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Guide to an Endowment Policy

This Guide is supplied for general information only. You should seek specific advice for your individual circumstances before acting on any suggestions made.

What is an Endowment policy?

Although most people come across a Life Assurance Endowment policy as a means of repaying a mortgage, the policy is in fact a savings plan, the proceeds of which are used, on it reaching the end of its term, to repay the outstanding mortgage.

It is not uncommon for endowments to be established purely as a method of saving for the long term.

The premiums paid into the policy have a dual purpose. Firstly they cover the cost of the Life Assurance protection offered within the policy. The person insured under the terms of the policy is called the Life Assured. The balance premiums are invested by the Life Assurance Company to increase the value of the policy.

Secondly, over the term of the policy the value of the savings element grows and over time the value of the policy exceeds the total of the premiums paid. This provides the growth on your money.

What are the different types of Endowment policies?

Most Endowment policies are established for a set period (the policy term) of 10 years or more, this is because advantageous taxation rules apply to Life Assurance policies with terms of 10 years or more. These taxation rules (called the Qualifying rules) allow for any investment gains made within suitable policies, called Qualifying policies, to be paid to the policyholder without any personal tax being deducted.

As endowment policies are Life Assurance policies then a term for the policy must be established at outset. Although it is possible for policies to have terms of less than 10 years, this is quite rare.

Most Endowments sold in the UK have traditionally been used as mortgage repayment vehicles, and so the term of these policies would normally be the same term as the owner's original mortgage term (frequently that is 25 years).

Where the policy premiums are invested will differ in accordance with the policy type. The majority of such policies are 'With Profits'. In these instances the policy premiums are invested in the With Profits fund of the Life Assurance company.

With Profits type policies have been popular for decades. Under these policies the Life Assurance Company makes all the investment decisions. They use any investment profits gained to provide bonuses, which are added to the policy, normally on an annual basis, to increase the policy's value.

The amount of bonuses added year on year is at the discretion of the Life Assurance Company. Often some of the profits made in years of high investment returns are held in reserve, and not distributed as bonuses. This allows the Life assurance Company to maintain the level of bonus during years of less attractive investment gains.

This smoothing of investment returns has, in the past, proved popular with savers. However more recently With Profits type investments have witnessed a series of reductions in bonuses. These have been triggered because the investment reserves built up during years of generous investment profits have been reduced as lower investment returns have become more common during the late 1990's and through into the new century.

What are my options if I need money from my policy?

Although it is not generally a good idea to cash a policy early, there can be times during a person's life when money is in short supply and the value of savings plans, like endowment policies, could help to tide you over. As endowment policies are normally established as long term savings (or mortgage repayment) plans, the money invested in them may not be immediately available. You should contact the policy provider for details of what is available from your plan.

If you need to draw money from the policy prior to the end of its established term (maturity date) you may find that the terms of the policy restrict you from doing so. There are however instances where you may be able to gain access to some money by electing for one of following:

Take a loan from the Life Assurance Company based upon the value of your policy.
Surrender all or part of the policy by arranging for the policy to be closed before the end of its normal term.
Sell your policy to someone else.

In the event of early surrender in adverse market condition the provider may make a Market Value Reduction. This is a reduction in the amount you receive to protect the remaining policyholders from the impact of withdrawals made when the markets, and therefore the fund value, is at a low point.

What happens if I surrender my With Profits policy?

Although the process can be relatively simple, the true impact of surrendering should be considered carefully before you decide to take this approach. The manner in which the charges are collected under Life Assurance policies often means that the values available on early surrender can be very small by comparison to actual premiums paid and the investment returns achieved.,/

The charges under a life assurance policy are normally spaced out throughout the whole of the expected term (e.g. 25 years). Should a policy be cancelled before the end of its term, most Life Assurance companies recoup their expenses from the amount available at the time of surrender.

Will I pay any tax if I surrender a policy early?

Most endowment policies are subject to special tax rules known as the ‘Qualifying Rules’. Under these rules where premiums have been paid to the policy for a period of 10 years or more then any ‘gains’ you make from the policy are free of tax.

The ‘gain’ in a policy is the difference between the amount you receive on surrender and the total premiums paid since the policy’s start.

Where a policy has been running for less than 10 years and has not been maintained for a period greater than 75% of its original term, there is the possibility that any ‘gains’ made within the policy could be subject to tax. If you fall into this category you should seek advice on the taxation position.

What are the benefits by selling my endowment policy?

The amount available from the Life Assurance Company on the surrender of an endowment policy has to take into account a number of different considerations. These include the expenses that would be collected over the policy term, investment conditions that prevail at the time you surrender and those that have occurred over the period you have held the policy.

If you were to sell the policy, the circumstances are different. The policy is continued by the new owners, which allows the Life Assurance Company to collect their charges in the normal way. The price offered by the purchaser normally reflects the ongoing investment opportunities for them and the fact that a good deal of the policy charges have already been paid.

Accordingly the amount the purchaser may be willing to offer you to buy the policy, rather than surrender it to the Life Assurance Company, could be significantly higher than the value available on surrender of the policy.

What happens if I decide to sell my endowment policy?

If you sell your policy then you will no longer be the owner (called a grantee) even though the Life Assurance cover will continue to be based on your life.

It is possible to change the legal owner of an endowment policy and for the policy to continue totally unaffected by this change. This process is known as ‘assignment’.

If you sell your policy and it is assigned to new owners and you should die during the term of the policy, the proceeds of the policy are paid to these new owners. Also when the policy reaches the end of its term, the value on maturity will be paid to the new owners.

Although it is possible to assign most types of Life Assurance policy, not all of them are attractive to the investors that buy existing policies (known as second-hand policies). Therefore before you consider the option of selling your policy you must establish what type of policy you own.

If you own a Unit Linked Endowment policy then it is unlikely that you will be able to sell it on. In these instances you should consider how much is available on surrender. The method of charging under unit linked policies normally mean that the value available on surrender is similar to the investment value of the policy

What is a traded endowment?

A traded endowment is the name given to an endowment policy, normally a With Profits policy, which has been sold onto another person by the original owner rather than being surrendered.

Will I pay any tax if I sell a policy?

Most endowment policies are subject to special tax rules known as the ‘Qualifying Rules’. Under these rules if premiums have been paid to the policy for a period of 10 years or more, then any ‘gains’ you make from the policy are free of tax.

The ‘gain’ made in a policy is the difference between the amount you receive from the sale of your policy and the total premiums paid since the policy’s start.

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