INVESTING AND TRADING The evolution of endowments – and why they’re now more relevant than ever
Shaun van den Berg Head of Client Education PSG Wealth
Given recent capital gains tax (CGT) increases, a new-generation endowment has become even more attractive for medium- to longterm investors in higher tax brackets. Unfortunately, many investors are sceptical of investing in these products due to the negative associations with old-generation endowments that traditionally charged high fees and offered lacklustre returns. This is a good time to review this investment alternative for your higher-earning clients. This article will explain the product features and show how endowments have evolved over time.
Then: old-generation endowment policies Life insurance companies initially offered traditional endowments only, which are policies with both a life insurance and an investment component. Investors pay their contributions over the course of their policy term, for which they then receive life cover and have a lump sum paid out to them at the end of the set period. However, the portion of the premium allocated to life cover became larger over time due to the increased mortality experienced in the face of the AIDS epidemic. This often meant that little to nothing was invested. As a result, endowments without life cover were later introduced to separate life risk and investment risk. However, in many instances the endowments offered by life insurance companies may still pose high fees, especially in the form of early-termination penalties if investors try to access their funds before the end of the investment term. Furthermore, fees are often difficult to understand or determine.
Now: new-generation endowments are more cost-effective and flexible Endowments, especially those offered by investment platforms, have evolved over the years to become much more investorfriendly. Importantly, the fees of new-generation endowments have become far more transparent and there are no longer any surrender or early-termination penalties attached to these products. There are, however, restrictions on the withdrawals an investor can make in the first five years – investors are restricted to one interest-free loan or one surrender (some product providers, such as PSG Wealth, offer access to both). The maximum withdrawal during this period is limited to the capital amount invested plus interest at 5%. No restrictions apply after five years.
Endowments encourage disciplined saving A further benefit is that endowments encourage disciplined saving, as investors contribute regularly to build their investment up over time. The investment can then be used for a significant cash requirement at the end of the minimum five-year period.
New-generation endowments allow investors to structure their investments freely Old-generation products often restrict investors to the funds offered by the life insurance company, although certain companies have started to make other funds available as well. In contrast, a new-generation endowment offers a far wider range of underlying investment options. For example, the PSG Wealth Endowment offers access to 484 unit trust investment options on the PSG Wealth platform, and investors can switch freely between these at any time without cost. Investors are also not restricted to maximum levels of equity and offshore instruments, as is the case with retirement savings products. However, it is important for clients to understand that the value of their investment is not guaranteed as it is linked to the market value of the underlying instruments they choose.
New-generation endowments offer flexible contributions Investors can choose to make a lump sum investment, regular debit order investments or a combination of the two. They can also add a lump sum at a later stage, provided it adheres to the ‘120% rule’. This rule states that an additional lump sum contribution by an individual investor may not exceed 120% of the highest total amount invested in each of the preceding two years. If so, a new five-year restriction period is triggered.
An attractive alternative for high-income earners Endowments are taxed on income at a flat rate of 30%, which makes them an attractive investment alternative for investors with a marginal tax rate of more than 30%. Any interest income from the investment is taxed at 30%, compared to the maximum marginal rate of 41% for individuals. Investors in endowments also qualify for a lower CGT rate of 12.0%, compared to the maximum rate of 16.4% for individuals invested in a standard unit trust-based investment. Furthermore, if the endowment is
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part of a trust with only natural persons as beneficiaries, then CGT will be charged at an effective rate of 12.0%, compared to the 32.8% effective CGT rate for trusts. (Read more about the tax and estate planning benefits of endowments in Waldo’s article.)
Consider discussing the benefits of an endowment with your clients Endowments have gained renewed relevance in light of the 2016/2017 Budget. For more information on the PSG Wealth Endowment, please click here.
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