MSN Money staff
January 01 2005
January 01 2005
What is an endowment?
Endowments are another example of life assurance products acting as a wrapper for basic investments. They are regular-premium savings plans in which payments are made monthly for a minimum of ten years. The money is invested, usually in a selection of stocks and shares, and at the end of the agreed period the investor receives a lump sum, free from all taxes.
Endowments also have an element of life insurance cover, that will pay out a lump sum if the investor dies before the agreed term. The amount paid out on death is usually a minimum of 75% of the premiums paid during the term of the plan, as this enables the plan to be "qualifying" for Inland Revenue purposes and therefore free of taxes when the policy matures.
Endowments also have an element of life insurance cover, that will pay out a lump sum if the investor dies before the agreed term. The amount paid out on death is usually a minimum of 75% of the premiums paid during the term of the plan, as this enables the plan to be "qualifying" for Inland Revenue purposes and therefore free of taxes when the policy matures.
The different types of endowment
With-profit
Unit-linked
Low-cost
With-profit endowments
A traditional with-profit fund takes premiums from the members of the fund and invests them in a range of investments: for example, 50% in UK equities, 30% in overseas equities, 5% in property, and 15% in fixed-interest investments.
In exchange for an agreed premium the insurer will guarantee a certain sum on the maturity date of the plan or earlier death of the policyholder. This is usually described as the "sum assured". Each year the actuary of the insurance company assesses how well the investments have performed and then declares a "reversionary" bonus which is then applied to the sum assured, increasing the guaranteed return at the end of the plan. Once added, this bonus cannot be taken away. The attractive feature of with-profits endowments is that the bonuses act to smooth the ups and downs of the stock market.
Traditional with-profits funds are becoming less common, however, and are being replaced by "unit-linked" with-profits endowments. A unit-linked with-profit fund, like a traditional fund, is designed to smooth out the investment returns from asset-backed investments over the longer term. Unlike traditional endowments, however, unit-linked with-profit funds only have a sum assured for death-benefit purposes. Money invested buys units within the with-profit fund. When the endowment provider declares the reversionary bonus it is expressed either in terms of a rise in the value of the with-profit unit price, or it purchases additional units where the units are all valued at £1.
Most with-profits funds provide a final or "terminal" bonus paid at the maturity of the plan. This bonus is designed to reflect the capital growth of the fund during the savings period over and above the bonuses already added to the fund. Terminal bonuses can represent as much as 60% of the total return on with-profit endowments--which means that savers who cash their plans in early miss out on much of the benefit of being in a with-profits fund. Unfortunately, the saver has no guarantee what the terminal bonus will be until the maturity proceeds are paid.
Unit-linked endowments
A unit-linked endowment places the saver's money into the insurance company's range of unit-linked funds. When the plan is first taken out, the saver is given a choice of funds from which to pick, but nearly all choose either the with-profit or the managed fund. Managed funds are typically invested 60% into UK equities, 10% into fixed-interest investments and 30% into overseas equities.
Part of the monthly savings premium pays for the life assurance provided by the plan, and the remainder of the investment (less charges) is placed into the fund of the investor's choice. At the end of the savings period the proceeds of the plan are tax-free. Unlike traditional with-profit endowments, where once bonuses are declared, they cannot be taken away, equity-backed endowments provide no guarantees as to what benefits will be achieved. Therefore unit-linked endowments have a higher risk level than with-profits endowments.
Low-cost endowments and endowment mortgages
A low-cost endowment is a combination of a life assurance plan and an endowment savings plan. They are usually sold as a way to build up a lump sum to pay off a mortgage, and may also be called "house purchase endowments".
A saver who takes out an endowment mortgage pays only the interest on the mortgage, not the capital sum. The endowment, usually a 25 year savings plan, is then used to build up sufficient capital to repay the capital sum. If the endowment generates more funds than the amount of mortgage outstanding, then the investor receives the surplus tax-free. If the amount is not enough, the investor has to make up the difference.
Endowments were very popular in the 1980s as a way to pay off a mortgage, but declined steeply in popularity during the 1990s as interest rates fell and the endowment proceeds often did not cover the repayment of the mortgage.
Life insurance companies now review the progress of an endowment every five years and if the amount generated is not on track to repay the mortgage will write to the investor to ask them to increase the premiums paid.
Unit-linked
Low-cost
With-profit endowments
A traditional with-profit fund takes premiums from the members of the fund and invests them in a range of investments: for example, 50% in UK equities, 30% in overseas equities, 5% in property, and 15% in fixed-interest investments.
In exchange for an agreed premium the insurer will guarantee a certain sum on the maturity date of the plan or earlier death of the policyholder. This is usually described as the "sum assured". Each year the actuary of the insurance company assesses how well the investments have performed and then declares a "reversionary" bonus which is then applied to the sum assured, increasing the guaranteed return at the end of the plan. Once added, this bonus cannot be taken away. The attractive feature of with-profits endowments is that the bonuses act to smooth the ups and downs of the stock market.
Traditional with-profits funds are becoming less common, however, and are being replaced by "unit-linked" with-profits endowments. A unit-linked with-profit fund, like a traditional fund, is designed to smooth out the investment returns from asset-backed investments over the longer term. Unlike traditional endowments, however, unit-linked with-profit funds only have a sum assured for death-benefit purposes. Money invested buys units within the with-profit fund. When the endowment provider declares the reversionary bonus it is expressed either in terms of a rise in the value of the with-profit unit price, or it purchases additional units where the units are all valued at £1.
Most with-profits funds provide a final or "terminal" bonus paid at the maturity of the plan. This bonus is designed to reflect the capital growth of the fund during the savings period over and above the bonuses already added to the fund. Terminal bonuses can represent as much as 60% of the total return on with-profit endowments--which means that savers who cash their plans in early miss out on much of the benefit of being in a with-profits fund. Unfortunately, the saver has no guarantee what the terminal bonus will be until the maturity proceeds are paid.
Unit-linked endowments
A unit-linked endowment places the saver's money into the insurance company's range of unit-linked funds. When the plan is first taken out, the saver is given a choice of funds from which to pick, but nearly all choose either the with-profit or the managed fund. Managed funds are typically invested 60% into UK equities, 10% into fixed-interest investments and 30% into overseas equities.
Part of the monthly savings premium pays for the life assurance provided by the plan, and the remainder of the investment (less charges) is placed into the fund of the investor's choice. At the end of the savings period the proceeds of the plan are tax-free. Unlike traditional with-profit endowments, where once bonuses are declared, they cannot be taken away, equity-backed endowments provide no guarantees as to what benefits will be achieved. Therefore unit-linked endowments have a higher risk level than with-profits endowments.
Low-cost endowments and endowment mortgages
A low-cost endowment is a combination of a life assurance plan and an endowment savings plan. They are usually sold as a way to build up a lump sum to pay off a mortgage, and may also be called "house purchase endowments".
A saver who takes out an endowment mortgage pays only the interest on the mortgage, not the capital sum. The endowment, usually a 25 year savings plan, is then used to build up sufficient capital to repay the capital sum. If the endowment generates more funds than the amount of mortgage outstanding, then the investor receives the surplus tax-free. If the amount is not enough, the investor has to make up the difference.
Endowments were very popular in the 1980s as a way to pay off a mortgage, but declined steeply in popularity during the 1990s as interest rates fell and the endowment proceeds often did not cover the repayment of the mortgage.
Life insurance companies now review the progress of an endowment every five years and if the amount generated is not on track to repay the mortgage will write to the investor to ask them to increase the premiums paid.
Surrendering an endowment
Because of relatively high charges in the early years of an endowment, cashing in the plan early can mean that the saver receives back little more than the amount paid in, or even less. Savers should therefore aim to keep making payments until the end of the specified term, and therefore collect the valuable terminal bonus. If you do have to cash in the policy early, write to the insurance company, which will then provide you with a "surrender value". Do not automatically accept this figure. If the endowment has been running for at least 7 to 8 years, you may be able to achieve a higher surrender value by offering the policy to a traded endowment policy market maker. For a list of dealers in second-hand policies, contact the Association of Policy Market Makers on 020 7739 3949.
There are more than a hundred different endowment plans offered by product providers in the UK, and their record in building up a cash lump sum varies dramatically. Ask an independent financial adviser to recommend a policy.
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