With Profits Bonds

Category: Investments
Date: 5/12/2009

What is a With Profits Bond?

• With Profits Bonds are a form of life insurance based investment and usually require lump sums to be paid in. The amount of life cover is normally only minimal, and most With Profits Bonds are taken for investment growth and not life cover alone.

• The investment buys a ‘sum assured' in the form of units in the insurer's With Profits fund which invests in a wide range of assets such as shares, fixed interest securities (corporate bonds and government gilts) and property.

• Each year bonuses are added to the sum assured either by an increase in the price of units or by allocation of extra units. These are called ‘Reversionary Bonuses'. If you don't cash in your bond in its early years, you may also get a 'Terminal Bonus' on encashment.

• Once added these bonuses cannot be removed and are seen as one of the attractions of With Profits Bonds. This annual declaration of bonuses is known as 'smoothing', and protects the investor from the ups and downs normally associated with investing in stock markets. In years when the performance has been very good the life company will usually retain some of the monies in "reserves" so that in difficult years some level of bonus can be maintained for policyholders.

• It is possible to take a regular income (monthly, quarterly etc) from With Profits Bonds by encashing units from the plan.

Who Are They Suitable For?

• With Profit bonds offer the potential for greater growth than deposit accounts but with a lower risk profile than for stocks and shares based investments. So if you want a decent return but don't want to put your money at risk, a With Profits Bond may be suitable.

• A With Profit Bond should be considered as part of a balanced investment portfolio as a low - medium risk investment.

What Should You Look Out For?

• With Profit Bonds incur an annual charge of around 1 - 2%. Some also have initial charges or price units more highly for when you purchase than when you sell (called bid/offer spread) which is another form of charge.

• There is no guarantee that you will get a Reversionary Bonus, particularly in times of a major or prolonged downturn in the financial markets.

• There is no fixed term to the investment. However, if the bond is encashed in the early years a penalty may be applied in the form of a percentage value of the investment.

• A Market Value Reduction (MVR) may be applied when there has been a large or ongoing fall in stock markets, or where investment returns are lower over a long period. This reduces the amount you receive if you withdraw from the bond during such times, particularly in the early years.

• Generally, if you are a basic rate taxpayer there is no income tax to pay when you cash in the bond, because tax has already been paid by the provider. If you are a higher rate tax payer, there may be an additional tax liability. You can withdraw up to 5% of the value of the bond each year without liability to tax.

Next Steps

Take a look at our With Profit Bonds best buy tables to see the best offers available at the moment.