Protecting the financial plan

Learning Objectives:

To understand and be able to factor into financial planning strategy

  • The main risk factors to take into account in relation to an individual’s financial plan
  • The fundamentally important role that protection can play in removing financial risk to the financial plan due to death or serious illness
  • How appropriate protection plans can protect the value and financial planning objectives related to ISAs , Loan trusts and Discounted Gift Trusts 

It’s hardly surprising that, when putting together a financial plan, the focus is on investment appropriateness, investment returns and tax efficiency. The latter, especially so since the Autumn Statement. All areas where informed advice leads to better outcomes.

There are so many choices and making the right ones for, and with, their clients is where advisers deliver the all-important “Advice Alpha” – the addition to an investor’s “bottom line” delivered through the adviser’s contextual knowledge and specific know-how. 

“Contextual knowledge” is represented by knowing the economic, investment and tax context in which advice will be given. Right now, knowing “what’s going on” in relation to markets, volatility, risk and, of course, taxation (both its current status and likely future) is essential to ensuring that the right choices are made.

“Specific know-how” is about knowing your client, their goals and aspirations, what’s important to them and their tax position – now and in the future.

Put together great contextual knowledge and brilliant specific know-how and you have the two essential components for the delivery of optimum financial outcomes. Focussing on keeping contextual knowledge and specific know-how sharp is a “way of life” for all great advisers – and those that do it really well will, as part of specific know-how, anticipate, and do something about, risk to the financial plan.

Risk in an investment context is of course not one dimensional. It has a number of facets. Anyone giving investment/wealth management advice will be very familiar with strategies to anticipate investment risk related to the attitude to, and appetite for, risk relevant to their client and factoring this into their asset allocation. There’s also liquidity risk – ensuring, as far as possible, that investments are accessible and capable of being turned into cash when needed. And there’s “tax risk” – the risk that returns can be materially diminished if insufficient attention is paid to ensuring that available reliefs and exemptions are not over-looked and tax wrapper and drawdown choices are made with complete awareness of the importance that being “tax smart” can make.

But there’s another, arguably potentially more pernicious, risk to the financial plan and the outcomes it seeks to achieve – the risk that the serious illness or death of the investor can bring. Let’s look at these two risks in order. The first, serious illness is one that can be particularly damaging where the evolution of the financial plan is dependent on a regular savings/investment plan and serious illness would cause the investor to stop or reduce saving and maybe also to have to deplete the “financial reserves” in the financial plan in order to replace any lost income.

To not even consider anticipating and providing for this risk with appropriate income protection or critical illness cover is to leave the financial plan exposed, with the desired financial outcomes possibly not being secured if illness is suffered.

And then there’s the risk of the investor’s death whilst the investor is building their financial plan, i.e. where the financial plan is not already at the point they want it to be.

An appropriate life insurance policy (held in an appropriate trust) can remove that financial risk. If appropriate “science” is applied it isn’t hard to anticipate a term for the policy that matches with the time anticipated to the achievement of the financial goal.

Properly explained and, of course, subject to affordability it is hard for the appropriateness of insurance not to be seen as an intrinsic part of the wealth management and financial plan.

It’s arguable that the adviser designing the financial plan even has a strong responsibility to at least explain the potential risk to clients and what can be done to financially deal with it.

Of course, whether a client decides to put cover in place is their call, but it’s definitely a good idea for the adviser to be “on the record” for having explained the risk and suggested how it can be dealt with.

Incorporating life insurance into specific investment strategies (as opposed to the “overall financial plan”) might be another way to go. Here are a few examples.

1. Protecting your ISA/JISA

If an investor has a specific investment goal for their ISA or JISA and they are funding the investment through regular savings, spending just a little more each month on an appropriate term or decreasing term (to cover the hopefully diminishing gap between the present value of the investment and the target investment value), held in trust for the investor’s intended beneficiaries, might be something the investor would like to consider.

2. An “immediate impact” loan trust

The loan trust (or gift and loan trust) is an inheritance tax (IHT) planning strategy that works over time – a kind of “freezer” trust that ensures that increases in the value of the investment bond that represents the trust investment accrue outside of the lender’s estate. And, as loan repayments are taken and spent the value of the loan that is in the settlor’s/lender’s estate will gradually diminish. This means that, on the “early” death of the settlor, the plan will not have achieved its objective – given that the settlor’s estate will not have diminished that much. So, an appropriate life insurance policy in trust for the intended beneficiaries can “make up the difference” with an IHT free payment.

3. An” immediate impact” discounted gift trust (DGT)

With a DGT, the initial (discounted) gift falls outside of the settlor’s estate once the settlor has survived the gift by seven years. Death within seven years will result in the discounted gift potentially giving rise to an IHT liability and, even if not, reducing the amount of the nil rate band available for the rest of the estate. A seven-year term policy in trust for 40% of the amount of the discounted gift would ensure that the full impact of the DGT will be secured – regardless of when the settlor dies.

We could go on – but you get the picture right?

Building income protection, critical illness and life insurance into a financial plan can deliver the reassurance that financial goals will be achieved regardless of when the investor’s death occurs.

Provided the economics are acceptable “protecting the financial plan” is a strategy at least worth considering for every investor who hasn’t yet achieved their financial goals.

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