In the late 1980's and early 1990's, Endowments were the belle of the ball. Now all of a sudden they are portrayed as the ugly sister of the finance industry. If you're about to buy a property you may still be offered an endowment policy to support your mortgage. If you have an endowment policy already you may have been worried by the concerns and hype surrounding these policies.
An endowment policy is simply a medium to a long-term investment plan that has an element of life insurance built into it. It is designed to produce a lump sum of money for the policyholder, or holders, at the end of its term, which is usually between 10 and 25 years.
It is most commonly used as a method of paying off an Interest Only mortgage though it is sometimes used as a stand alone long-term savings plan, independent of any mortgage arrangements.
The future of endowments is uncertain. Many carry high up-front charges, often penalise early surrender and offer results dependent on performance. Endowments come in many different types and it is important to understand the differences between them.
With Profit Endowments they do have the advantage of building up bonuses which are a form of guarantee, so long as they are left for their full term. They don't guarantee to repay the full mortgage, but once bonuses are declared they can't be taken away.
Like most investments Endowments often suffer from management charges, which can result in them often being worth very little in the early years. They should only be viewed as a long-term investment.
Unit Linked endowments are not so secure as With Profits Funds as they invest heavily into shares and equities. They normally offer a range of managed funds which depend on an increase in the unit price for growth. These prices can fluctuate and do not offer the guaranteed bonuses offered by With Profits Funds.
If you have an existing endowment plan, you may have recently received projections relating to the future repayment of your mortgage. These letters have caused widespread panic and confusion!
You should remember that these figures are only a projection. The percentage rates used within these documents are set by the industry regulator and do not reflect actual performance that has been attained. If your values do not look favourable then you should seek advice! Ask your financial adviser for the actual past performance figures for the fund you've invested in before making any decisions. Your investment may be exceeding estimates and it is possible that you may be worrying over very little.
Please remember that an endowment is a long-term investment and most of the charges were paid up front. Endowments tend to be designed to pay a large bonus on maturity, if you surrender you could lose this benefit. If you are likely to fall short in repaying your mortgage then you should consider changing part of your mortgage to a standard repayment loan. This will settle your mind in the short term and if the endowment does exceed expectations you will still receive the cash in your hand at maturity.
If you prefer not to be dependent on your endowment for repayment of your mortgage, the policy could be used as a form of "Wealth Creation" for the future. You may then elect to switch your mortgage to a standard repayment loan. This will result in higher expenses in the short-term and you should asses your monthly budget carefully before taking this route.
It is not normally recommended to cash in an endowment, as the only winner in this situation will be the product provider. If you are adamant on off-loading the policy then you should consider selling it on the Traded Endowment market. This will normally yield a higher I value for your asset, however this is only available to policy holders invested in With Profits funds.
Provided an endowment runs for at least 10 years, it is regarded by the taxman as a "qualifying policy" policy. What this means is, an endowment that runs for at least 10 years and qualifies for a tax-free payout at the end of the term.
However…
Lets get one thing straight. Endowments, qualifying or not, are not tax-free. Some advisers sometimes point out that the proceeds of an endowment are free of all taxes.
That's true, the proceeds are, however the growth of the policy has been taxed throughout its life. Therefore it's more accurate to say that the proceeds of endowments are free of any further tax liability on your part.
The tax man has already charged, he just doesn't do it twice!!!!
The life assurance company pays tax on the investment growth in two ways. First of all it pays tax at 22% on the capital gain of the assets of the fund, in other words the growth in value of the shares etc. Secondly it pays 20% tax on income, this would come from the share dividends etc.
The actual tax paid is less however, because the insurance companies are allowed to offset certain expenses against the tax bill, in effect reducing it.
For lower rate tax payers any tax paid within the fund is not refundable, this means that lower rate payers would end up paying tax they wouldn't have normally been liable to. Standard rate payers simply would be paying the equivalent tax they would of paid on alternative investments.
Higher rate tax payers have the most to gain from an Endowment contract as the tax applied to the policy is likely to work out at around 17%.
This is lower than a number of alternative types of plan.
Whether considering a new policy or contemplating the future of any existing plan don't rush your decision. As a form of building capital Endowments do meet one golden rule of saving. The strict regime of contributions provide long-term discipline, commitment that may not be provided by other savings plans. Each case should be treated individually. In the gay community we know only to well there's no accounting for taste (You know what I'm saying).
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