A with-profits bond is a form of ‘pooled’ life insurance-based investment, and usually requires lump sums to be paid in. You may have heard about ‘with-profit’ options when speaking with a financial adviser about an investment bond or life insurance policy or you may have read about them.
With-profits bonds will usually guarantee the investor a certain minimum return (‘guaranteed benefit’), based on the initial sum invested. Investor’s money is pooled together and invested in other assets (such as stocks, shares, property, equities and bonds) usually for the medium to long term. The investor’s lump sum provides them with a number of units, which are used to calculate the size of any revisionary bonuses or guarantees offered by the plan.
Features of investment bonds
Smoothing
Investors invest a lump-sum (or for some plans, regular premiums) in a with-profits bond. These funds will in turn be invested in a variety of different assets, and managed by a professional investment manager. They will then provide bonuses to investors each year, known as ‘reversionary bonuses’ (which can be zero, depending on market conditions).
The size of these bonuses can fluctuate in size each year. Investment managers can shelter investors from some of the highs and lows by holding back some profits from good years to boost profits during periods of poor performance.
How large any bonuses are will be based on the fund’s returns and costs, shared across each investor based on the amount invested. Once added the reversionary bonuses cannot usually be taken away, however, there are no guarantees that bonuses will be added. In some circumstances an MVA/MVR (Market Value Adjustment/Market Value Reduction) might be applied on surrender. This can make it difficult to anticipate when bonuses will be received, and their size.
Other ‘terminal bonuses’ can also be added when investors encash their bond, or pay-out on death. The aim of the terminal bonus is to ensure the policyholder receives a fair share of the performance of the fund over the period the bond is held.
Regular income
Investors can choose to take an income from with-profits bonds, encashing a percentage of the units at regular intervals up to a specified limit. While some plans are designed to provide a regular income, others are not. Some plans have a fixed maturity date and have penalties for withdrawing funds early. It is important to understand the rules around your policy when encashing it.
Up to 5%o of the amount invested per year can be taken without any immediate tax liability. The tax could be considered to be ‘deferred’, as when the bond is cashed in, withdrawals will be added to any profit made and taxed as income in that tax year. Anything above the 5% may incur a tax liability.
Bonds are still subject to the personal savings allowance. Investors should also be wary of any tax liabilities they have, as they may be required to pay tax on any gains they make from their investments. Your tax position will depend on your individual circumstances and is subject to change in the future.
Legacy and guarantees
There are several features that will differ between with-profits bonds from different providers:
- Life insurance – Some with-profits plans offer life insurance as part of their product, however the cover these plans offer is typically minimal. Most with profits bonds are taken out for investment growth and not life cover alone.
- Regular premiums – Some bonds may require investors to pay regular amounts into their bond, rather than a lump sum. If so they must continue to do so until the maturity date to avoid losing these guarantees or seeing a reduction in their bonuses.
- Bonuses – Usually, once added, bonuses can’t be taken away. But if you surrender early, the insurance company may limit some or all of the bonuses paid by applying a Market Value Reduction (MVR) – or Market Value Adjustment (MVA) – to your policy. This is most likely in times of adverse investment conditions like a stock market crash.
- Other guarantees – Other guarantees may be available, we have covered the most common ones in this article.
The value of an investment can go down as well as up, you may get back less than your original investment. Making withdrawals and charges may also reduce the value of your investment.