Getting to Know the Hierarchy of Financial Needs
Most clients will have more financial planning needs than they have the financial means to resolve. Prioritising is therefore a key adviser skill. In this article, we take a look at using the hierarchy of financial needs as a basis for prioritisation. This is a concept that may be tested in the CII’s R01, CF1, R06, and AF5 examinations.
Hierarchy of Financial Needs
The hierarchy of financial needs can be viewed as a pyramid:
At the very base of our pyramid, we have our emergency fund. This is the foundation for all good financial planning and takes first priority. It is only once an adequate emergency fund is in place, typically considered to be 3-6 months’ expenditure, that we can move on.
Second, in terms of our priorities, are the client’s immediate financial protection needs. Here we’re talking about protecting the client and their financial dependants from the financial consequences of dying earlier than expected and of serious ill-health. These are unpredictable future events that can have a significant impact in both the short- and long-term. They should be provided for before consideration is given to needs higher up the pyramid as, if the worse happens and financial protection is not in place, the money to set aside for future goals may no longer be available.
Once an adequate emergency fund has been built up and immediate financial protection needs have been provided for, the client can start looking to their future. Generally, this means making tax-relieved contributions into a tax-efficient pension fund to provide an income and/or lump sum at the client’s preferred retirement age.Using the hierarchy of financial needs as a basis for prioritisation - this is a concept that may be tested in the CII’s R01, CF1, R06, and AF5 exams. Click To Tweet
Savings and Investments
If there are still surplus funds after making retirement provision, consideration can be given to other savings and investment needs. Making the most of tax-efficient vehicles, such as ISAs, is often the priority here.
Inheritance Tax Planning
Finally, for those with sufficient wealth to incur an inheritance tax on their estates, we have inheritance tax planning. There are typically two approaches to IHT planning that can either be used in isolation or together. Firstly, the focus may be on reducing the value of the estate to under the available nil rate bands by gifting, if that’s affordable. The second approach is to make financial provision for the anticipated IHT bill. This is usually achieved by taking out a whole of life policy for the amount of IHT due and placing it under trust for the beneficiaries of the estate.
A Final Word on ‘PIPSI’
You may well have come across the mnemonic PIPSI in the CII study texts. It stands for protection, income protection, pensions, savings and investments. It’s another way of thinking about the hierarchy of needs. But, be warned, it’s missing the top and tail of the pyramid as there’s no mention of the client’s emergency fund or IHT.
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Information in this article is correct as at 27 January 2021.