Endowment Explained - Life Assurance Savings Plans
Lump sum investments: No
Regular premiums allowed: Yes
Flexible payments allowed (stop/start/additional/increase/decrease): No (unless mortgage shortfall)
Changing funds and risk profile allowed: Yes
Moving to another company allowed: No
Life Insurance Included: Yes
Personal Tax Benefits:
- Tax free pay out on maturity or death (provided complies with normal qualfying rules)
- Investment fund pays taxes before you receive returns
Can be held inside Trust: Yes
- Basic Rate Tax Payers
- High Rate Taxpayers
Insolvency Compensation Limits:
- Insurance Company Funds - 90% of total funds invested. No Limit.
A Brief Description:
Life Assurance savings plans are endowment policies. These are effective savings plans and are good for tax payers as the benefits are paid tax free, provided qualifying rules are not breached. Most people associate endowment policies with mortgages and these have received poor press given that they use up valuable premiums to offer and pay for higher levels of life cover and that investment return assumptions were too optimistic. It is possible for endowment policies to be taken out, even if you do not have a mortgage with low life cover requirements to deliver potentially excellent returns.
Endowment savings can sometimes be a tricky subject if you don't understand them, contact us for help.
Types of Endowments
1. Conventional With Profits
- Most older style, conventional with profit endowment policies have a set amount (known as the minimum sum assured) which would be payable on maturity.
- During the term of the policy, bonuses are added as a percentage of that sum assured and that's how the value of the policy grows.
- If a terminal bonus is to be added at maturity or on death, it will also be calculated as a percentage of the minimum sum assured.
- Unitised With Profits
- Some newer profits funds are set up as unit linked funds, where the fund is split into units and your investment premiums buy shares or 'units' in the fund. As the value of the investment fund grows and hopefully, its profits, either the price of each unit goes up in value, much like a share price, or you receive your bonuses in the form of additional bonus units being added to your policy.
- Death Sum Assured for both types of with profits endowment
- In addition, and not to be confused with the minimum sum assured or the unit prices and value, endowment policies have a death sum assured, this is the guaranteed amount that would be paid out on death of the policyholder within the term.
2. Unit Linked Endowments
- Unit linked endowments are alternatives to with profit endowment plans although it is possible to have a link to a unit linked version of the with profits fund called unitised with profits.
- Unit linked endowments can invest in a range of funds such as managed, property, stockmarket, cash and fixed interest funds.
- These funds are seperated into units, much like shares in a company and each time you pay a premium you buy some more units.
- The premiums that you pay on either a monthly, quarterly or annual basis buy units in the fund of your choice and are given a value.
- This value can fluctuate on a daily basis, depending on how much the underlying assets of the fund are worth e.g. the fund might own a shopping centre or be invested in the stockmarket. As this rises or falls, so does your share price or unit price.
- Every time you pay a premium you buy more units. The value of your policy at any given time is the number of units you hold, multiplied by the current price of those units.
3. FAILED Endowments - Low cost endowments are aimed at mortgage repayment.
- They are with profits endowment policies with different investment sums assured (the guaranteed maturity pay out).
- These plans then have a generally lower 'investment' sum assured included in them to which with profit fund bonuses are added throughout the life of the plan.
- The idea is that the mortgage could be repaid at any time in the event of death and that the amount of bonuses added throughout the term should be enough to repay the outstanding loan.
- In addition, they have a death benefit sum assured, which is the guaranteed pay out on death within the term.
- Some companies have even offered low start versions of these plans, meaning that the premiums start at a low level and increase over possibly five or ten years. The attraction of this was that the premiums are lower in the early years. Many people have fallen foul of this and now have shortfalls.
- Endowment policies have been criticised heavily in view of projected payout shortfalls, especially if they were taken out in connection with a mortgage over the last fifteen years.
- The criticism comes because of general changes in our economy.
- At the moment interest rates and inflation are relatively low, meaning that investment returns are also relatively low compared to when you started your endowment mortgage.
- The knock on effect of this is that bonuses paid by life assurance companies have reduced and so have the investment projection rates used by those companies to show possible future projections of growth.
- Terminal bonuses have generally stayed the same meaning that there is a greater reliance on the Terminal bonus to produce enough to repay the mortgage, without premiums having to be increased during the term or other steps taken to ensure the mortgage is repaid.
Assumptions were too high:
- Investment assumptions were much higher in the past meaning that it was assumed that you could pay less into a plan and still acheive the investment target to pay off the mortgage.
- Investment and interest rate returns have fallen since but people have not saved more to compensate. This results in a shortfall.
What to do if you have a shortfall:
- You may consider complaining to the person that arranged your endowment.
- You cannot complain about poor investment performance.
- You can complain about not being told about the risk of shortfalls or poor investment returns.
- Whether you have a valid complaint or not, you must take remedial action with your mortgage repayment plans.
4. Sell Your Endowment?
- If you have an endowment policy, are you thinking of cashing it in? If so, have you thought about selling it instead?
- If not, you should consider it, it could mean more money for you.
- The Traded Endowment Market gives you the choice to either cash in or sell your policy. They are also known as Traded Endowment Policy (TEPs) and Second Hand Endowment Policy (SHEPs)
If you answer yes to the following questions, your endowment policy could be suitable for sale:
- Is it a with profit endowment or with profit whole of life policy?
- Has it already completed at least five years of its term?
- Is the current surrender value at least £1,500?
Sell Your Endowment Form
- If you answered 'yes' to the above, complete our on line valuation form and we can search the various dealers and traders for you to find out how much you could sell your policy for.
Lost Life Cover: What if you cancel/cash in/sell?
- If you are considering or have already sold or cashed in your endowment policy, do you need to replace the valuable life assurance cover it provided?
- If you do, visit our Life Cover section to learn more about the different types of cover or get a quotation for life insurance cover now!
Taxes On Encashment
- Endowment policy proceeds are normally paid tax free but , if you cash in your endowment early and breach qualifying rules, you may incur a tax liability. Find out more about qualifying rules.
What About Buying A Traded Endowment Policy?
- Buying Traded Endowment policies can be a way of obtaining a relatively low risk investment with the prospect of good returns. If you buy a policy part way through it's term, it is likely that the effect of the charges in the early years has already been borne by the original investor.
- The new purchaser also has the benefit that whatever With Profit bonuses have been added to the policy, they cannot be taken away.
- There is normally a wide range of policies to choose from, meaning that you can buy one within your budget and usually for the maturity date that you want. If you do not wish to keep the policy, simply sell it on again.
Once bought, a second hand traded endowment policy is not tax free.
Once you have bought a Traded Endowment policy you will be responsible for paying the remaining premiums. These types of policy include an amount of life assurance cover which will pay out to you if the original owner (and life assured) dies during the term. For this reason, it is always good to keep in touch with the previous policy holder. However, as these policies are formally assigned from the old to the new owner, the provider of the policy will be aware that you have purchased the policy.
- If you are the original beneficial owner of the policy that you are selling, you will not be liable to capital gains tax.
- If you hold a qualifying policy and sell it after ten years (or three quarters of its term whichever is less) the sale will not trigger what is known as a chargeable event and there will be no income tax to pay. If you sell your policy within 10 years or three quarters of its term, it will no longer be classed as a qualifying policy and will trigger a chargeable event.
- Non qualifying policies will always trigger a chargeable event.
- If you are already a higher rate taxpayer or the sale proceeds (after top slicing) make you one, there will be income tax to pay of 20% on the gain.
If you buy a qualifying policy and then hold it to maturity or the person whose life the policy was written on, dies, a chargeable event will not be triggered and there will be no income tax payable.
Non qualifying policies will always trigger a chargeable event.
The chargeable gain is worked out by adding up the premiums paid by the seller and the buyer and deducting the maturity value or surrender value immediately before death. Remember, it doesn't matter what you actually paid for the policy, only the regular premiums are taken into account.
If there is a chargeable gain, you as the buyer will pay income tax at 20% if you are a higher rate taxpayer or the top slicing exercise makes you one.
Capital gains tax is also a possibility for buyers. It is not normal for the same policy to be liable to income and capital gains tax - one offsets the other.
However, if capital gains taxis due you as the buyer can deduct what you paid for the policy and also any expenses that you incurred during the purchase. Taper relief may also be available.
Remember that each person has a capital gains tax allowance each tax year. If the gain is less than your allowance (taking into account any other gains you may have realised in the tax year) there will be no further tax to pay.
For help and advice with buying and selling endowments, speak to us.
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