Endowments often overlooked

Roenica Tyson, Investment Product Manager at Glacier by Sanlam.

Decreases in cost and increases in transparency and choice regarding underlying investment options make endowments a viable option to consider for tax-efficient discretionary (non-retirement funding) savings.

No tax relief for high income investors in the 2018 budget

Most of the hype around the 2018 budget was around increased VAT, but there was also little good news on the investment front. Interest and capital gains allowances remained unchanged and personal income tax for investors in higher tax brackets had below-inflation adjustments. The personal income tax bracket of 45% introduced last year remains daunting for high income earners and trusts (where the trust itself is taxed), supporting the need for investors to look for more tax-efficient ways to grow their discretionary savings. 

When does an endowment make sense?

There are a number of factors to consider when choosing between a pure discretionary investment plan or an endowment. This includes availability of interest and capital gains allowances as well as required access to capital within the first five years. 

A key consideration in how to allocate between the two products is the investor’s tax rate. Income tax legislation requires policyholders of an endowment to be classified as an individual, company or untaxed policyholder and income and capital gains tax varies accordingly. An endowment under the individual policyholder classification, such as the Glacier Vantage Life Plan, is available to individuals as well as trusts with individuals as beneficiaries. Tax is applied as follows: tax on income at 30% and effective tax on capital gains at 12%. 

Individuals in an investment plan are taxed at marginal rates up to 45%, resulting in an effective tax rate on capital gains of 18%. Within the two products there is no differentiation for dividend tax, which is withheld at 20% either way.

How much can you save on tax in an endowment?

For high income earners the endowment can offer significant tax savings. Consider an individual that has no interest and capital gains allowance available and invests R5m for five years. Assume a balanced fund-type investment with 11% return per annum and 20% trading of the portfolio each year. 

After five years, allowing for redemptions for payment of income tax annually, such an investment would have grown to R7.93m in an investment plan. An equivalent investment in an endowment would have grown to R8.09m, saving the investor R161 000 over the period. This consists of:

• income tax saving (30% versus 45% marginal rate assumed)
• capital gains tax saving (on realised capital gains)
• additional return earned as a result of compounding from a higher base 

If the investor completely sells out of the investment after five years, the tax saving when realising the remaining capital gains would be an additional R90 000 when opting for the endowment. 

Do the math

Trusts or individuals with significant discretionary savings and high marginal tax rates should consider an endowment. There are restrictions that may not make it a suitable option, but multiple benefits and the significant potential tax saving are not to be ignored. 

More reasons to consider an endowment and sinking fund

In addition to tax savings, an endowment offers the following advantages:

• Simplified tax administration as tax is recovered within the endowment and taken care of on behalf of the investor.
• Insolvency protection – the entire value of the policy will be protected against creditors after three years. This protection will continue until five years after the termination of the policy.
• No restriction on maximum levels of equities and offshore investments, as in the case of retirement savings products.
• Ability to draw income upon retirement after the five-year restricted period has ended. This can be done on an ad-hoc basis, without the investor being forced to draw income at specific intervals.
• Estate planning benefits, such as saving on executor’s fee (up to 3.99%).
• Liquidity is created in the estate as payment of the death benefit does not depend on the winding up of the estate and beneficiaries will receive the proceeds relatively quickly.