Investment Bonds

As well as providing life assurance policies, life assurance companies and friendly societies also offer pooled investments. The investment you have with the life assurance company or friendly society is called a policy.
Like open-ended investment funds you can invest by making regular contributions (called premiums) or by investing a one-off lump sum (a single premium). When you have a policy with regular premiums there is usually a fixed term, and cashing in before the end of the term can involve penalties. Some single premium policies also have a fixed term but most are open-ended.
When you invest in a life assurance policy, a proportion of your contribution will be used to buy life assurance that pays a fixed sum of money if you die before the end of the policy. For regular premium policies the amount of life assurance can be quite high; there can be different levels to suit different requirements. For single premium policies the amount of life assurance is usually minimal. On either kind of policy, the company will spend part of each contribution you make to meet its costs.

How does it work?

As with open-ended investment funds, a life assurance investment company pools its money and invests in one or more of the asset classes. The company promises to pay you, as described in the policy, part of the money it makes from that investment. The company organises its investments into funds and it will usually allow you to decide which fund you want to share in. There are usually a number of funds to choose from within the policy, for example, shares (UK and overseas), bonds, property, and cash deposits. Similarly, there are usually funds which invest across different asset classes and these are usually called managed funds. With life assurance investments there is often an option of a with-profits fund which is not available with any other type of pooled investment. See with-profits funds below.
Most life assurance policies allow you to switch between funds once a year without charge. Some companies make a charge for more than one switch per year, while others allow several switches without charge.
You can buy life assurance investments direct from the company or through a financial adviser – see Related links. There are some differences between regular premium and single premium products.

Single premium

Single premium products are often called investment or insurance bonds. Don’t confuse this use of the word bond with the normal use – see bonds. Here, investment or insurance bond is simply another expression for a single premium life assurance investment.
Your single premium (after any costs) buys units, which give you the right to share in the return from your chosen fund(s). The return you achieve, and the risk you take, will depend upon the amount of costs taken from your contribution, the quality of the insurance company's investment management and on the underlying investments – the asset classes chosen.

Risk

The risk to your money is similar to the risk with open-ended investment funds. Most single premium life assurance bonds are open-ended like funds; that is they don't have any fixed term. However, it is generally best to hold them (and open-ended investment funds) for at least five years. Some life assurance bonds do have a fixed term and this is likely to mean penalties if you cash in early. Also, some bonds, although they do not have a fixed term, have penalties if you cash it in within, say, five years.

Regular premium

Regular premium life assurance investments are usually called endowment policies and have a fixed term. An endowment policy is an investment plan that you usually pay into each month. The life assurance company accumulates money from you and other policyholders. It gives you a policy, which is a contract that promises certain things, such as to provide life insurance which pays a fixed sum of money if you die before the end of the policy. The company also promises to invest the money – for example in shares or bonds – with the aim of making it grow enough to provide you with a lump sum at maturity.
Mortgage endowments work on largely the same basis but have a higher level of life assurance cover. Endowments purely for general investment purposes would either be qualifying or non-qualifying. The rules for a policy to be qualifying are complex but require the policy to be run for a minimum time and to include a certain amount of life assurance cover.
The advantage of qualifying endowments is that you do not pay any tax when they mature, even if you are a higher-rate taxpayer (some tax is still paid within the policy, see below). With a non-qualifying policy you may be subject to income tax on maturity if you are a higher-rate taxpayer.

With-profits funds

Life assurance companies and friendly societies often provide with-profits funds. Policies that are linked to these are generally long-term investments. People usually invest in them for one of following reasons:

• to produce a lump sum at a known date in the future (for example, low-cost endowments linked to a mortgage); or
• to provide an income from your investment with the possibility of investment growth.

With-profits policies usually include some life insurance cover.
For more information about how with profits work see With-profits policies in Product news.

Charges

Like many open-ended investment funds there is normally a bid/offer spread of, typically, 5% which is the effective cost. However, life assurance investments also have an allocation rate.
An allocation rate of 100% means that all of your investment is put into the contract. An allocation rate of 102% means that you get an extra 2%. However, the bid/offer spread will still come off your investment. In addition, an annual management charge will also be taken from the fund to pay for the management of your investment. Some policies have penalties if you cash them in early (often within the first five years).
For regular premium policies there may be other charges such as:

• capital units (units bought by the premiums in the first year or two which are subject to a higher annual management charge); and
• a monthly policy fee.

Policies often have additional charges if you cash them in before the maturity date.
Charges on with-profits funds can be more complicated than other pooled investments. There are usually explicit charges as above but there may also be implicit charges to do with the running of the business and the bonus policy.

Tax

Any income or capital gain within a life assurance fund is taxed at different rates depending on the type of investment. If you withdraw your money and are a basic rate, lower rate or non-taxpayer then you are not subject to further taxation. Higher-rate taxpayers will have to pay an extra 20% tax on the gains. Lower rate and non-taxpayers cannot reclaim the tax paid within the fund.
You are able to withdraw 5% of the original investment each year without any immediate tax liability and so may defer the payment of tax for up to 20 years. Higher-rate tax payers, therefore, may receive a 5% per annum income each year (for up to 20 years) which has only been taxed at around the basic rate. The tax deferred will not be paid until the policy is finally cashed