Retirement Planning, Protection Planning, Estate Planning, and Trusts
Retirement Planning
1.1 Introduction
It is generally recognized that people are living longer than ever due to medical advances and general improvements in health, with significant increases in life expectancy over recent decades. This situation impacts clients' attitudes toward risk in retirement planning.
Health and Attitude to Risk: A client in good health who expects to live into old age may approach retirement with caution, needing to spread their capital over several years due to expected longevity.
Income Requirements: To enjoy these extended years of life, clients need sufficient income to support their desired lifestyle during retirement. Therefore, planning well in advance is crucial for a satisfying retirement.
State Pension Limitations: Worldwide, state pension benefits provide only about 40% of net average earnings. Due to changing demographics and the rising cost of state pension provisions, this reliance on state pensions is becoming less viable.
Significance of Early Savings: Substantial amounts of capital need to be built up for a meaningful retirement income; hence, starting to save early is critical for achieving satisfactory results.
1.2 Intended Retirement Age
Learning Objective 8.1.1: Understand the impact of intended retirement age on retirement planning
Once an individual retires, they stop earning income while still needing to meet living expenses and commitments, creating significant financial planning needs.
Retirement Age Variation: Individuals may plan to retire at varying ages, from the normal retirement age (NRA, typically in their 60s) to those who wish to retire earlier (in their 50s) or later (in their 70s).
Funding Retirement: Most retirees may need to fund 20 to 45 years of living and leisure expenses, depending on health status and other unforeseen circumstances such as job loss or early retirement due to ill health.
Compound Interest and Future Value: Chapter 5 discussed how to calculate future values to quantify the impact of delaying retirement savings.
For instance, if a person starts saving at 25 into a fund growing at an average rate of 5%, saving $1,000 in the first year, increasing by 10% annually, they could accumulate nearly $900,000 by retirement at 65. Delaying savings by five years reduces this amount to around $525,000. The difference underscores the importance of timely saving.
Income Generation from Pension Fund: The larger pension fund (close to $900,000) would generate approximately $45,000 annually at a 5% yield, while the smaller fund (around $525,000) would yield only about $26,000.
Example
Future Value Formula: To estimate the future value of ongoing savings, the following formula can be applied:
where:Payment = annual contribution
r = annual interest rate (5% or 0.05)
n = number of years of investment
Calculation Example:
If a client invests $10,000 at the beginning of each year for 20 years at an annual compound interest rate of 5%, the accumulated value is:
1.3 Retirement Planning Products
Learning Objective 8.1.2: Know the types of retirement planning products, associated risks, and suitability criteria
Pension schemes enjoy favorable tax treatments from governments to encourage individuals to plan for retirement independently, thereby easing the state's financial burden for pensions.
Tax Benefits: These tax benefits typically include tax relief on contributions and exemptions for gains and dividend income.
Types of Pension Schemes: Determining the specifics of a client's existing pension scheme is essential for advising effectively, including:
Availability of retirement benefits
Age at which the client can retire and collect benefits
Form of benefits (e.g. tax-free lump sum, ongoing income or otherwise)
Any continuation of benefits to surviving spouses or family after death
1.3.1 Occupational Pension Schemes (OPS)
Setup: Initiated by employers, these schemes offer significant benefits to employees.
Employer Contributions: These schemes often reflect contributions from the employer, alongside tax incentives.
Employee Contributions: Some schemes require employee contributions which may vary in amount and eligibility conditions.
Defined Benefit (DB) vs. Defined Contribution (DC) Schemes:
DB Schemes: Provide a predetermined pension based on criteria like salary and years of service.
Career Types: Final salary schemes relate to the final salary at retirement, while career-averaged schemes consider average salary over the career.
Security Concerns: Clients often seek certainty in retirement income, leading to discussions about pension sustainability and the firm's financial health.
DC Schemes: Provide a pension based on contributions and investment performance, placing risk on the employee.
Investment Outcome: The outcome depends on how well the investments perform, making retirement planning harder.
1.3.2 Suitability Analysis
Factors to analyze when reviewing pension schemes include:
DB Schemes:
Expected retirement income and longevity of the scheme.
Pension increases and security.
Employer’s financial standing and future obligations.
DC Schemes:
Options for income generation, indications of market conditions, and potential size of the retirement fund based on investments made.
1.4 Quantifying Needs in Retirement
Learning Objective 8.1.3: Be able to calculate the financial needs for retirement
Retirement planning encompasses a structured process:
Key Stages: Gathering solid client information, assessing retirement goals, predicting necessary capital for those goals, examining existing retirement plans, and formulating an investment strategy.
1.4.1 Current Financial Position
Gather comprehensive details about the client including:
Personal Information: Age, marital status, and work details.
Dependants: Details on children or other dependents whose needs require planning.
Health Status: Client’s health, current job, and activities that may be dangerous.
Assets: Current savings, prospective inheritances, and their value.
Liabilities: Analyze continuing debts like mortgages or other loans.
Income and Expenditure: Establish how much the client earns and spends, helping gauge retirement income needs.
Protection Policies: Any existing protection policies should be noted as part of the retirement plan.
1.4.2 Aspirations and Needs
Identifying retirement expectations has changed over time based on socio-economic trends. Financial assessments should consider:
Retirement Age: Identifying the planned retirement age and evaluating needed lump sums or income requirements.
Living Costs: Estimate a potential outgoings plan comparing pre-retirement versus post-retirement expenses (utilities, food, travel, etc).
Example
If a client wants $50,000 in annual income, with $30,000 from their pension and $5,000 from state benefits, they must cover a shortfall of $15,000. Assume a 6% return is attainable, the required lump sum at retirement would be: To forecast future values, factors like inflation (assumed at 4% per annum) need to be considered, predicting future needs:
Expected future requirement (e.g., 25 years ahead):
This inflated target sum reflects real needs adjusted for inflation in a realistic planning framework.
1.4.3 Assessing Existing Pension Plans
Reviewing Client's Existing Plans: Assess if current plans align with clients’ goals and necessities. This includes:
Generation of Benefits: Expected amounts from defined benefit schemes and the growth of defined contribution plans.
Retirement Age Considerations: Age at which benefits can begin collecting, potential lump sums at retirement.
2 Protection Planning
This section discusses the vital features of various life and protection products to cover financial risks.
2.1 Main Areas in Need of Protection
Learning Objective 8.2.1: Protect against life, mortgage, long-term care, and business losses
Protective policies aim to cover financial losses due to critical life events, including:
Life Assurance: Protects dependents by providing financial aid upon the policyholder's death.
Mortgage Protection: Insures against job loss or health issues affecting the ability to make mortgage payments.
Long-term Care: Financial assistance when incapacitated, preventing asset depletion from care costs.
Business Protection: Safeguards against loss due to key personnel's misfortune, ensuring business continuity.
2.2 Assessing Protection Priorities
Learning Objective 8.2.2: Prioritize what needs protection
Advisors should help clients identify potential risks or issues based on their family, lifestyle, assets, and business:
Impact of Life Events: Explore the ramifications if primary wage earners suffered from critical illness or injury, determining necessary protections.
2.2.1 The Prioritization Process
Learning Objective 8.2.3: Prioritize according to necessity and finances
Assess and rank protection needs in line with:
Importance and Feasibility: Address controllable risks first and find affordable coverage options.
Balance Current Versus Future Needs: Distinguish between immediate needs and long-term planning.
2.3 Quantifying Protection Needs
Learning Objective 8.2.4: Calculate requisite protection levels
Establishing a real-time income and expenditure plan helps assess the protection required for financial stability during life events.
Plan for Replacement Income: Consider if income is needed or if capital sums benefit most; many situations necessitate both.
Income Generation Capabilities: Assess long-term impacts of inflation and consider conservative income systems.
2.4 Life Assurance
Learning Objective 8.2.5: Types and principles of life assurance
Life assurance splits into various types:
Settlor (Proposer): Person proposing insurance on their life or another’s where they have an insurable interest.
Life Assured: The person protected by the policy.
Joint Life versus Individual Policies: Structures protective cover for one or multiple lives, each has its particular advantages.
2.4.3 Term Assurance Types
Fixed Cover Options: Depending on individual needs, one can select between level, increasing, or decreasing cover. Depending on specific payouts required, premiums may remain the same or adjust with inflation.
3 Estate Planning, Trusts, and Foundations
3.1 Estate Planning
Learning Objective 8.3.1: Key estate planning concepts
Aims to ensure wealth is passed on effectively while mitigating tax liabilities via:
Balance Sheet Analysis: Identify total assets vs. liabilities.
Drafting Wills & Powers of Attorney (PoA): Facilitate management of client interests during incapacity.
3.1.1 Assessing a Client’s Estate
Asset Identification and Liabilities: Total up all properties, savings, and expected insurance payouts, including any due estate taxes.
3.1.4 Estate Taxes
Tax liabilities on death may arise depending on jurisdictions, with available exemptions affecting tax burdens.
3.2 Family Investment Vehicles
Learning Objective 8.3.2: Trusts, offshore trusts, investment companies
Trusts: Legal constructs to manage and distribute assets effectively, provides control over timing and distribution posthumously, minimizing tax exposure.
Types of Trusts:
Bare Trust: Beneficiaries have full access to capital once of age.
Discretionary Trust: Grants trustees control on distribution based on pre-defined criteria.
3.2.4 Offshore Trusts
For high-net-worth individuals, offshore trusts reduce tax liabilities while enhancing asset protection. These structures often require expert advice and management.
3.2.5 Offshore Foundations
Offer characteristics similar to trusts but may be more attractive to clients from civil law jurisdictions. They facilitate management across generations.
3.3 Key Feature Documents (KFDs)
KFDs provide essential information about protection products, ensuring clients understand their policies, charges, and any associated risks.
End of Chapter Questions
Difference between DB and DC schemes?
Information needed for retirement strategy preparation?
Factors for reviewing protection products?
Types of coverage under term assurance?
Conditions of accident protection products?
Considerations for selecting protection products?
Importance of financial strength in product providers?