inter-vivos for PETs of £19,000 each.
• 2 x single life initial sum assured of £7,600 (40% of £19,000).
• Level term assurance to protect NRB
• 2 single life.
• Sum assured of £130,000 (40% of NRB £325,000)
• Each for 7 years.
• All policies written in trust.

Question 12

State the reasons you would give to Peter and Katie to explain why you needed to review their investments annually.

Answer 12

• To review investments/performance/rebalance.
• To determine if they are still suitable/change in ATR.
• To see if there have been any changes in circumstances.
• Change in taxation/legislation/new products/economic changes.
• Use of annual tax allowance.