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Bonds on the run

In 1999, I invested 100,000 in with- profits bonds because I wanted a regular flow of income and the prospect of some capital growth without too much investment risk. I already had some with-profits endowment policies which seemed to have done well. I thought I had done the right thing at the time but now I am not so sure. Should I cash them in and invest elsewhere?

You might do worse than cashing in your bonds and investing elsewhere but you should consider the consequences.

When you purchased your with-profits bonds, they probably did pretty much what was said on the tin – a regular flow of “income” on which you probably were not subject to tax (other than the tax paid in the fund by the product provider).

I place the word “income” in speech marks because it is not really income but actually capital withdrawals. Just because payments are made on a regular basis does not necessarily make them income.

As long as the annual bonus rate declared on your with-profits fund was greater than the rate at which you were extracting money from the policy, you also stood some chances of making a little capital growth as well. All things being equal, the with-profits bond might well have delivered what you were looking for.

However, all things are never equal. Circumstances have delivered a real wake-up call. First, it is important to understand how a with-profits fund works and then think about your future requirements and ask if there is much prospect of your current arrangements delivering the results you require.

You and other policyholders hand over your money to an insurance company to buy a life insurance policy. In your case, you have purchased a single-premium, non-qualifying, unit-linked, whole-of-life insurance policy. Wow, I wonder if you knew that? I am sure you were told that you were buying an investment bond.

It is just a question of the words used – single premium because you made a one-off payment, whole of life because there was no end date on the policy, non-qualifying because of the tax treatment of the policy and unit-linked because the policy values were linked to the price of units in a chosen fund, in this case, the with-profits fund.

The money you and other policyholders paid to the insurance company was then invested. Typically, in 1999, a with-profits fund would have been quite heavily invested in equities. This was not considered a problem. In fact, it was generally considered that equities were the best asset class to support the returns needed to provide future bonuses to with-profits policyholders.

Some of the fund would have been invested in fixed-interest assets and possibly some in property and cash.

Each year, you might have reasonably expected your policy value to have grown by the addition of bonus payments from the investment profits made by the with-profits fund manager. Some of the investment profits might have been set aside as a reserve to support future bonus rates if investment conditions deteriorated.

I need not tell you that investment conditions, at least for equities, did indeed deteriorate. Bonus rates fell and, if you tried to encash your bond, the insurance company will have applied a market value reduction so that you did not take out more than your fair share of the fund and disadvantage those policyholders who stayed put.

You are probably now in a position where your policy is worth less than it used to be and it will continue to be eroded in value if you take out more than the bonus being declared.

Should you cash in the policy and invest elsewhere? This is a question of confidence and cost. Many with-profits funds have moved their investments into fixed-interest assets and away from equities. As equity markets (hopefully) recover, the fund is no longer able to benefit quite so much from equity growth. The prospect of seeing your policy value recover to its 1999 position and beyond is thus reduced and may take quite some years to achieve.

If you encash your policy, you might then invest the proceeds elsewhere. It may even be that you might invest in a further investment bond but in different linked funds.

It follows that the risk/ reward profile of your with-profits fund may have changed.

You might like to ask your adviser to create an asset class model where you invest in a mixture of equity, fixed-interest, property and cash funds in such a way that you might generate sufficient returns to achieve and even exceed the level of withdrawal from the investment bond.

Of course, there are no guarantees associated with such a move and there are costs involved in encashing the policy and investing elsewhere. A lot less money is invested today in with-profits bonds than was the case when you purchased your plans and this is understandable.


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