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You might not know this but we write articles for other newsletters as well. Below is an article I wrote about endowment investment policies which I thought was too good to not publish on our own InsuranceFundi site. Why do I think it’s great? Simply because it explains why certain people should stay away from endowments while others shouldn’t!

So here goes…

Okay, maybe you find yourself in a situation where you’re already contributing the maximum tax allowable contribution towards your retirement annuity, but you’d like to save even more towards retirement?
So while investing in a retirement annuity makes sense, you’re not too comfortable with the fact that:

  • you can only withdraw one third at retirement, and
  • any income from this annuity will be taxed

What about an endowment policy?

Well the great thing about endowment policies is that the benefits tax-free on maturity.
Let’s imagine for a moment that you have accumulated a hefty lump sum in your endowment. You have the option of taking the lump sum in cash absolutely tax-free or you can allow the investment to continue growing while partially surrendering a portion each year in order to provide tax free income.

Now this doesn’t mean to say that endowments are completely tax-free!
You see, the investment company pays the tax within the investment. What happens is that they pay tax on gross interest and net rental income earned by your investment at a rate of 30% per annum. 25% of any capital gains is also taken into account by them and taxed at 30%.Basically 7, 5% of the capital gain is paid as tax (25% of the capital gain is taken into account for natural persons. In the case of a company owned policy, 50% of any capital gain is taken into account). The good thing here is that the investment company handles all the tax issues!

Feeling a little disappointed? You shouldn’t be!
Consider for a moment those whose marginal tax rate is currently sitting at 35%, 38%, or at 40%…Owning this investment in their personal capacity would mean being taxed at between 35% and 40%.
Of course, if your marginal tax rate is lower than 30%, it doesn’t make sense for you to own an endowment and you need to explore other options.

What you also need to know about endowments…

All endowments have what is known as a five-year restriction period.
What this means is that the insurance or investment company is not allowed to

  • fully surrender the investment or
  • loan the full investment value to the investor

Within the five-year restriction period (which starts from inception of the investment).

During this restriction period you, as the investor, are only entitled to the lesser of market value or premiums paid in by you plus 5% compound interest.

Watch out for this…

Never increase your premium by more than 20% over that of the previous year. This is known as the 20% rule (or 120% rule depending on who you ask!). Why not?
Doing so would result in a new five-year restriction period being applied from the date of increase.

Here’s an example:
In 2000, the client takes out a R200 a month endowment policy. This has a restriction period valid until 2005.
In 2004, the client increases the premium to R250 per month. Since this is more than 20%, a new five-year restriction period commences, which means that the full proceeds are only available in 2009.
What this client should have done is take out a brand-new endowment policy! This would then have allowed the client to access the full proceeds of the first endowment policy in 2005.

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