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Endowment policies
Wednesday, March 25, 2015 - 02:16
New deal

Using endowment policies as an investment vehicle is usually one of my most difficult “sells” as a Wealth Manager. Barry Hugo of Seed Investments says the moment a client hears the word “endowment”, the hairs on the back of his neck tend to rise and the fight or flight syndrome kicks in. “Unfortunately, this reaction is not totally unjustified. Endowment policies have a legacy of high total costs (especially in terms of commission), vague returns and conditions, and front end loading of costs. Quite often in the good old days of twenty year endowment policies, the first year of premiums disappeared in costs.”

Given all of the above, says Hugo, “and the fact that I don’t charge initial fees or use any investment products that charge initial investment fees, why on earth would I be suggesting that clients use endowments?
“The fact is that things have changed. We now have endowment wrappers with no upfront costs and transparent costs and returns. They are mainly housed on the various unit trust platforms. When the investment holder is a Trust and the investment objective is long term growth, the use of an Endowment becomes a no brainer,” he says.
Endowments are often marketed as tax free investments by unscrupulous or ill-informed advisors, this is incorrect. They are, however, often tax efficient vehicles especially when the investor is a Trust. In the table is a comparison of the current tax treatment of endowments and discretionary investments in a trust, which clearly shows the tax advantages of an endowment.

The graph illustrates the differences in tax paid by a Trust on a R 25m discretionary investment on the one hand, and through an endowment wrapper on the other. In this case the platform charged no extra fee for housing the investment in the endowment wrapper. Returns are assumed at 10% pa (6% capital + 2% income + 2% net dividend).

As can be seen, the discretionary investment has a much higher tax burden, which results in a much lower after tax return. In this instance the discretionary investor’s net investment after five years would be just over R 37m (8.2% pa), while the endowment’s net investment after five years would be just over R 39m (9.3% pa).
There are restrictions when using the endowment in that you are only allowed one withdrawal in the first five years and that withdrawal is restricted to the contributions plus 5% per annum growth (some companies also allow an interest free loan). But endowments have the added advantage that the taxes are paid by the wrapper so income does not need to be included in the Trust’s tax return. This means that nasty income tax surprises are avoided.
“So when your wealth manager wants to use an endowment wrapper to house your investments hear him out. If, however, returns are opaque and costs are difficult to explain and understand think carefully,” warns Hugo.

Copyright © Insurance Times and Investments® Vol:28.3 1st March, 2015
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