With-profits funds were sold heavily up until a few years ago, usually via endowments and investment bonds. While the concept of smoothing returns by holding back profits (in reserve) during good years to tide over bad years sounds sensible, in practice many investors have been left disappointed.
The problems typically stem from a combination of high charges (often to pay excessive sales commissions), poor investment management, poor transparency and difficult markets. Heavy stockmarket falls between 2000 and 2003 caused a lot of initial problems, while more recent falls have simply compounded the misery.
However, even if you’re an unhappy with-profits investor, selling, or surrendering, is seldom a straightforward decision. Use our action points to help you make a sensible decision. To find out more about with-profits see our insurance investments page.
1. Check the bonuses you’re receiving
You’ll normally receive an annual (or ‘reversionary’) bonus for each year that you hold the policy. Some providers currently pay reasonable bonuses while others pay next to nothing, so check what you’re receiving (look at recent paperwork or ask the provider). Generally speaking, the lower the bonus the lower the appeal of staying put.
2. Consider investment prospects of the underlying fund
With-profits funds usually invest in a mix of shares, corporate bonds, property and cash. Longer term you’d expect funds with more invested in shares and property to perform the best (and pay bigger final bonuses). However, during troubled times funds with more exposure to corporate bonds and cash might fare better.
Take a look at the table below to see the investment mix and underlying fund returns for a range of popular with-profits providers.
The underlying fund returns won’t match the return you get (that’s the nature of with-profits) but do give you an idea of how well or badly your money is being managed.
3. Check for surrender penalties
Ask your with-profits provider for a surrender value, which will include any penalties for selling the policy. With-profits bonds are unlikely to have any penalties if you’ve held it for at least five years, but endowments tend to have hefty penalties unless the policy is nearing maturity.
In the case of investment bonds it’s usually worth staying put until the penalties cease. As this could be many years in the case of an endowment you might consider either making the policy 'paid-up' (i.e. you hold until matrity but pay no more in) or selling via a traded endowment broker.
4. Is a Market Value Reduction being applied?
If the underlying fund has fallen in value since you invested then it’s unlikely there’ll be any money held in reserve for you. In fact returning your money plus any bonuses added to date might mean you getting more than your fair share from the fund (at the expense of other investors), in which case the provider will normally levy a ‘market value reduction’ (MVR) to protect other investors.
Some providers guarantee not to apply a MVR on certain dates, for example a policy’s 10th anniversary. If affected, always check whether you could benefit from such a guarantee before surrendering.
5. Is the MVR fair?
If your with-profits provider applies a MVR to your policy, is it at a fair level? If so, it may make sense to take the hit and start afresh. However, a penal MVR could leave you having to attain unrealistic investment returns elsewhere to compensate, so staying put in the hope the MVR falls in future might be a more sensible option.
Fortunately, the FSA has been putting pressure on providers to treat all investors fairly, so it's less likely that you are being treated unfairly than in the past. One way of gauging whether the surrender value is fair is to compare performance of your with-profits fund with a comparable ‘balanced managed’ fund run by the same insurer. If the surrender value of your with-profits fund is greater than the notional value of the comparable fund over the same period it suggests the ‘smoothing’ process may have worked in your favour.
6. Will you have to pay any tax?
If the surrender value plus any withdrawals is greater than the original sum invested, you might owe some tax. Because basic rate tax will have already been deducted within the bond (unless held offshore) you’ll generally only owe further tax if you’re close to or in the higher rate tax band. The tax calculation is called ‘top-slicing’, read more on our insurance investments page and use our Investment Bond Tax calculator to estimate how much tax, if any, you’ll owe.
If surrendering will incur a tax liability, you might consider a ‘Deed of Assignment by way of a gift’ which allows you to transfer ownership to any adult person(s) without invoking a tax liability on the transfer (the provider can supply a form). This could be beneficial if the new owner (e.g. your spouse) would not be liable to further tax when surrendering. In order for this not be viewed as a way of avoiding tax, it’s suggested that transactions take place in different tax years or at least three months apart.
Alternatively, it might be possible to switch from with-profits to an alternative investment fund within the same bond, in which case a taxable (‘chargeable’) event will not occur.
There’s no further tax to pay an endowment provided it has ‘qualified’. To qualify it must not be surrendered within the first 10 years or three quarters of its term, whichever is lower. Where a policy hasn’t qualified the tax treatment will be the same as an investment bond.
7. Decide whether to surrender
Armed with the above information you should be able to make a reasonably informed judgement on whether to surrender. Assuming you don’t need the money now your decision should be based on whether you’re likely to end up with more money overall by investing elsewhere versus staying put.
If you’re unsure what to do then don’t be afraid to seek advice. Of course, you’ll need to wary of financial advisers who might recommend switching regardless to earn a commission or fee, but a good adviser who carries out meaningful analysis could be worthwhile.
8. Think carefully about how you re-invest the proceeds
If you decide to surrender your policy you don’t want to jump out of the frying pan and into the fire! Think carefully before re-investing the proceeds.
9. Finally, a morbid but important point
Bear in mind that in the event of the life assured dying, the payout will be in excess of the surrender value, particularly if a surrender penalty and/or MVR apply. If death occurs soon after surrender, your heirs could lose out.
Investment mix and underlying fund returns
Use the information below to get a feel for how your with-profits fund is managed and invested, as this will affect future peformance.
|AXA Sun Life
|Legal & General
|All figures shown as at 31 December of respective years|
What's a traded endowment broker?
Suppose you have a 20 year with-profits endowment and decide after 12 years you don't want it anymore. Someone else might want to buy your policy if they think they can make a worthwhile profit paying the premiums and holding until maturity. Given you'll have already paid most ofthe charges upfront they might be willing to pay more than the insurer is offering as a surrender value. Traded endowment brokers try to match buyers with sellers, taking a cut for themselves alongthe way.
Read more about with-profits on our insurance investments page.
Estimate investment bond tax liabilities using our Investment Bond Tax calculator
Find traded endowment brokers via the Associaion of Policy Market Makers.