With-Profits Fund – Why Is The Transfer Value Higher?Written on May 11, 2017 by Kirk Rice LLP
The Question:
I have a personal pension which I started in 1989 and recently received a statement. For once I have actually read it and I was surprised to see that the transfer value is noticeably higher than the fund value. I do not understand why?
Kirk Rice LLP answers:
From the information provided it is likely your pension is invested in a with-profits fund, which can pay a terminal or final bonus upon transfer or eventual retirement. A with-profits fund will typically invest in a mixture of asset types such as UK equities, overseas equities, corporate & government bonds, commercial property and a small amount in cash. How well the fund performs will be down to these assets and the skill of the fund manager. A proportion of any returns realised are paid to you in the form of an annual bonus and once paid the bonus cannot be removed. Any returns not paid out as a bonus are retained within the fund and can be paid out in future.
As an example, the underlying assets (as above) may see the fund grow by 9% one year. The fund manager may then pay 2% of this to investors as a bonus and retain the remaining 7% to cover charges and to act as a reserve for any bad years. The following year, the underlying assets may fall in value and the fund therefore realises a negative return. The fund manager, however, can still pay a bonus of 2% (example) using profit retained from previous years. This process means the returns from a with-profits fund tend to be quite smooth; you will not see large fluctuations in values. In essence, you do not fully participate in the gains during good years, but equally you do not get hit by the falls during bad years.
Over time the fund manager recognises there is profit retained in the fund you are entitled to. This will be paid in the form of a terminal or final bonus, but unlike the annual bonus this can be decreased or removed at any time. To secure the terminal bonus the pension would need to be transferred OR if the provider allows switched into another fund. A final point to be aware of is that with-profits funds can also impose a market value reduction/adjustment (a penalty) upon encashment, but this will generally only be during or shortly after poor stock market performance.
Any reader interested in discussing this topic further can telephone Peter Sharratt on 01344 875000 or email info@kirkrice.co.uk
If you would like to receive Money Matters electronically, simply email info@kirkrice.co.uk stating Money Matters Article in the subject heading and we will add you to our distribution list.
Please note: answers are given for general guidance only and specific advice should be taken before acting on any of the suggestions made. The FCA does not regulate tax and trust advice.
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