Endowment policies: tax, access and beneficiaries

What is an endowment?

An endowment is one way to build savings over five years or more, with the tax handled inside the policy and the option to pay the money straight to the people you name. It is an investment policy issued by a life insurer, and it works like a wrapper: inside it, your money is invested in funds you choose, such as unit trusts. You can invest a lump sum, a monthly amount or both.

How is an endowment taxed?

The insurer pays tax on the income and gains inside the policy, at set rates. You do not pay that tax yourself, and the amount paid out to you at the end is tax-free.

This helps if your own marginal tax rate (the rate on your next rand of income) is higher than the policy’s rate. If your rate is lower, you could pay more tax in an endowment than you would by investing in your own name.

What is the restriction period?

By law, an endowment has a five-year restriction period:

You can make only one withdrawal during those five years.
That withdrawal is limited to what you have paid in plus 5% a year compound interest, or the policy’s value if that is lower.
If you increase your contributions by more than 20% compared with the previous two years, a new five-year restriction period starts.

After the restriction period, you can take money out when you need it.

Naming beneficiaries

You can name beneficiaries, such as your spouse, so that the insurer pays them directly when you die, rather than into your estate. Estate duty can still apply to the payout, and the beneficiary pays the part of the duty that relates to the policy.

Things to know

An extra layer of costs. You pay the insurer’s fees as well as the fees of the funds inside the policy, and some policies charge penalties for early withdrawals.
Not for emergency money. Keep money you may need soon somewhere you can reach it.
Check the tax sums. Whether an endowment saves you tax depends on your own tax rate and what the policy invests in.

Who it suits

An endowment may suit you if:

your marginal tax rate is higher than the rate the policy pays;
you can leave the money invested for at least five years; or
you want the investment paid straight to named beneficiaries.

It usually does not suit people on lower tax rates, or money you might need within five years.

Sources

Questions people ask

Can I withdraw from an endowment in the first five years?

Once. During the five-year restriction period you can make one withdrawal, limited to what you have paid in plus 5% a year compound interest. Some policies also charge penalties for early withdrawals.

Is an endowment payout taxed?

Not in your hands. The insurer pays tax on the income and gains inside the policy, so the amount paid out to you is tax-free.

Who is an endowment good for?

Mainly people whose marginal tax rate is higher than the rate the policy pays, and who can leave the money invested for at least five years.

What happens if I increase my contributions?

If you raise them by more than 20% compared with the previous two years, a new five-year restriction period starts.

Does an endowment avoid estate duty?

No. If you name a beneficiary, the insurer pays them directly, but estate duty can still apply. The beneficiary then pays the part of the duty that relates to the policy.