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
A new-generation endowment is an investment product that offers attractive tax benefits to investors in higher tax brackets who can stay invested for five years or longer. Unfortunately, many investors remain unsure or sceptical of investing in these products, due to the negative associations with old-generation endowments that traditionally charged high fees and offered lacklustre returns. However, given recent capital gains tax (CGT) increases, now may be the perfect time to consider including an endowment in your investment portfolio.
Old-generation life endowment policies explained
New-generation endowments allow you to structure your investment freely
Life insurance companies initially offered traditional endowments only, which are policies with both a life insurance and an investment component. You pay your contributions over the course of your policy term, for which you then receive life cover and have a lump sum paid out to you 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 you try to access your money before the end of the investment term. Furthermore, fees are often difficult to understand or determine.
Older-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 you can switch freely between these at any time without cost. You are also not restricted to maximum levels of equity and offshore instruments, as is the case with retirement savings products. However, it is important to understand that the value of your investment is not guaranteed since it is linked to the market value of the underlying instruments you choose.
New-generation endowments are more cost effective and flexible Endowments, especially those offered by investment platforms, have evolved over the years and many have become much more investor-friendly. Fees of new-generation endowments are now transparent, and there are no longer any surrender or early termination penalties attached to these products. There are, however, restrictions on the withdrawals you can make in the first five years: you 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 South Africans are notorious for not saving enough. Endowments encourage disciplined saving, because you contribute regularly to build your investment up over time. The investment can then be used for a significant cash requirement (such as university fees) at the end of the five-year period.
Contributions are flexible You can choose to make a lump sum investment, regular debit order investments or a combination of the two. You can also add a lump sum at a later stage, provided it adheres to the ‘120%’ rule. This states that an additional lump sum contribution may not exceed 120% of the amount invested in either of the preceding two years (the higher of these two amounts will apply). If so, a new five-year restriction period is triggered.
High-income earners can benefit For high earners with marginal tax rates greater than 30%, an endowment is an attractive investment alternative. Endowments are taxed on income at a flat rate of 30%. This means that any interest income from the investment is taxed at 30%, compared to the maximum marginal rate of 41% for individuals. Investors 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 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.) For more information on the PSG Wealth Endowment, please click here. It is also a good idea to get professional financial advice before you make any financial commitments.
FIRST QUARTER 2016