Stuck in a with-profits policy? How to bail out
But think before you do because it could still be worth keeping, reports Chiara Cavaglieri
Saturday 01 March 2014
They were originally touted as the investment choice for the cautious, but today with-profits policies are seen as confusing , old- fashioned and poor value. There is no doubt that returns have been disappointing over the past decade and many people want to take their money and run. But after Prudential declared it paid out £2bn in bonuses to its investors last year, could they still have a place in your portfolio?
Prudential’s announcement last week certainly cemented it as a market leader for with-profits investments. Last year £700m was added in annual bonuses and £1.3bn in final bonuses and policyholders typically saw year-on-year increases of between 5 and 8 per cent. Prudential’s payouts compare favourably against rivals – with a 20-year, £200-a-month pension payout of £85,460 against Aviva at £84,921, Standard Life at £78,669, Legal & General at £78,544 and Scottish Widows £70,863.
Patrick Connolly of independent financial adviser Chase de Vere says: “While it is easy to be critical of with-profits investments, there are often good reasons why investors should retain existing policies. The financial strength of the provider, their ability to invest in growth assets and commitment to paying competitive bonuses and payouts should be important considerations. Prudential is the market leader in these respects.”
The idea behind with-profits is to smooth out the peaks and troughs of the stock market, and policies were sold in droves by life assurance providers in the Eighties and Nineties. All policyholder money is pooled together and invested in the insurer’s with-profits fund (which in turn invests in a combination of assets such as shares, bonds, property and cash). Each policyholder gets an annual bonus – as well as a potential final or terminal bonus upon maturity – but money is held back in good years so that returns are consistent regardless of performance.
Unfortunately, this theory did not play out in reality because in the early days providers were paying out overly generous bonuses in a bid to attract business. In good times, they were overpaying and shifting their investment strategies from being very conservative to being far more aggressive, which left them with nothing to pay investors when markets nosedived.
David Smith, wealth management director at the adviser Bestinvest, says: “In the good old days the stock market only seemed to go up in value and with-profits funds normally made more money than was paid in bonuses. When the market started losing money, all of a sudden what had been paid in bonuses was more than the underlying funds had made.”
After the market crashed, insurers realised they had paid out too much in previous years and had to claw back profits by slashing annual bonuses and putting market value reductions (MVRs) on funds, which in effect took bonuses away by greatly reducing the maturity payouts.
Exit costs mean some investors are still lumbered with a policy offering returns barely above cash. These “zombie funds” are closed to new business and pay the bare minimum (they are usually invested in gilts and corporate bonds instead of equities) .
The nature of with-profits funds also means it’s not always clear how much money is being held back for the smoothing process and how much is being deducted to cover management costs. With all this in mind, advisers rarely recommend new investment in with-profits, largely because there are cheaper, more flexible and more tax- efficient alternatives.
Danny Cox of the adviser Hargreaves Lansdown says: “We have probably seen the worst of the problems but we haven’t recommended with-profits since June 2002. Prudential with-profits is one of the better funds, but the sector itself has been a disaster for over ten years with investors remaining trapped in poorly performing funds with stiff exit costs.”
The problems have left investors struggling to decide whether to stay put or cut their losses. The message from the experts seems to be that not every with-profits company should be tarred with the same brush, so the decision on whether to get your money out or stay put depends largely on the strength of your provider. Look at the bonus rates paid in recent years, how actively the fund is being managed and whether it is open to new business. Then check for exit penalties, tax liabilities, the maturity date and whether there are any extra guarantees (some older plans have valuable minimum guaranteed rates).
Your policy may have an MVR-free date after which you can cash in without penalty (this is usually available on the tenth anniversary). MVR rates can change over time and some providers will cut theirs after periods of strong performance, so keep an eye onthat. It may also be the case that policies offer little or no annual bonus but are paying relatively large terminal bonuses.
If you can get your money out without a harsh penalty, there are alternatives. Multi-asset funds and absolute return funds are in some ways the natural choice if you want exposure to a diversified pool of assets with low volatility. Like with-profits, absolute return funds aim to provide positive returns regardless of market conditions. But these cannot offer a predictable income and are more likely to carry high fees.
“If you are being offered a guarantee, you must be missing out somewhere, either by overpaying on charges or getting a limited performance,” says Mr Cox.
Increasingly, advisers and DIY investors are using online platforms to build tailor-made portfolios, mixing shares, bonds, cash and equity funds rather than buying into pooled investments such as a with-profits fund. In effect, many investors are constructing their own with-profits funds without actually realising it. And the advantage of using online platforms – run by the likes of Fidelity and Hargreaves Lansdown – is that fees are generally low and investments can be sold in a heartbeat, giving much more flexibility.
An equity individual savings account is a sensible place to start as you can invest in stocks and shares free from capital gains and income tax. The entire allowance of £11,520 for this tax year can be invested (only half is allowed in cash) and you can pick your own investments and withdraw money at any time without worrying about exit penalties.
Independent Partners; request a free guide on NISAs from Hargreaves Lansdown
Questions of Cash: Bupa costs bore no relation to what I'd been quoted
Bargain Hunter: Getting your hands on these baby goodies is child's play
Problem gambling: Amid heavy advertising and a surge in remote sports betting, more and more 16 to 24-year-olds are now seen as 'at risk'
The Cyprus dream becomes a nightmare
Plans to tackle fuel poverty are slammed by campaigners
- 1 Secret Cinema: Why were Back to the Future screenings cancelled?
- 2 Christians: The world's most persecuted people
- 3 The secret report that helps Israelis to hide facts
- 4 Danish TV reporter is all business up top, all party down below
- 5 Ross Burden dead: MasterChef and Ready Steady Cook star, dies aged 45
The secret report that helps Israelis to hide facts
A day in the life of Vladimir Putin: The dictator in his labyrinth
Were 'Poor Doors' added to mixed developments so wealthy residents don't have to go in alongside social housing tenants?
Arizona execution lasts two hours as killer Joseph Wood left 'snorting and gasping' for air
A new Russian revolution: The cracks are starting to appear in Putin’s Kremlin power bloc
Opponents of Israel's military operation in Gaza are the real enemies of Middle Eastern peace
iJobs Money & Business
Data Governance Manager (Solvency II) – Contract – Up to £450 daily rate, 6 month (may go Permanent)
£350 - £450 Per Day: Clearwater People Solutions Ltd: We are currently looking...
£500 - £560 per day: Orgtel: Java Developer FX - Banking - London - Up to £560...
£350 - £400 per day + competitive: Orgtel: My client, a leading bank, is curre...
£26000 - £30000 per annum + Benefits: Ashdown Group: Account Manager - (Produc...
Day In a Page
A two-bedroom flat in a beautiful old vicarage, with many original features, close to the city centre
A three-bedroom 16th-century home with an aga kitchen, private gardens and heated outdoor pool, in Hadleigh
A three-bedrom home in sought-after Queen's Gate Mews, with Italian marble-finished bathrooms
Surrounded by glorious countryside in the village of Udimore, sits this impressive four-kiln oast and barn conversion
A five-bedroom house in the picturesque village of Kettlewell, north Yorkshire
An 18th-century former coaching inn with original staircase, open fireplaces and beams throughout
A Grade II-listed Georgian town house with three bedrooms and a south-facing courtyard, near Arundel Castle
Feel on top of the world at this über chic penthouse on the 37th floor of one of Europe’s tallest blocks.
A Grade II-listed Victorian villa with six bedrooms and two further cottages, all with spectacular sea views
A grade II-listed, Georgian cottage with mature 50ft garden, perfect for summer entertaining
A magnificent Georgian pile with turrets, seven bedrooms, a heated pool and four acres of gardens
Fairoak Farm has five bedroom suites, gym, outdoor swimming pool and golf course
Chic two-bedroom river-fronted flat with a private lift that delivers you directly to your home
A spectacular seven-bedroom Tudor pile, once owned by Henry VIII, with 18 acres of land
A seven-bedroom Georgian property previously used as a picturesque wedding venue
A split-level flat in a church conversion with two en suite bedrooms and 1,200sq ft of living space
A three-bedroom bungalow situated behind an impressive stone wall, £645,000
Windsor Castle overlooks this three-bedroom Victorian cottage located on one of Windsor's smartest roads
Chapel House is a former vicarage with nine bedrooms in the beautiful Upper Wye Valley
A five-bedroom B&B and separate owner's accomodation with potential for conversion
Enjoy summer by the Thames in this two double-bedroom converted warehouse in Rotherhithe village
A one-bedroom, luxury apartment with private gym and concierge service in Moorgate
A four-bedroom house in Hermitage Gardens with three reception rooms and landscaped gardens
A seven-bedroom Grade II-listed property with a separate self-contained apartment
A five-bedroom Victorian house with three reception rooms and galleried landing, £695,000
A six-bedroom farmhouse with five acres of land in a former cloth-making village
A secluded seven-bedroom detached house with large private garden, £490,000
A three-bedroom cottage overlooking Sarratt village green with open fires and solid oak floors
A three-bedroom maisonette flat in a Grade I-listed, Georgian townhouse in a sought-after location
A one-bedroom apartment located within a private gated development, north of Turnham Green
Look forward to a brighter future at two-bedroom Sunny Cottages, ideal for Londoners looking to downsize
A three-bedroom red-brick cottage with outbuildings and pretty gardens, £200,000
This three-bedroom flat within a former textile factory spans the corner of the fourth floor and has a balcony
A charming four-bedroom Oxfordshire cottage with oak floors and chunky-beamed ceilings, £465,000
A beautiful one-bed flat in a sought-after portered block, with access to Norland Square communal gardens
A one-bedroom flat within a Sixties school conversion with high-spec design and open-plan kitchen, close to Lambeth North Tube, £435,000
A 17th century four-bedroom house, with open fireplaces, cellar and pool, £600,000