What is a with-profits bond?

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’.

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 be taken away, however, there are no guarantees that bonuses will be added. 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. This ensures the investor is not penalised for taking their funds at any particular point in the year.

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% 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.

Unlike ISAs, 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 relief will depend on your individual circumstances and is subject to change in the future.

Greater regulation

With-profits investments were widely scrutinised following the closure of Equitable Life to new business in 2000, which had grown to be the UK’s second largest life insurer. Since then, with-profits products have become one of the most highly regulated financial products in the UK. Many of these troubles were due to guarantees that promised to match or exceed performance targets.

Providers are now required by the Prudential Regulation Authority to hold adequate capital to cover all their liabilities. Providers also publish their management charges and breakdowns of their asset allocation. This clarity allows investors to understand how their money is being invested.

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.
• Benefits – With-profits bonds will usually guarantee the investor a certain minimum return (‘guaranteed benefit’), based on the initial sum invested.
• 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.