How With-Profits Funds Work
A with-profits fund pools your money with thousands of other policyholders and invests across a mix of equities, bonds, property, and cash. The fund manager smooths returns over time, holding back some gains in good years to bolster payouts in bad years. This smoothing mechanism aims to provide steady, predictable growth.
Returns are paid to you through two types of bonus:
- Annual (reversionary) bonuses — added to your policy each year and, once declared, usually cannot be taken away
- Terminal (final) bonus — a one-off payment when you retire, transfer, or cash in your policy. This is not guaranteed and can be reduced or removed entirely
The Problem with Modern With-Profits Funds
Several factors have made with-profits funds less attractive in recent years:
| Issue | Impact on You |
|---|---|
| Declining bonus rates | Annual bonuses have fallen from 5–7% in the 1990s to 0.5–2% for many funds today |
| High charges | Many with-profits policies carry annual charges of 1–2%, compared to 0.1–0.5% for modern index funds |
| Opaque management | It is difficult to see exactly how your money is invested or what charges you are paying |
| Conservative asset allocation | Many funds have shifted heavily into bonds and cash, reducing growth potential |
| Closed funds | Many with-profits funds are closed to new business, meaning no new money flows in while the fund gradually runs down |
Market Value Adjustments (MVAs)
An MVA is a reduction applied to your policy value when you transfer or surrender during periods of poor investment performance. It adjusts your payout down to reflect the true underlying asset value, preventing you from taking out more than your fair share at the expense of remaining policyholders.
Guaranteed Annuity Rates: The Hidden Treasure
Some older with-profits policies (typically those started before 1990) include guaranteed annuity rates (GARs). These are contractual rates at which you can convert your fund into a retirement income, and they are often dramatically higher than anything available on the open market today.
A GAR might guarantee an annuity rate of 11%, meaning a £100,000 fund provides £11,000 per year of retirement income. The open market equivalent might only be £5,000–£6,000 per year. Giving up a GAR is almost never in your interest.
When Switching Might Make Sense
- Your policy has no guaranteed annuity rate or other valuable guarantees
- Bonus rates have been very low for several years and the fund is closed to new business
- Charges are significantly higher than modern alternatives
- You want more control over your investment strategy
- You can exit without an MVA penalty
When You Should Stay Put
- Your policy has a guaranteed annuity rate
- Your policy has a guaranteed minimum fund value or growth rate
- An MVA would significantly reduce your transfer value
- You are close to an MVA-free exit date or retirement date
- The terminal bonus represents a large proportion of your total fund value
Next Steps
Dig out your original policy documents and check for guaranteed rates or other valuable features. Request an up-to-date fund value and transfer value from your provider, and ask specifically whether any MVA would apply. Then speak to an independent pension adviser who can compare your with-profits policy against modern alternatives and help you decide whether switching is in your interest.