A with profits bond is a form of life insurance-based investment, and usually requires lump sums to be paid in. The amount of life cover is normally only minimal. Most with profits bonds are taken for investment growth and not life cover alone.
This form of investment buys a 'sum assured' in the form of units in the insurer's with profits fund that invests in a wide range of assets such as shares, fixed interest securities (corporate bonds and Government gilts) and property.
Your investment value builds up with the addition of bonuses, called reversionary bonuses, which are usually added every year.
Once added, these bonuses cannot be removed and are 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's possible to take a regular income (monthly, quarterly etc.) from with profits bonds by redeeming units from the plan.
With profits bonds offer the potential for greater growth than deposit accounts but come with a lower risk profile than stocks & shares-based investments. This is because the funds are usually a mixture of assets. So, if you've got a cautious attitude to risk – or you want a decent return but don't want to put your money completely in the firing line – a with profits bond may be suitable.
A with profits bond should be considered as part of a balanced investment portfolio as a low to medium-risk investment.
In years of strong growth, income withdrawn from with profits bonds would normally be balanced, in part, by the annual bonuses that would be added to the policy, and any terminal bonus payable at the point the bond was cashed in. As a policyholder, you would expect to be able to withdraw an income and still preserve your capital.
However, there is no guarantee that you will get a reversionary bonus, particularly in times of a major or prolonged downturn in the financial markets.
With profits bonds incur an annual charge of around 1-2%. Some also have initial charges, or price units more highly when you purchase than when you sell (called bid/offer spread), which is another form of charge.
There is no fixed term to the investment. However, if the bond is cashed in during the early years, an early surrender penalty may be applied in the form of a percentage value of the investment.
A market value reduction (MVR) or market value adjustment (MVA) 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 should 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 the tax has already been paid by the provider. If you are a higher rate taxpayer, there may be an additional tax liability on any gains you make. You can withdraw up to 5% of the initial capital amount invested into the bond each year without an immediate liability to tax. Tax is assessed when you close the bond, and if you are a basic rate taxpayer at that point there will be no further tax to pay, even if you were a higher rate taxpayer when you held the bond.
Units are encashed to provide income, but the value of the remaining units can also increase over time, thereby maintaining the original value of the bond.
Your insurer should provide annual statements indicating any income withdrawn and the current value of the bond. As a policyholder, you can also request a valuation at any time and a projection of how your investment is likely to progress. This should clarify how the investment is performing and indicate if any capital has been depleted.
Disclaimer: This information is intended solely to provide guidance and is not financial advice. Moneyfacts will not be liable for any loss arising from your use or reliance on this information. If you are in any doubt, Moneyfacts recommends you obtain independent financial advice.