For many younger investors and IFAs, the idea of endowment policies seems a little old fashioned. These were vehicles that our grandparents used before collective investment schemes effectively democratised investing.
Their reputation was also sullied by product providers who made them opaque and charged prejudicial early termination charges and high fees. However, the market has changed, and endowments are no longer the ‘black boxes’ that attracted so much criticism.
“From the mid-1990s the insurance industry revamped the disclosures as well as the underlying assets that fit these products,” says Peter Dempsey, deputy CEO of ASISA. “The modern endowment has very similar disclosures to what a unit trust fund would have, and in some cases even has similar underlying assets. They are also competitively priced.”
The question then arises whether there is still an argument for using these products? Dempsey believes there is, but only where the circumstances warrant it. This is because endowments do have certain benefits and, where they align with client needs, there is a place for them in a financial plan.
“I don’t think endowments’ time has come and gone,” Dempsey says.
The most important consideration is that, by their nature, endowments demand a certain level of discipline. The policy-holder cannot access the money for a set period of time, and if they are making monthly contributions, these have to be maintained, or causal event charges will be levied. This does restrict liquidity, but the positive is that it can prevent people from dipping into savings to fund their lifestyle.
This makes endowments particularly appropriate for long-term goals such as saving for a child’s education. According to a recent analysis done by PPS Investments, an average four-year university qualification for children born in 2015 could cost R1.2 million by the time they reach 18. That kind of target is unlikely to be reached if the savings pool is eroded along the way.
The second important consideration is that you can add insured benefits to endowments, such as premium waivers in the event of death or disability. This must of course be weighed up against a client’s existing life insurance policies so as not to over-insure, but it can again be important when saving for something like a child’s education.
Thirdly, endowments can hold assets that are not available in the CIS space. This includes private equity funds, infrastructure funds or guaranteed funds that can have positive diversification benefits.
The tax treatment of endowments is also worth bearing in mind.
“In an endowment product the growth within the fund is taxed in the fund at the rate applicable to the insurance company’s policy holder fund, which is typically 30%,” Dempsey explains. “The amount that is paid out at maturity is then an after-tax amount. So for people whose tax rate is above 30% the tax treatment can be attractive.”
This does however require a thorough analysis to make sure that it will be beneficial. With RDR there is also a chance that the tax benefits will be removed from endowments anyway to level the playing field with other investment products.
RDR will influence another characteristic of endowments, which is that 50% of the adviser’s commission can currently be front-loaded. IFAs therefore have to think carefully about whether they continue to offer endowments on this basis, or if they move pro-actively and enhance the value of their practices by switching to as-and-when commission.
Either way, what IFAs can’t afford is to put their own interests ahead of those of their clients. And that means using endowments sparingly and wisely, and only when they are serving a clear purpose.
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