By Jan van der Merwe
CREATING a financial legacy for your children requires you to start early. It also requires investment discipline.
A product that may help increase the level of discipline in your investment process is an endowment. This article explores the way in which an endowment product can help you create a financial legacy.
Basic features and benefits of an endowment
Endowments are investment contracts issued by life companies. They offer access to a range of underlying investment options, including unit trust funds and, in some cases, share portfolios.
The key features of endowments are:
They have an initial “restriction period” of five years. Investors have limited access to the funds within this restriction period. This aspect introduces a level of “forced discipline” in keeping your savings invested.
- Contributions to an endowment can be made as a lump-sum or recurring premiums – it depends on the options offered by the product provider.
- Tax on investment returns is paid by the life company on behalf of the client at a rate of 30 percent.
- Endowments can be useful in providing insolvency protection. Given that certain criteria are met, the entire investment can be protected against creditors after a three-year period.
- Endowments, unlike retirement fund savings, are regarded as discretionary investments and are therefore not subject to Regulation 28 requirements. This may be useful in increasing offshore investment exposure within your investment portfolio.
Estate planning benefits of endowment
Endowments are also beneficial when it comes to estate planning. This investment product allows for nominated beneficiaries to receive the proceeds directly instead of having to wait for the estate to be wound up. Alternatively, you can nominate a beneficiary for ownership to inherit the investment and become the new policyholder should you pass away. In addition, the executor’s fees will not apply to the proceeds of an endowment.
Using endowments to help realise tax savings
With increasing tax rates, it is important to consider products that may help you manage your effective tax. With an endowment product, tax is paid by the life company on your behalf, at a rate of 30 percent. Individuals with a marginal tax rate above 30 percent may therefore benefit from using the endowment structure. To illustrate this, we include an example below that highlights the cumulative tax saving realised by investing R1 million in an endowment (compared to an investor in a voluntary investment) at various marginal tax rates and rates of return. We also include an example of a trust with natural persons as beneficiaries.
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Comparing after-tax outcomes in an endowment to after-tax outcome in a Voluntary Investment Plan (VIP). Assumes the above investor withdraws after five years, with no withdrawals/loans within the first five years; assumes investors in VIP has exhausted all tax exemptions. Assumes a 25/75 percent split between income and capital gains.
Addressing the perceived drawback: lack of access
Endowments restrict the maximum amount that can be accessed in the first five years to capital contributions accumulated at 5 percent a year. They therefore introduce a form of “forced discipline” to keep your savings invested. However, they do offer limited access within the restriction period, by means of a loan and/or once-off withdrawals. During the initial restriction period, you can make one loan from your investment without being charged interest. You can also make one withdrawal without having to pay it back. Hence, funds are not completely inaccessible within the first five years. Please note that access options may differ between providers.
As always, before investing, talk to your financial adviser.
Jan van der Merwe is head of actuarial and product at PSG Wealth
Editor’s note: Be aware that endowment policies are contractual products and that if you break the contract by not keeping up with contributions or withdrawing your money before the end of the investment term, you may be liable for a penalty.
PERSONAL FINANCE