Investment Masterclass – Simplicity is King

Ian King, Monday January 13, 2014

One of the key roles of any Financial Planner is to help their clients navigate the complexity of various investment and tax solutions.  A large number of options are available, many of which involve particularly sophisticated approaches which are difficult for the client, and in many cases, the adviser to comprehend.

This post is not setting out to attack any particular strategy or product, all of which have their place and can be suitable for the right client.  What is concerning is the frequently with which we meet clients who had previously been advised to invest or implement complex tax or investment strategies which were really not necessary.


Financial planning works best when kept simple. The motto KISS – Keep It Simple, Stupid really should be adhered to more frequently. If a more simple solution is available which offers all, or nearly all, of the benefits of a more complex alternative, then you should need a good reason to select the more complex option.

There are some clients’ whose situation is sufficiently complex that a more bespoke solution is required. In my experience however in many cases a more effective planning process can help to clear much of the complexity and therefore can allow a more simple solution to be afforded.

The trick here is in the planner having a strong process via which he or she can help the client to consider, discount and prioritise their objectives and ultimately allow them to make more informed decisions.  Lazy or disorganised planning does not allow this to happen which can frequently result in the client being “sold” a more complex solution to that which they actually need.

An Example

One example of a complex scheme being employed more frequently than necessary is the Discounted Gift Trust (or DGT for short).  Using a trust tax structure and a suitable investment vehicle (often an investment bond) a DGT offers, on the face of it, a non contentious way of achieving the following benefits:

  • An “income” equal to 5% of the initial investment every year until either the death of the investor or the fund is used up.
  • The need to provide an income notwithstanding, any funds remaining on death will be available to the family.  If death happens more than seven years after the plan is set up such a payment will be free from Inheritance Tax (IHT).
  • An immediate “discount” on the size of the estate of the investor, i.e. part of the investment will not fall into the investor’s estate for IHT purposes even if death occurs the day after investment.

Many clients, particularly those who have retired and have concerns about IHT often jump at the chance to acquire a new relatively secure source of income and to provide capital for the family, likely free from tax.  As a result, it is often an easy “sale” for an adviser and will frequently attract both high initial and ongoing adviser charges given the respective complexity of the plan at outset and the need to monitor the capital investment to reduce the potential for capital erosion.

Suitability of DGT’s

In my experience, a little bit more work by the planner at the outset to engage the client frequently casts a different light upon the suitability of DGTs.

For example:

  • Does the investor actually require an income? Whilst an extra source of income is always welcome, generating extra income in this case can be counter productive.  If the income payments from the DGT are not used to meet the cost of living of the investor then they will simply accumulate within the investor’s estate for IHT purposes, in effect nullifying overtime the IHT benefits of the plan.  A comprehensive budget planning approach at the outset does in many cases highlight that such an extra source of regular income is not needed.
  • Is the investor aware of the implications for them and their family of the rigidity of the plan? In effect, funds within the DGT cannot be accessed until the death of the investor.  HMRC have suggested that those who could not acquire life insurance on the open market, often those in poor health and/or in the later years of their life, will not be able to arrange a DGT with the aforementioned benefits.  As a result the life expectancy of the investor may not be inconsiderable and hence the family will not likely have access to the funds for many years.  Could the family not best employ the funds now rather than waiting?
  • If the need for income is not so great, does the investor require access to the capital?  A cash flow analysis should be undertaken by the planner to see what the likely need to access the capital of the proposed DGT investment.  My standard approach is to consider the current and projected financial resources of a client as being either resources that the client will need (i.e. to meet their regular expenditures), resources they may need (e.g. to meet the costs of any future long-term care) and resources they don’t need (the balance of resources after those which will and may be needed).  The question is where does a DGT fit within this analysis?  If the investor was definitely going to need the funds to be invested then surely they would prefer full access to all of the capital going forwards without tying it up within a trust? If the investor may need the capital it is likely to be of a lump sum nature, something which cannot be provided from a DGT.  If the capital is not likely to be required should the client not consider giving the funds away now such that their family can benefit immediately?  The short-term potential tax benefits of the DGT often don’t look so attractive against this more simple approach.

DGTs and other complex strategies do have their place but the onus is on the planner to make sure they are only used when necessary.

As always we welcome your comments.

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