7 March 2019
It’s an investment contract with a life insurer which typically offers limited access to capital in the first five years. This encourages disciplined saving over the medium to long-term. It also offers potentially attractive tax benefits for some clients. In an endowment, the life insurer pays tax on your behalf, at a rate of 30% on income and 12% on capital gains. This is tax efficient for any client with a marginal tax rate above 30%. If you are an affluent individual and you were to invest that money in your own hands, you would probably be using your interest and capital gains exemptions already, and you would be earning a high income taxed at the marginal rate greater than 30%. So, there’s a clear tax benefit for the right investor.
Endowments are not subject to asset allocation limits. They allow you to invest 100% in equities or 100% offshore, for example. Retirement annuities (RAs) and preservation funds, on the other hand, are subject to Regulation 28 of the Pension Funds Act, which limits the extent to which these retirement products can invest in particular asset classes. Therefore, you may want to include an endowment in your portfolio to provide greater exposure to an aggressive investment strategy.
An RA should be your first choice, followed by a tax-free savings product as your second choice when saving for retirement. But once you have maximised the caps on these products, an endowment can be your next port of call. You can use an endowment to save a lump sum and make regular withdrawals on this to supplement your retirement income. Currently, these withdrawals are tax free in your hands.
This may stem from the fact that people often terminate their endowments early, incurring costly termination charges. However, if you maintain your endowment for the contractual term, these charges won’t apply. Traditionally, contract terms lasted 10 to 15 years on endowments. Recently, this has been reduced to five years on most endowments. With a Sanlam recurring premium endowment, the termination charge only applies for the first two years, which helps to improve the value for money should you terminate from year three onwards.
Also, people forget that endowment maturity benefits are tax free, so the returns are after-tax returns. When you compare this to the return on other products like unit trusts and bank accounts, you need to take the tax differential into account.
Most life insurers offer endowment policies with a variety of underlying funds to choose from. Sanlam’s endowments typically offer you options across both in-house and externally managed funds, as well as funds with underlying guarantees. In addition to assessing the underlying fund choices, compare benefits like loyalty bonuses and also do a cost comparison using the effective annual cost (EAC) measure. It’s also prudent to seek expert guidance from a financial adviser.