The purpose of 'With-Profits Bonds' is to smooth out the fluctuations in the stock market. This presents you with a very low risk, low volatility investment. Each year the fund managers guarantee a level of return for that year and pay that rate of return to you. If the bond actually grows more that year the extra is added into the reserves of the bond to cushion the effects of downturns in performance in latter years. If the performance is down, the next year the fund manager uses the reserves to ensure that smooth returns are provided. The basic principle is that the reserves built up in the bonds from the good years pay for the bad years, having the overall effect of smoothing out the returns received from the stock market.
This cushioning may reassure you when investing in the stock market. At the end of the life of the investment, most companies will give an additional bonus called 'a terminal bonus'. This 'top up' bonus is a one off and it reflects the fact that the annual bonuses paid to your policy may not have reflected the full investment performance of the fund. In other words, the fund manager holds back some of its investment gains, and then gives it to you as a bonus at the maturity of the policy.
They are generally considered low risk investments that should be held for a long term i.e. five years or more.
TaxNon-Taxpayers and 10% Taxpayers
Tax is paid at a basic rate within the fund and you cannot be re-claimed. This means you are paying tax for which you are not liable. This could mean you could achieve a higher return in other accounts.
22% Taxpayers
Basic Rate tax is paid by the fund and therefore there is no further liability to tax unless your gain made on encashment makes you a higher rate taxpayer. You are also allowed withdrawals of up to 5% of the original capital a year, over a maximum of 20 years without any tax liability on the withdrawals. This can help you achieve a tax efficient income.
40% Taxpayers
The insurance company pays Basic rate tax within the fund. If the Bond is en-cashed when you are a higher rate taxpayer then you have a further 18% liability on the gains that are made. The extra tax is only liable if you are a 40% taxpayer at the time of encashment. Therefore this can help people in the run up to retirement when they are currently higher rate tax payers but envisage retiring as basic or lower rate taxpayers therefore potentially reducing your tax liability.
Pro's
Can help reduce a 40% taxpayers liability to income tax.
Helps smooth returns for investors so you are not exposed to the normal fluctuations of the stock market
Con's
As well as smoothing the returns you may not reap the full benefits of the highs in the stock market.
They are lower risk investments that therefore attract potentially lower returns.
There is an element of risk involved to the original capital invested.
Unit Trust
