Should I ditch my with-profits funds?
I have two with-profits pension schemes with Scottish Widows: one from contracting out the contributions, the other from a group pension plan.
I’ve read in the financial press recently that I should get rid of these pension schemes, even though there will be a market value reduction.
Is it worth taking the hit now, rather than waiting to see if my investment goes down further?
Ask the Professionals: Philip Pearon, a partner at P&P Invest in Southampton and investment portfolio specialist, says:
The case for with-profits investment is not black and white, so any action you take should reflect what’s best for you, given your circumstances.
In theory, with-profits provides a low-risk approach towards investment over the long term. The company awards profit to your plan on an annual basis – this is known as a ‘reversionary bonus’.
The level of the bonus is discretionary, and can go down as well as up in the future. But once it’s added, the company can’t deduct it from the plan, unless you surrender the policy before maturity.
At maturity, a final payment, or ‘terminal bonus’, is potentially available. Again, the level of this is at the company’s discretion.
However, with-profit funds normally invest heavily in shares, and as returns from shares over the last few years have been poor, this is reflected in the low level of bonus payments currently being awarded by most companies.
If you’re prepared to adopt a higher level of investment risk, you could consider an alternative to with-profits – you should benefit from the higher risk over the longer term. The company will offer you alternative choices of funds linked either to the performance of equities, fixed interest or commercial property.
However, before switching to alternative funds you should investigate whether an exit penalty, known as a ‘market value adjuster’, will be applied. How much this is will depend on the company.
It’s important to establish what the effect of this will be upon the value of your fund to see whether it’s worth paying in return for the potential to achieve higher returns.
If you don’t understand the alternatives to with-profits or the investment risk involved, you should seek advice from an IFA specialising in portfolio management.
An additional bonus added to a with-profits policy when it comes to the end of the term specified at the outset and “matures”. The terminal bonus is paid as a percentage of the final payout and is at the discretion of the life company and are not guaranteed and the rate changes from year to year depending on the return from the with-profits fund. In some cases, the terminal bonus accounts for half the maturity value of the policy.
The annual bonus paid by a life company and added to a with-profits endowment or pension plan or savings bond, and paid as a percentage of the basic sum assured (see endowment policy). Once added, these cannot be taken away and are added to the basic sum assured so this grows over the life of the policy and each subsequent bonus has a compounding effect which increases the value of the policy.
A financial adviser who is not tied to any financial services company (such as a bank or insurance company) and is authorised by the Financial Services Authority (FSA). They can advise on financial products to suit your circumstances. All IFAs have to give consumers the choice of paying by fees or commission and have to explain which would best suit the customer in that particular instance. Also, if commission is paid either by the client or the financial service provider recommended by the IFA, the IFA must disclose what that commission is.
An interchangeable term for shares (UK) or stocks (US). Holders of equity shares in a company are entitled to the earnings and assets of a company after all the prior charges and demands on the company’s capital (chiefly its debts and liabilities) have been settled. To have equity in any asset is to own a piece of it, so holders of shares in a company effectively own a piece proportionate to the number of shares they hold. (See also Shares).