Many investors remain sceptical about investing in endowments, due to the negative associations with old-generation products that traditionally charged high fees and offered lacklustre returns. However, given recent changes, now may be the perfect time to consider including an endowment in your investment portfolio.
Old-generation life endowment policies
Life insurance companies initially offered traditional endowments only, which are policies with both a life insurance and an investment component. You pay your contributions over the course of your policy term, for which you then receive life cover and have a lump sum paid out to you at the end of the set period. However, the portion of the premium allocated to life cover became larger over time. This often meant that little to nothing was invested.
As a result, endowments without life cover were later introduced to separate life risk and investment risk. However, in many instances the endowments offered by life insurance companies may still charge high fees, especially in the form of early-termination penalties if you try to access your money before the end of the investment term. Furthermore, fees are often difficult to understand or determine.
New-generation endowments are more cost effective and flexible
Endowments, especially those offered by investment platforms, have evolved over the years and many have become much more investor-friendly. Fees of new-generation endowments are now transparent, and there are no longer any surrender or early termination penalties levied.
The minimum investment term for an endowment is 5 years; there is no maximum term. If you need to, you can make withdrawals during the life of the investment with certain restrictions. In the first five years, you are restricted to one interest-free loan or one surrender (some product providers offer access to both). The maximum withdrawal during this period is limited to the capital amount invested plus interest at 5%. No restrictions apply after five years.
New-generation endowments allow you to structure your investment freely
Older-generation products often restrict investors to the funds offered by the life insurance company, although certain companies have started to make other funds available as well. In contrast, a new-generation endowment offers a far wider range of underlying investment options. You are also not restricted to maximum levels of equity and offshore instruments, as is the case with retirement savings products. However, it is important to understand that the value of your investment is not guaranteed since it is linked to the market value of the underlying instruments you choose.
Contributions are flexible
You can choose to make a lump sum investment, regular debit order investments or a combination of the two. You can also add a lump sum or increase your debit order at a later stage, provided it adheres to the ‘120%’ rule. This states that any amounts contributed may not exceed 120% of the amount invested in either of the preceding two years (the higher of these two amounts will apply). If so, a new five-year restriction period is triggered.
High-income earners can particularly benefit
For high earners with marginal tax rates greater than 30%, an endowment is an attractive investment alternative. Endowments are taxed on income at a flat rate of 30% for individuals. This means that any interest income from the investment is taxed at 30%, compared to the maximum marginal rate of 41% for individuals. Investors also qualify for a lower effective CGT rate of 12.0%, compared to the maximum effective rate of 16.4% for individuals invested in a standard unit trust-based investment. Furthermore, if the endowment is part of a trust with only natural persons as beneficiaries, then CGT will be charged at an effective rate of 12.0%, compared to the 32.8% effective CGT rate for trusts.
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