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With profits and unit linked - the differences

Two very different investment vehicles

Insurance companies, by and large, offer two types of investment vehicles, with profits and unit linked.

Unit linked

Unit linked funds enable you to buy and sell units from an investment fund managed by the insurance company. The units have two prices, the offer price and the bid price. The higher offer price is what you are able to buy the units at and the lower bid price is the price you able to sell the units at. The difference is termed the bid/offer spread and is essentially a charge. The price of the units are linked to the value of the underlying investments that make up the unit linked fund. There is also an annual management charge levied.

All the charges are transparent and you can find out the value of each unit fairly simply which will give you a pretty precise value of your unit holding.

Investing in such funds on a regular basis lets you take advantage of pount cost averaging. This is where you are buying units at their troughs and peaks avaraging out your overall price for each unit bought.

With profits

A with profits investment builds its value from annual bonuses paid by the insurance company. These bonuses are not guaranteed but once added cannot be removed. These bonuses are based on the returns experienced by the with profits fund as a whole. To help ensure the life assurance company can pay a bonus each and every year they normally hold back some of the profits in reserve so in the event the with profits fund performs badly they have enough in said reserve to make a bonus payment.

What can bring a lot of value to a with profits investment is the terminal bonus. This is only paid at the end of the agreed investment term. If you decide to cash in your investment early you will not get the terminal bonus and, more often than not, a heavy penalty levied. The terminal bonus can be quite high and normally a substantial portion of the investment return. It is based on all the returns held back when bonuses were paid previously. Therefore, if the fund has experienced a number of bad years the terminal bonus could be nothing.

The charges associated with a with profits investment are hidden as they are stripped out before any bonus is paid.

Main difference

So, with a unit linked investment you are completely open to market conditions as your investment value is directly linked to the value of the funds underlying it. A with profits investment, however, builds a guaranteed value over its term.

Before making the decision which investment is right for you it is important you understand the differences.