The difference is that the value of a With-Profits fund goes up smoothly and there’s a guarantee that the value will not reduce provided you cash in the investment on the day that you set at the start of the investment.
How does a With-Profits fund work?
There are a number of key features of a With-Profits fund. The way some of them work may vary among providers and specific funds, so if you’re invested in a With-Profits fund it’s best to check the details of your policy. However, there are some common features.
As with any investment a With-Profits fund will likely experience ups and downs in its market performance.
Smoothing is a process designed to lessen the impact of periods of market volatility on the value of the fund. It does this by holding back some of the returns the fund generates during periods it has grown and putting them back into the fund in periods when the fund’s value drops. This helps to even or ‘smooth’ out the value of the fund such that its value fluctuates less dramatically over time.
The value given of your investment, which has been smoothed, doesn’t always reflect the true value of your share of the assets in the fund. However, if you terminate your contract at a time other than the date you specified at outset, the transfer value will reflect the underlying value of your share of the assets in the fund. This is done by applying a market value reduction factor.
Smoothing is achieved in a With-Profits Fund through a bonus mechanism. Bonuses are awarded based on the performance of the underlying assets after deducting any costs such as management fees, associated with the fund. Generally, bonus payments come in two different forms, regular and final (sometimes referred to as terminal) bonuses.
A regular bonus is typically declared annually. It’s paid annually on older contracts but added daily on unitised With-Profit funds through the price. As regular bonuses are linked to the fund’s performance, the size of the bonus may vary. Some With-Profits funds give a guarantee of the minimum amount of the regular bonus so check the details of your policy. Once a bonus is awarded, it can’t be taken away provided the investment’s encashed at the date specified at outset.
Final (terminal) bonus
A final bonus may be paid out when a fund member takes their money at the date specified at outset and possibly at other times. The amount paid is generally determined as the difference between any regular bonuses paid and the overall performance of the fund during the time you have been invested in it.
Market Value Reduction
If the market value of a With-Profits fund has fallen when a fund member decides to leave the fund before the date specified at outset, a Market Value Reduction (MVR) may be applied to the value of the fund. The purpose of an MVR is to ensure that the fund members who aren’t leaving will be left with a fair share of the remaining assets. Without an MVR, the leaving member would receive a greater portion of the fund’s value.
Market value reduction vs exit fees
Whilst an MVR will reduce the size of the payout received an MVR is different from an exit fee, which is charged by some providers when transferring out of an investment before the date specified at outset.
Some key differences are:
- An MVR is based on the reduced market value of the fund, which is usually the result of unfavourable market conditions. In contrast, an exit fee is applied when an investor transfers out before the date specified at outset in order that the provider can recover the charges it incurred when setting up the investment.
- An MVR is typically only charged when the market value of the fund has dropped significantly and where its value can’t be smoothed out. An exit fee, if applicable, is charged irrespective of the fund’s market value at the time an investor leaves the fund as it’s a recovery of charges.
MVR and retirement
Generally, an MVR isn’t applied if you take your retirement benefits on the date you selected at outset but it’s best to check the details of your specific policy. However, an MVR may be applied if you take your investment at an earlier or later date.
If you’re planning on taking an early or late retirement, you may want to reconsider whether you should instead take retirement at the date you selected at outset, if your policy states an MVR won’t be applied at this time.
If an MVR is applicable at the time you’re looking to take your investment, you may want to consider delaying your disinvestment to a time when market conditions are less volatile and an MVR may not be applied. Doing so will also keep your funds invested for longer, giving them more time to grow.
The application of an MVR won’t necessarily reduce the value of your payout below that of your original investment so you may still get back more than you invested.
As always with investments, your capital is at risk. The value of your investment can go down as well as up, and you may get back less than you invest. This information should not be regarded as financial advice.
Last edited: 15-12-2022