So you have a With-Profits based investment and your wondering whether it is worth hanging on to it or if you should cash it in, or in the case of a pension transfer out.
In this article I will discuss the factors you should consider when weighing up your options.
The first thing that you really need to know is what sort of With-Profits fund your money is invested in, two types exist "conventional" sometimes called traditional and "unitised" you should be able to see which type you have from your policy documents.
If you are invested in a Conventional With-Profits plan, you have basically thrown your money in to one big investment pot with all of the other people who have invested in the same with-profits fund.
Everyone in the fund shares the profits, in the form of "bonuses". Two types of bonuses generally exist annual and terminal. Annual bonuses are as you might expect added each year, terminal bonuses are stored up to be paid out at the the end of the plan. Terminal bonuses are used as an incentive to stay invested.
One of the biggest criticisms of with-profits plans relates to the way bonuses are awarded. You may find that you receive a fund update from your provider telling you how well the fund has done this past year achieving growth of 10% (just an example) but when you check your statement you received a much lower amount as your bonus. Why? It all comes down to a process known as smoothing, the fund managers are allowed to hold back profit in good years so that they can make up for losses in the bad years. The idea was to give the fund nice steady growth even through tough years, this is why it was a favourite investment vehicle for mortgage related endowments.
With a unitised with-profits policy your premiums buy units in the with-profits fund at the current unit price. A unitised with-profits policy allows investing part of your premiums in the with-profits fund and part in other, unit-linked funds offered by the insurer.
There are two basic types of unitised with-profits fund:
- Fixed price – the unit price does not vary, so regular bonuses add extra units to the policy at the same price.
- Variable price – the unit price increases with regular bonuses and the policy is guaranteed not to fall in value.
Over the last ten years or so a variety of problems have hit the with-profits sector. According to the Chartered Institute of Insurers (CII) in 2006, the amount of money annually invested in the funds reduced from £15bn pounds in 2001 to less than £1bn in 2005.
Since the early nineties there has been a relentless cut in bonus rates with many offices now routinely issuing annual bonus rates of 0%. This coupled with the closure of many life offices and their with profits funds, household names such as Guardian, Royal London, London Life, Pearl and NPI all closed their doors to new business. This led to a reduction in consumer confidence.
The fact that more money is heading out of these funds than in and that they have commitments in the form of guarantees to many of the investors means that most closed funds have reduced their exposure to equities (where the real growth potential lies) and invested in fixed interests and property instead which they hope will offer more steady growth and less risk of loss to capital so that they can meet the guarantees on investors plans. It doesn't necessarily follow that because a fund is closed that it will perform poorly as it may in fact be able to provide lower charges and in recent years some have paid out just as well their "open" counterparts. However, from a long term perspective I personally don't see how they can continue to pass good investment performance on to investors or make anything but the most cautious of investments without new money coming in to the fund.
Market Value Reductions (MVRs) a form of financial penalty for leaving the fund have been imposed by many funds since the start of the new century, to try and ensure the fund can make good on it's guarantees.
Before surrendering or transferring out of a with-profits fund you should check you policy documents for any guarantees. Some Pension plans for example offered quite attractive guaranteed annuity rates (the rate at which they convert your pension fund to a pension) you need to find out what sort of level of investment performance you would need from a pension without the guarantees to provide the same pension you currently have guaranteed. Some endowment policies have guaranteed sums assured on death and you should take in to account the cost of replacing this insurance before surrendering.
Questions to ask yourself before transferring or cashing in your plan?
What sort of policy do I have?
The type of policy you have will determine your options should you wish to get out of the plan, for example, if it is a pension you may be able to transfer out to another plan provider or to another non with-profits fund held with the same company. If on the other hand it is an endowment rather than surrendering it you might be able to sell it on the second hand endowment market for a better price.
Does the Policy still meet my needs?
This is a difficult one if your initial aim was for a great investment then possibly not. However, if you took this plan out because you had a target such as repaying your mortgage by a set date and it's still on track you may feel that it is fine. If you do have an endowment covering your mortgage however I would encourage every reader to ask a Financial Adviser (Preferably one not tied to a product provider) to check firstly the likelihood the plan will hit it's target and secondly if it would be cheaper for you to switch to a repayment mortgage, taking in to account the cost of replacement insurances etc. (make sure the IFA is qualified to give mortgage advice as well as investment advice – I am in case you're wondering)
The benefits or guarantees of your policy
As discussed earlier you really have to ask yourself, are the guarantees and benefits good enough to accept poor performance. Or equally are these guarantees and benefits good enough to accept lower performance than you expected.
When does the policy end?
Nearer the end of a policy it becomes easier to see what the return is likely to be. So your decision should be easier. If you surrender a fixed term policy in the early years you may get back much less than you have invested.
What can you expect if you keep your policy until maturity?
The provider can offer you a projection to maturity supposing the fund achieves certain rates of return each year. The likelihood of the fund achieving those returns varies greatly from fund to fund and comes down to the underlying asset mix, you will usually find details on the mix of your fund on the providers website. A Financial Adviser will be able to give you guidance on this matter if you are not sure yourself.
What would you get if you ended your policy early?
There are three ways to end your policy early:
- Making the Plan Paid Up. This means you simply stop paying in to the plan but leave it invested with the current fund until maturity is due. If you decide to do this you should ask the life office for a "paid up projection" as they may still be deducting annual charges, depending on the plan features, so your plan's value could be going down.
- Cash in the policy, you may be charged a penalty by some funds for doing this so ask for both the current value and the surrender value to workout what the penalty is.
- Sell the plan on if you have a with-profits endowment you may be able to sell it on the second-hand market.
If you end your policy early it may have life cover attached, if you still need it make sure you re place it before you surrender.
Can you cash the plan in without a penalty?
Some plans have certain dates you can cash in without any penalty, often in year ten and every five years thereafter. Ask your life office if you have any "MVR-Free Dates"
Transfer your policy to another insurer
You may be able to do this if you can find a provider whose plan has lower charges or a better asset mix. This is mainly an option with pension plans.
Switching to a unit-linked fund
Some providers will simply let you switch in to a more standard type of investment, if you are going to do this give consideration to whether they are the best provider of the new investment.
As you can see deciding whether to surrender is a minefield, further complicated by the fact that the provider of the with profits bond is most likely not allowed to give you any advice on what you should do but rather just answer factual questions.
The above should give you a pretty good idea of the factors you should consider when deciding what to do with your investment. Most Financial Advisers can offer you an analysis of your investment and advice on what you should do. I would always recommend that you take advice from a suitably qualified person, however, if the policy is mortgage related you should seek an adviser who is qualified and authorised to give advice on both mortgages and investments. I am authorised for both and will be happy to help if you wish.
Your home may be repossessed if you do not keep up repayments on your mortgage.
Typically for mortgage work we charge a research fee of £99 and receive commission from the lender or you can opt to pay us a fee of £699 and any commission from the lender will be passed back to you.