Financial Planning Process Flashcards

A married couple both aged 65 seek advice on generating retirement income. Which of the following should the adviser consider FIRST?

Answer: Assessing both clients' combined financial position, income needs, tax positions, and health status

The adviser must first conduct a comprehensive assessment of both clients' combined financial position. This includes all pension entitlements, State Pension status, other investments, property, income needs (essential vs. discretionary), tax positions (utilising both personal allowances), health status (which affects annuity rates and life expectancy assumptions), and capacity for loss. Only after this holistic assessment can appropriate recommendations be made.

What does the term 'sequencing risk' refer to in retirement planning?

Answer: The risk that poor investment returns early in retirement disproportionately deplete the portfolio when combined with withdrawals

Sequencing risk (or sequence of returns risk) is the danger that negative investment returns occurring early in retirement, combined with regular withdrawals, permanently impair the portfolio's ability to sustain future income. Even if long-term average returns are adequate, poor early returns while drawing income can deplete the portfolio faster than expected. This is a critical consideration when advising on drawdown versus annuity options.

Under UK pension rules, what is 'flexi-access drawdown'?

Answer: A method of accessing a defined contribution pension pot from age 55, allowing flexible withdrawals with no limits after taking the tax-free lump sum

Flexi-access drawdown allows individuals aged 55+ (rising to 57 from April 2028) to access their defined contribution pension flexibly. After taking up to 25% tax-free (the pension commencement lump sum), the remainder stays invested and the individual can withdraw any amount at any time, taxed as income. This offers maximum flexibility but carries investment risk, longevity risk, and sequencing risk. The Money Purchase Annual Allowance (£10,000) applies once triggered.

Why is 'emergency fund' planning an important part of the financial planning process?

Answer: It ensures the client has accessible liquid reserves to meet unexpected expenses without having to sell investments at an inopportune time

An emergency fund (typically 3-6 months' essential expenditure in easily accessible cash or near-cash) provides a financial buffer against unexpected costs such as job loss, car repairs, or home emergencies. Without this buffer, a client might be forced to sell investments during a market downturn to meet immediate needs, crystallising losses and undermining their long-term financial plan. It is a foundational element of sound financial planning.

What is the primary advantage of a 'whole of life' insurance policy over a 'term' assurance policy for estate planning purposes?

Answer: A whole of life policy guarantees a payout whenever death occurs, making it suitable for covering a known IHT liability

A whole of life policy pays out on the death of the life assured regardless of when death occurs, making it ideal for covering a known or estimated IHT liability that will arise whenever the policyholder dies. Term assurance only pays out if death occurs within the specified term and is therefore unsuitable for IHT planning where the liability has no fixed end date. When written in trust, the whole of life payout falls outside the estate for IHT purposes.

In the context of retirement planning, what is the 'natural yield' approach to generating income?

Answer: Taking only the income naturally generated by a portfolio (dividends, interest, rent) without selling capital assets

The natural yield approach involves constructing a portfolio that generates sufficient income from dividends, interest, and rental payments to meet the client's income needs, without needing to sell capital. This preserves the capital base and can be appropriate for clients who wish to maintain their estate value. However, it may constrain asset allocation toward income-producing assets and may not always generate sufficient income without capital drawdown.