With-Profits Pensions: How They Work and What to Do With Them

The with-profits pension was one of the defining financial products of the late twentieth century. At their peak, insurers including Prudential, Standard Life, Legal & General, Aviva, and many others sold millions of with-profits endowments, pension plans, and whole-of-life policies. Their appeal was simple: they promised to smooth investment returns, avoiding the sharp falls that direct equity investment brought, while delivering steady growth through declared bonuses.

Decades later, many people hold with-profits policies they barely understand — sometimes inherited from former employers, sometimes the result of advice they received in the 1980s or 1990s that felt right at the time. Understanding what you have, what it is worth, and what your options are requires working through several technical concepts. This guide sets them out clearly.

How With-Profits Works: The Smoothing Mechanism

The with-profits concept rests on the idea of a large "with-profits fund" managed by the insurer. All policyholders' premiums are pooled into this fund. The insurer invests the pool in a diversified portfolio — traditionally a mix of UK equities, bonds, property, and cash — and manages it on a long-term basis.

Rather than allocating to each policyholder a direct share of the fund's investment return (which would fluctuate with markets), the insurer distributes returns through a bonusing system. In good years, the insurer does not pass through all the investment gain — some is retained. In bad years, the retained reserves subsidise bonuses, preventing a fall in declared values.

This smoothing mechanism was the central selling proposition: the policyholder would not see their policy value fall in a market downturn. In practice, the smoothing works over the long term, and the mechanism breaks down in severe or prolonged market downturns — which is why MVRs are sometimes applied.

The Bonus Structure in Detail

Reversionary (Annual) Bonuses

Each year, the insurer's actuary calculates what bonus rate the insurer can sustainably declare given the fund's performance and reserves. This bonus is added to the policy's guaranteed sum assured or existing accumulated value, depending on how the policy is written.

The key feature: once declared, a reversionary bonus cannot be removed. It forms part of the policy's guaranteed value going forward. This "ratchet" effect gives policyholders certainty about a minimum future payout.

In practice, reversionary bonus rates have collapsed over the past 20 years:

• In the 1980s, bonuses of 8–12% per year were common
• By the early 2000s, they had fallen to 3–6%
• By the 2010s, many insurers were declaring 0–1% reversionary bonuses
• Some policyholders have not received a reversionary bonus for several years

The generous bonuses declared in the 1980s and 1990s explain why long-running with-profits policies may have a large accumulated guaranteed value — those early reversionary bonuses compounded over decades.

Terminal (Final) Bonuses

The terminal bonus is the mechanism by which the insurer "catches up" between the conservative reversionary bonus trail and the actual investment return of the fund. If the fund has performed well, the terminal bonus can be substantial — in some cases equal to or exceeding the accumulated reversionary bonuses.

The terminal bonus is:

• Discretionary — the insurer can set it at zero and has done so during market downturns
• Variable by policy — the insurer can (and does) apply different terminal bonus rates to policies of different vintages, premium histories, and types
• Often waived or reduced when an MVR applies — an insurer will not pay a generous terminal bonus if the fund's assets are underperforming

The uncertainty of the terminal bonus is the principal weakness of with-profits as an investment proposition. A policyholder cannot know their terminal bonus until they are close to, or at, the point of claim.

Guaranteed Minimum Returns

Some older with-profits policies — particularly those written before the early 1990s — include guaranteed minimum annuity rates (GMARs), guaranteed returns, or guaranteed maturity values. These guarantees can be extremely valuable.

A guaranteed annuity rate locked in at the point of purchase in, say, 1985 might provide an annuity of £1,000 per year for every £10,000 of pension fund — an effective rate of 10% per year. Current open-market annuity rates are a fraction of this. A policyholder with a GMAR giving a 10% annuity rate from a £200,000 pension pot could secure £20,000 per year — far above what is available on the open market today.

GMARs and similar guarantees should be investigated carefully before transferring or surrendering a with-profits policy. Transferring away from a with-profits policy almost always means forgoing any guaranteed annuity rate.

Market Value Reductions

The Market Value Reduction (MVR) is the mechanism by which the insurer aligns the transfer or surrender value of a with-profits policy with the actual asset value of the fund, when that asset value is lower than the guaranteed policy value.

MVRs are typically applied:

• During and after market downturns (such as 2002–03, 2008–09, and 2020)
• When an insurer's with-profits fund is under financial pressure
• To policyholders who wish to transfer or surrender outside of guaranteed maturity dates

MVRs are typically NOT applied:

• On death
• On reaching a guaranteed maturity date specified in the policy (often the original "retirement date" chosen at outset)
• If the policy has a specific "MVR-free window" — some policies allow a penalty-free transfer within a specific period each year

The MVR can be significant. In the early 2000s, some insurers applied MVRs of 15–25%, meaning a policyholder who wanted to transfer received 75–85p for every £1 of guaranteed policy value. This is a material cost to consider before transferring.

If you are considering transferring or surrendering a with-profits pension, the first question to ask the insurer is: "Does an MVR currently apply, and if so, how much is it?"

The Closed Fund Problem

Many with-profits funds are now "closed to new business" — the insurer stopped accepting new with-profits premiums. The fund therefore receives no new premium income, only investment returns and claims outflows. A closed fund's dynamics are different from an open one:

• No new money dilutes or supports the existing fund
• Claimants exit progressively, reducing the pool
• Investment strategy may become more conservative as the fund runs down
• The insurer may cut bonuses aggressively to ensure the fund remains solvent

Policyholders in closed with-profits funds are in a "run-off" situation. The fund will ultimately wind down — either by paying out all policyholders at their maturity dates or by transferring the fund to another insurer via a scheme of arrangement (which requires court approval).

From a regulatory perspective, the Prudential Regulation Authority (PRA) supervises insurers' management of with-profits funds and requires them to maintain sufficient capital. The with-profits committee — a governance body required by PRA rules — must oversee the fair management of the fund on behalf of policyholders.

Your Options for a With-Profits Pension

If you hold an old with-profits pension — whether a personal pension, a section 32 buyout policy, a retirement annuity contract (RAC), or a deferred occupational pension in a with-profits fund — you have several options:

1. Leave It Until Maturity

If the policy has a specific maturity date — typically the retirement age you chose at outset — leaving it until maturity may produce the best outcome, particularly if:

• An MVR is currently applied (which would be waived at maturity)
• The policy includes a guaranteed annuity rate (which is only available if you take the policy on its terms at maturity)
• The guaranteed sum assured plus reversionary bonuses already accrued represents a reasonable value

2. Transfer to a SIPP or Other Pension

You can request a Cash Equivalent Transfer Value (CETV) or transfer value from the with-profits insurer and transfer to a SIPP or other registered pension. This gives you:

• Full investment choice rather than the insurer's discretionary fund management
• More transparent charging (with-profits charges are often opaque)
• Greater flexibility at retirement (SIPPs work with the pension freedoms; some old with-profits policies have more restricted access options)

The transfer value may be subject to an MVR, and you will forgo any guaranteed annuity rate. Both of these costs must be weighed against the benefits.

3. Leave It as a Deferred Pension

If the with-profits policy is linked to former employment, it may be a deferred pension from that employer's scheme. In this case, leaving it as a deferred pension — drawing the income when you reach the scheme's pension age — may be straightforward. The insurer manages the fund until you draw.

4. Take the Benefits at Retirement

At your policy's retirement date, you can take 25% as a tax-free lump sum (subject to the Lump Sum Allowance) and use the balance to purchase an annuity or enter drawdown, depending on what the policy structure allows. Some older with-profits policies require you to use the balance to purchase an annuity from the insurer — at the insurer's rates, which may or may not include any guaranteed rate.

The Expatriate Dimension

For UK expats holding old with-profits pensions:

• Transfer to a QROPS: A with-profits pension can be transferred to a QROPS on the same basis as any other UK pension. The CETV (subject to any MVR) is transferred to the QROPS. The guaranteed annuity rate and any reversionary bonuses accrued are forfeited.
• Tax on income from abroad: When you draw benefits from a with-profits pension — as income — it is subject to UK income tax withholding if you are non-resident. The double taxation agreement between the UK and your country of residence determines which country ultimately taxes the income.
• Accessing benefits from abroad: Most insurers allow policies to be managed remotely and benefits to be paid to overseas bank accounts. There may be exchange rate considerations if the benefits are paid in GBP and you live in a non-GBP country.

How Global Investments Can Help

With-profits pensions are among the most opaque and misunderstood pension products still in existence. Many holders have lost track of what their policy is worth, whether an MVR applies, and what guaranteed features it contains.

Our advisers help clients:

• Obtain and analyse the current transfer value of with-profits policies, including any MVR applied
• Identify guaranteed annuity rates or other contractual benefits that should not be given up lightly
• Model the comparison between leaving the policy to maturity and transferring to a SIPP or QROPS
• Navigate the transfer process with insurers who may not make it straightforward
• Integrate the with-profits policy into a broader retirement and estate plan

The guidance in this article is general in nature. Pension and insurance rules are complex and product terms vary widely. This article does not constitute regulated financial advice. The value of your with-profits policy depends on the insurer's management of the fund, and past bonus rates are no guide to future rates. We recommend taking professional, regulated advice before making any decision about a with-profits policy.