It may seem like a good idea to take out a life assurance endowment policy that commits you to setting aside money for your child’s education and guarantees your savings goals will be met if you die prematurely or become disabled and cannot earn a living. But you may, in fact, be better off providing for your savings and your life assurance needs separately.
One of the main reasons is that if you cannot afford the monthly premiums – because, for example, you lose your job – the life company may impose a penalty of up to 15 percent of your savings. This charge may reduce to nothing over five to 10 years, but until then you will be at risk.
A few life assurers offer a retrenchment waiver, which is a benefit that will pay your premiums for about a year if you are retrenched, or they will allow you to take a “premium holiday” of, for example, 12 months over the life of the policy in the event of a financial crisis, but these benefits add to the costs.
Natasja Norval-Hart, an independent financial planner with Sasfin, says premiums on endowments are low, but the costs are often high.
“My first advice to anyone looking at an education policy is: be very critical of the costs. You don’t want to be losing value because of costs.”
Jan-Carel Botha, an independent financial planner with Ultima Financial Planners in Pretoria, says another drawback of a policy that combines savings and risk cover is that you may not know what portion of your premiums is used for savings and what portion funds the risk premiums.
Life assurers pay tax on endowment policies on your behalf at 30 percent and then pay out a tax-free amount at the end of the investment term. But Botha and Norval-Hart say that most young families who need to save for education are on marginal tax rates of below 30 percent, which makes an endowment an inappropriate vehicle.
If you separate your savings and life cover and use a discretionary product, such as a unit trust fund, to save for your children’s education, you must ensure that your risk life cover is sufficient to fund their education and other needs. Your need for this cover will be greatest when your children are young and will decrease as they get older.
Norval-Hart says she spends a lot of time with her clients with children looking at risk planning.
She says some companies offer an ancillary benefit to a life policy that pays tuition costs on the death or disability of a parent. The benefit is paid directly to the education institution – this avoids the problems of who will get the money or the money potentially ending up in the Guardian’s Fund (if parents leave their assets to minor children).
She says parents can pay for this cover as long as they need it.
Botha says that a discretionary investment such as a unit trust gives you the flexibility to use your savings as you wish. You may start to save for a child’s tertiary education but later use the savings for private schooling or pay for unexpected medical expenses, he says.
Life companies sometimes point out that their policies have guarantees on investment performance. However, in order to provide a guarantee, the life company will offer you a lower return.
Botha says that, because you are likely to save for education over a long period, you are unlikely to need a guarantee. The returns from the equity market can be volatile over shorter terms, but, on average, the equity market will seldom deliver negative returns over a longer term, such as five or 10 years.
If your term is shorter than five years, you can invest in an interest-bearing unit trust fund that has no exposure to equities, he says.
HOW EDUCATION POLICIES WORK
We randomly selected three life assurers’ endowment policies that are intended for education savings to give you an idea of the benefits these policies provide and what they cost.
Liberty: Education Builder
Minimum term: Five years. Policies can be renewed for further five-year periods. If risk life cover is linked to the savings, it will also be renewed.
Investment: You can choose up to seven different portfolios from more than 100 managed by Liberty, Stanlib and external managers.
Risk component: You can, although you do not have to, take out cover that, in the event of your death, disability and/or severe illness, pays for your child’s education until he or she is 24 years old. This benefit will pay the tuition fees (subject to certain maximums) and, in the case of a tertiary institution, the residence fees and an allowance for other expenses. Liberty will, subject to certain limits, take the risk of providing for those expenses when they arise. In addition, you can take out a premium waiver that will ensure that your premiums are paid on disability and will provide additional savings at the end of the policy term.
Minimum premiums: R500 a month, or an annual lump sum of R6 000. You can top up the premiums with ad hoc payments of at least R2 500 a year.
Optional extras: You can take out a guarantee on some of the underlying portfolios to ensure that you do not lose money in the event of market volatility. You can take out a premium waiver that will pay your premiums for 12 months if are retrenched. You must have been working for at least 12 months consecutively and your policy must have been active for at least 12 months. You can claim this benefit three times over the term of the policy. The retrenchment benefit is not available if you are self-employed or a director of a company.
Policy bonuses: At the end of the fifth year, if your premiums for the past five years have exceeded R30 000, 25 percent of the accumulated ongoing management fees will be paid back into your policy.
Annual premium increase: There is a compulsory premium increase based on education inflation as determined by Liberty.
Costs: These include management fees, the recovery of upfront commission paid to an intermediary and charges for guarantees if you select them. Guarantee costs depend on the actual portfolio selected, but range from 0.75 percent to 1.8 percent a year. You pay more if the portfolio is riskier (contains more equity).
What happens if you stop or reduce your premiums: Liberty will impose a once-off charge of up to 15 percent. This reduces each year the policy is in place, reaching 0 percent after year five, and remains at 0 percent if you renew for another five years.
Old Mutual: SmartMax Education Plan
Minimum term: 10 years, unless the premium is R2 000 or more a month, in which case it is five years.
Investment: You can choose from 200 unit trust funds managed by Old Mutual and other asset managers.
Risk component: You can, but you do not have to, buy premium protection that, in the event of death or disability, will continue to pay your premiums for the term of your policy.
Minimum premiums: R250 a month for a 10-year policy and R2 000 for a five-year policy. You can choose to pay the premiums monthly, quarterly, half-yearly or annually. Alternatively, you can pay a lump sum of R10 000 into a flexible plan that does not require any further premium payments and does not have a fixed term.
Policy bonuses: Old Mutual will top up your policy once it is half way through the term. The top-up amount will depend on the term and will start at one percent of the policy value a year, increasing to a maximum of 2.5 percent of the value in the final year of the policy.
Annual premium increase: You can choose no premium increase, an increase that matches education inflation, or an increase that you can afford.
Costs: An administration charge of R12.30 a month. A plan charge, which includes a commission-recovery fee. The plan charge is a percentage of the value of the policy and depends on a combination of factors, such as:
* Whether you committed to paying premiums for a term or invested a lump sum;
* The size of the premium;
* The term;
* Whether you chose a life policy or invested through the linked-investment services provider; and
* Whether you selected Old Mutual funds or external funds as the underlying funds.
Here is an example of costs based on a life policy with a premium of R500 a month invested in Old Mutual unit trust funds, and a term of 15 years: The initial maximum plan charge is 3.25 percent a year, decreasing to 2.97 percent a year as the policy value grows over time.
Charge for a guarantee on the performance of the underlying funds: This varies per fund depending on the type of guarantee.
Other charges: Asset management fees, which are charged in the investment funds selected and are included in the unit price. These fees vary according to the investment funds chosen.
What happens if you stop or reduce your premiums? If the premiums are stopped or reduced on a policy with non-committed premiums, there are no fees applied for changing the premium. However, for the committed premium policies, a reduction fee or penalty and an administration fee are deducted from the policy value. The reduction fee depends on the premium size and the term, ranging between 0 and 15 percent. A 50-percent reduction in premium would result in a 7.5 percent reduction fee or penalty. The transaction administration fee depends on the policy value, but it will not be more than R300.
Sanlam: Stratus Edufocus
Minimum term: Any term between five and 20 years.
Investment: You can choose from a number of trust funds managed by Sanlam Investment Management (SIM) and other asset managers.
Risk component: A waiver benefit that will pay future premiums at death or disability can be added.
Minimum premiums: R150 a month, depending on the term and the underlying investments.
Optional extras: Investment funds that offer guarantees or smoothed investment returns.
Policy bonuses: Rebates (loyalty bonuses) for certain charges are added to the fund value on every fifth anniversary. The loyalty bonuses increase the longer the policy remains in force.
Annual premium increase: A premium increase is compulsory if the premium is less than R500 a month. You can choose an increase of between five and 20 percent a year, or an inflation-linked increase.
Costs: A monthly plan charge, a fixed and a variable administration charge, a performance guarantee fee (if applicable) and an asset management charge. There is a loyalty bonus charge structure, which returns some of the administration charges at five-yearly intervals. On a policy with a R500 a month premium and a 15-year term where the underlying investment is a SIM multi-asset unit trust fund, the charges will reduce the gross investment return by three percent a year.
What happens if you stop or reduce your premiums? There is a transaction charge of R300. In addition, there may be an alteration charge of up to 15 percent of the value of the policy, depending on the stage at which the premium is reduced or stopped. This charge starts to decrease in year two until it is zero in year five to 10, depending on the original term of the policy.
EXAMPLE
A 40-year-old non-smoking man whose child is one year old wants to save R500 a month until his child is 13.
If the man takes out death and disability cover, and assuming he is healthy and undergoes medical underwriting, Old Mutual says R73 of the R500 will go to risk life cover, while Sanlam says it will deduct R28.45. Liberty says the risk cover will cost about R90. If the policyholder adds a disability and retrenchment waiver, it will cost a further R45, Liberty says.
Sanlam says that if the policyholder wants an investment performance guarantee, he will pay between 0.5 and 1.1 percent of the annual value of the policy.
Liberty says although the cost of the guarantee depends on the specific portfolio selected, it will range from 0.75 percent to 1.8 percent a year.
Sanlam says assuming the premiums increase in line with the consumer price index (CPI) – that is, by six percent – and the policy earns a return of CPI plus two percentage points after costs, the policy value will be R158 292 when the child turns 13.
Old Mutual says it cannot provide projections on policy values, because these depend on the annual premium increases, the underlying funds and the charges.
Liberty says assuming the man invests R410 a month, with an escalation of 10 percent a year, and the policy value grows by 10 percent a year, the policy will be worth about R177 000 when the child turns 13.
It is important to note that if inflation is six percent a year, in 12 years, the R177 000 will be the equivalent of R88 000 today.
Liberty also says to achieve a 10-percent return you have to invest in a well-diversified balanced strategy. The asset allocation should be: equity, 55 percent; bonds, 10 percent; property, five percent; cash, five percent; offshore, 20 percent; and alternative investments, five percent.