In recent years, endowments have gained popularity as an investment vehicle in the South African market. These unique investment vehicles offer a range of benefits to investors, including tax advantages to middle and high-income earners as well as estate planning benefits. In this article, we will explore what endowments are and how they work, while unpacking the advantages and disadvantages of this product in next week’s article.
The Basics of How an Endowment Works
An investor can either invest a lump sum of money into an endowment product or they can make regular contributions to the policy. Endowment policies are offered to investors by an insurance company, and it has a set term, usually ranging from five to thirty years. Depending on the product provider, there is usually a wide range of underlying investments that the investor can choose to invest in, and it is generally easy to switch the investment into different unit trusts and asset classes.
At the end of the policy term, the investor receives a lump sum pay out, which consists of their original investment plus any investment returns earned over the term of the policy. These policies are popular with investors who want to save for a specific goal, such as a child’s education or a down payment on a home, while enjoying some measure of protection against market downturns.
What Happens to the Policy in the Event of the Policy Holder’s Death?
In the event of the investor’s death during the policy term, the endowment can either pay out a death benefit to the investor’s beneficiaries or the nominated beneficiary can take ownership of the policy. An endowment can therefore be a strategically beneficially product to use from an estate planning perspective since the beneficiary of the endowment would not have to wait for the estate to be wound up before they can get access to the funds in the policy. This is an important consideration because estates can take years to be wound up, often leaving financial dependents of the deceased in great financial difficulty due to liquidity constraints. It is however important to point out that although the death benefit of the endowment is considered as part of the estate for estate duty, it is excluded when calculating executor’s fees.
Withdrawals
It is important to note that endowments are generally considered to be a long-term investment, and there are specific rules restricting how much and when withdrawals can be made from the policy.
An endowment is limited to one withdrawal and one loan within the 5-year restricted term. The withdrawal or loan is limited to the number of total contributions made plus interest at a rate of 5% per annum. If a loan is taken, it does not have to be paid back in the 5-year term but can be added back to the endowment.
After the 5-year period, the investor is no longer in the restriction period and may withdraw any amount, at any time. Regular monthly withdrawals are also allowed to be instated after this 5-year period.
Tax benefits of Endowment Policies
In South Africa, endowments also offer some tax benefits. Any income earned within the product is taxed at a flat rate of 30% meaning that investors who have marginal tax rates higher than 30% will be able to take advantage of this flat marginal tax rate. Any capital gains accumulated in the product are therefore also taxed at a flat rate of 12% which will also be beneficial to any investor with a higher marginal tax rate than 30%.
Another benefit investors appreciate about endowments are that they can assist in simplifying your tax administration. This is because the tax is recovered within the endowment and taken care of by the policy provider on behalf of the investor. The investor does not have to declare any investment income or growth on their personal income tax return.
Can you invest in Offshore Endowments?
It is also possible for investors to invest directly in offshore investment vehicle called an ‘Offshore Wrapper’ which has similar tax and estate planning benefits to a local endowment.
An Offshore Wrapper has an additional benefit for investors concerned about the depreciating rand, since the capital gains tax payable is calculated on the foreign currency growth of the investment and not the on the rand value.
Endowments are a unique investment vehicle that offer investors a range of benefits. Not only do they provide a tax-efficient way to save for the future, but they are also effective vehicles to provide liquidity as part of an estate planning strategy. These policies are also flexible and can be customised to meet the unique needs of each investor. In next week’s article we will break down all the benefits and drawbacks of investing in an endowment to ensure that you, as an investor, make an informed decision before deciding if this product fits your investment needs.
