With Profits Bond - an Overview 

A With Profits Bond is a single premium investment policy primarily designed for capital growth but can also provide an attractive way for bondholders to supplement their net income through a regular withdrawal facility, if required. 

A With Profits Bond fund is a relatively low risk fund that aims to provide steady consistent growth whilst evening out the inevitable fluctuations that occur in world investment markets. It gives you the protection of a widely spread balanced portfolio of investments that may include stocks and shares, fixed interest investments, cash deposits and property. The value of your investment in this fund will be enhanced by the addition of bonuses declared by the Insurance Company and reflected in the price of units.

In addition to this a Terminal Bonus may also be payable upon encashment or death although this will largely depend upon the extent to which past investment conditions have been reflected in the annual bonus declaration.

In exceptional circumstances, the Insurance Company may seek to apply a Market Value Adjustment factor to your Bond to ensure the cash surrender value equates to the performance of the underlying investments.

You may cash in your investment at any time. However, this can only be done by selling units, the value of which cannot fall unless a Market Value adjuster is applying. In these circumstances you may lose money by selling at such times. For this reason you should view it as a medium to long term investment.

A Little More Detail

With-profits bonds are a popular way for some people to invest a portion of their savings with a view to receiving a better return than from deposits (bank, building society etc), but without the associated risk and volatility of direct equity investment (stocks, shares etc).

However many people find them difficult to understand, especially when providers try to confuse by wrapping their bonds in complex and difficult-to-compare structures. 

The following summarise the findings detailed in the rest of this comprehensive guide. It is suggested that you read the entire guide, but for those who are new to with-profits bonds or possibly daunted by the guide’s size, it is hoped that this summary section helps as a ‘first-step’.


Brief Explanation

With-profits bonds are lump sum investments. They have no fixed term, although they generally have early surrender penalties during the first five years, and as such should be considered a longer-term investment. 

Regular withdrawals can be taken and most offer a range of payment frequencies, including monthly, quarterly, half-yearly.  In addition, these regular withdrawals can be stopped, or started, at any time, to meet your changing requirements.

How they work

Your money is invested in the provider's with-profits life fund, along with the money of thousands of other investors. Technically a with-profits bond is a life insurance policy, although the amount of extra life cover is negligible at just 1% of the sum invested. 

With-profits funds typically invest in a range of UK and overseas equities, property, fixed-interest investments such as government bonds and cash. Each year, the provider announces a bonus (termed annual or reversionary), and it is this which gets added to your investment. Once added to your investment this annual bonus cannot be taken away, so your investment grows smoothly, unlike the ups and downs normally associated with stock market investments. When you encash your bond, the provider may also add a terminal bonus, but this is not guaranteed. Terminal bonuses are generally larger the longer you hold the bond. 

In order to maintain bonus rates, should underlying returns not be as good as expected, in good years providers hold back some of the profits made and top-up their reserves. Then during lean years they can use these reserves to maintain bonus rates – thus smoothing the returns. In effect the provider acts as a ‘buffer’ between you and stock market volatility.

Financial strength

Ultimately, you want to be sure that your selected provider has the financial strength to maintain overall returns during good times as well as bad. For this reason it is important when considering a with-profits bond to look at the provider’s financial strength. It is no good investing with a provider that pays the highest bonus one year, if this is at the expense of future bonuses. 

Charges

Traditionally, most investments have an initial charge and an ongoing annual management charge, with typical figures of 5% and 1.5%, respectively. A with-profits fund doesn’t necessarily fall so easily within this charging structure because the direct link between the value of the underlying assets and your fund is broken as a result of the provider smoothing the investment returns (see above). The overall charges on your contract will also be affected by how much the provider holds back in reserve. The total charge on your contract will therefore consist of both explicit charges, as detailed in the contract, and implicit charges depending on each provider’s bonus declaration policy. Always remember that the initial charge on a bond, which can represent a hefty chunk of your money, can be substantially reduced by using the services of a discount broker such as The With Profits Bond Shop. In addition, more and more companies are introducing no-initial charge contracts in which all your money is invested on ‘day one’.

Allocation rates

With-profits providers often add a layer of complication with their ‘allocation rates’. This is a mechanism whereby they actually invest more or less of your money, depending on the amount. Typically the larger the amount you invest the less you will pay in initial charges. For example, if you invest £50,000 or more a provider may increase your investment by £2,000 (ie it adds 4%) before then deducting the initial charge, of say 5%. However, allocation rates on their own are virtually irrelevant, without knowing what initial charge will also be applied.  Always examine the combination of these two factors.

Early surrender penalties

Should you wish to encash your with-profits bond during the first five years, with one or two exceptions, the provider will levy an early surrender penalty. These charges reduce over time and are highest if you cash in during the first year, then falling in subsequent years. This is why with-profit bonds should be considered only if you can invest your money for at least five years. 

Market Value Adjuster

Occasionally, if you make an early encashment your bond provider may apply a further charge, known as a ‘Market Value Adjuster’, or MVA. This is designed to stop people receiving an unfair advantage as the provider uses its reserves to protect the with-profits fund during periods of poor investment returns. MVAs are only likely to occur if the value of the fund has fallen significantly and providers are less likely to apply them the longer your bond has been in force. The MVA is never applied on death and providers typically guarantee that exit penalties and the MVA will not be applied on regular withdrawals up to a certain amount, say 7.5% per annum. 

Tax situation

All returns from with-profits bonds have had basic-rate tax deducted at source. In addition individuals have no personal liability to capital gains tax. Non-taxpayers cannot, however, reclaim the tax that has already been deducted. Higher-rate taxpayers may, though, have a further liability to tax with withdrawals being taxed at 18% (currently the difference between higher-rate tax and basic rate). However, regular withdrawals of up to 5% of the original investment have no immediate tax liability. This limit is cumulative, so you could for example withdraw nothing for the first year and then 10% in the second year, with no tax implications. When cashing in the bond, higher-rate taxpayers pay a further 18% on the total profit the bond has made. If you are on the borderline between basic and higher-rate tax, then the profit on the bond may take you into the higher tax band and you will have further tax to pay. 

With-profits bonds are open-ended contracts although, of course, medium to longer-term in nature and offer a range of withdrawal options. Most bonds offer the opportunity to make withdrawals annually, half-yearly, quarterly and monthly, with some also offering four-monthly withdrawals (‘termly’) to aid those using such an investment for school fees planning. 

Withdrawals can be stopped or started at any time. With-profits bonds can be left to grow for a number of years before making withdrawals at a later stage, to supplement a pension, for example.