MCA Endowment Policies

Endowment Policies – Seek advice first

Endowment policies have over the years had a lot bad press because of high costs and a lack of transparency, but newer-generation endowments are more transparent and have lower costs, so it is certainly advantageous to look into them considering the financial life stage and tax position you are currently at.

Old Generation Endowment Policies

Although the environment has changed and legislation now forces financial services providers to give customers appropriate advice, disclose costs and put their interests first, there are still many thousands of South Africans who are chained to the old “legacy” contractual policiesthat have high costs that were not disclosed; disappointing investment returns; and have penalised customers for breaking the contract through ending it early or reducing or stopping the premiums.

Those who are stuck in the old legacy retirement annuity (RA) or endowment policies and want to get out would have to decide on whether to take the knock of the penalty versus the costs of staying invested until maturity. Seeking guidance from a professional (and independent)Certified Financial Planner (CFP)who are members of the Financial Planning Institute (FPI)and obtain the Postgraduate Diploma in Financial Planning(or higher); will enable customers and/or clients to make an informed and appropriate decision based on their financial situation.

New Generation Endowment Policies

With the emergence of tighter regulation and increased competition, life companies have started to design and market new and improved investment products, including endowment policies, that, until recently have far more attractive benefits.

The new-generation products have lower costs, are more transparent, with greater choice of underlying investments, and are less onerous in terms of contractual conditions, offered through independent financial advisors by both the traditional life companies and some of the bigger asset managers that have a life assurance licence, such as Allan Gray & Momentum Wealth.

The Advantages

If the endowment policy has a life assured (a person on whose death the invested amount is paid), it is possible to add a beneficiary (only if you do not name any beneficiaries, will it pay into your estate). This has the advantage that on the death of the life assured, the policy pays directly to the beneficiary. This means that, although the policy is still an asset in the estate for estate duty purposes, the proceeds do not physically form part of the estate, and therefore avoid executor’s fees. The proceeds can also pay out immediately to beneficiaries on death and avoid the delay and complexity of having to be wound up with the rest of the estate assets.

If dealing with an Insolvent estate, in terms of the Long-Term Insurance Act, and a policy has life cover, and was effected by the insolvent on their own life or that of their spouse, and was in force for a minimum of three years prior to the date of an insolvency, such a policy would be protected against creditors. This protection will continue until five years after the termination of the policy.During the restriction period, you are allowed a single withdrawal.

Access to smoothed-bonus portfolios. Endowment policies allow you to access smoothed-bonus portfolios offered by the life companies. The objective is to provide you with market-related returns but without volatility, by holding back returns in good years in order to boost returns in bad years.

1. Tax relief for high-earners– Assuming you, as a natural person, own the policy, the life assurer through its policyholder fund will apply the following fixed tax rates: 30% on any income earned and 12% on any capital gains made. The life assurer will pay this tax on your behalf through what is known as the five-fund approach, but the tax will be recovered from your portfolio. These tax rates are lower than the top marginal rates for individuals, which are 45% on income and 18% on capital gains. This means that individuals that pay tax at a marginal tax rate of 45% (highest), will potentially have their tax rates reduced by investing in an endowment policy. The saving doesn’t take into account your annual tax exemption on interest or the CGT exclusions, so the benefits would become apparent only once you had exhausted these exemptions. Trusts, other than special trusts, would pay also 30% tax on income and an effective 12% (instead of 36%) on capital gains.
2. The tax issues around investing in a particular wrapper are complex. An endowment policy might be the right vehicle for you, but it all depends on your personal and tax circumstances.
3. Switching– If you invest in funds through an investment platform and you switch between investments during the tax year, CGT will be payable. However, if you are invested in an endowment policy and you switch between underlying investments, this CGT will be paid from your portfolio, which means you won’t be faced with a cash flow problem.
4. Multiple unit trusts– Holding units via the endowment wrapper offers tax-compliance benefits and makes your tax return much simpler, as all the tax is paid by the life assurer directly via its policyholder’s fund and there is nothing for you as an individual to pay. Normally, if you held these different investments personally, your tax return at tax year-end would be extremely complex and
5. There is no restriction on maximum levels of equities and offshore investments, as is the case with retirement-saving products (Regulation 28).

Where Endowments are not appropriate

The tax rate for the individual policyholder is fixed at 30% for income gains and 12% for capital gains. This means that if you have a lower tax rate than this, it would not make sense for you to invest via an endowment policy, as you would then be increasing your tax rate. In this case, having a tax rate that is lower than the endowment rate, it would better suit an individual to invest in a unit trust instead.

As an individual, you do not qualify for your tax rebates if you invest in an endowment policy, as you are not the taxpayer, the fund is. This means that you cannot make use of your R23 800 interest rebate – assuming you are under the age of 65 – or your annual R40 000 CGT exclusion. These rebates will not be available to reduce the tax in your endowment portfolios and if you aren’t using them for other investments, it is a missed opportunity to reduce your tax. You could, however, use these rebates for a unit trust investment.

Finally, although companies have different products and different rules around loans, generally access to the money in an endowment is limited to one partial or full withdrawal in the first five-year period. The overall amount that can be taken is also limited by a formula. This issue is complex and should always be discussed with your financial advisor.