UK: With-profits investments - When funds close to new business, should you twist or stick?

With-profits investments have been popular with investors for many years, as they give investors the opportunity to gain exposure to a variety of asset classes, whilst protecting them from the volatility often associated with equity returns. However, issues surrounding these policies in recent years have forced many of the long established life assurance companies to close their with-profits funds to new business. These issues included mounting liabilities, consolidation within the life assurance sector and financial solvency issues.

So what should you do on hearing that a fund in which you have invested has been closed? Should you stay invested or should you sell (or, in the case of a pension policy, transfer or draw benefits)? Unfortunately, there are no ‘hard and fast’ answers that apply for every investor.

We have recently reviewed a number of closed with-profit funds to help investors make a decision regarding their investments. We research and fully consider all the relevant factors such as:

• the reasons the fund has closed;

• the changes that have been made to the investment strategy; and

• the impact on future investment returns.

We also interpret third-party actuarial analysis to help us reach an independent and informed decision on a closed with-profits fund.

We can help you consider how each of the following factors affects your particular circumstances:

It is widely believed that a closed fund will not perform well in the future. This is because the investment strategy is likely to change considerably so that the fund is heavily weighted towards more cautious investments such as cash and bonds. This change in asset allocation does not automatically lead to poor performance, rather returns commensurate with the lower investment risk profile. This change of strategy may be entirely suitable for those investors with a lower risk appetite. Performance may also be poor as management of the fund may not be a priority for the insurance company, given that there are no new investors to attract.

On the other hand, investors who require a more aggressive investment strategy will have to weigh up whether an investment with a more appropriate risk profile should be sought elsewhere, after taking into account the additional investment return required to match the existing policy’s projected benefits after charges/surrender penalties.

Some investment structures offer the ability to switch from the with-profits fund to a range of equity funds. This option ought to be considered, when thinking about a new home for the investment.

If the policy has been held for less than five years, then an early surrender penalty may be imposed. In addition, many closed funds are currently applying a penalty known as a ‘Market Value Adjuster’ (MVA). This penalises investors surrendering early, so that they do not claim an unfair share of the fund’s previous investment returns. Certain policies carry an ‘MVA Free Guarantee Date’, which is usually the tenth anniversary of the date the policy was started or the stated retirement date in the case of a pension. It is important to check your policy details to see if this concession applies.

For those holding a with-profits fund through an investment bond, advantage can be taken of the option to withdraw 5% of the original capital invested each year whilst deferring part of the tax charge. There are two issues to consider here.

Firstly, is the capital likely to be eroded by withdrawing amounts in excess of the investment return? Secondly, if the policy is surrendered, can any income requirements be met elsewhere?

For a with-profits holding within a bond, the tax consequences of surrendering should be considered. It is particularly important to ensure that any ‘chargeable gain’ is accurately calculated, taking into account any income that has been withdrawn in previous years, to enable the planning opportunities to be considered so that any resulting tax liability can be mitigated.

In the case of with-profits pension investments, consideration needs to be given to guaranteed annuity rates (‘GARs’), which are often attached to with-profits investments. A GAR is where, at the outset of the policy, the pension company guaranteed a minimum annuity rate that they would apply on retirement. GARs were offered at a time when interest rates and inflation were higher than today and, in general, providers did not expect that they would need to honour the guarantees. In the event, many are now exceedingly valuable compared with the open market annuity rates on offer today. It is important to identify the policies which have GARs and to evaluate their benefits, before considering a transfer.

It is clear that the future of many with-profits funds is uncertain as life companies review their position. Each investor will face a different set of circumstances, so it is vitally important to consider your particular circumstances and take independent advice to ensure you reach a suitable investment decision.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.