Endowment policies have become a major element in retirement planning for most people and form a large part of all business written by life insurance companies.

Many people still refer to endowment policies as investment policies. Although endowment policies have a large investment component, by law they have to have significant life cover built in. Without this element of life cover, the generous tax exemption on the policy proceeds upon maturity falls away. A further restriction imposed upon endowment policies (excluding certain exemptions) is that the policy must be at least 10 years old before any proceeds are exempt from tax.

Funds Investing

Despite these restrictions endowment policies have been very good investments over the last 10 to 15 years with overall returns easily beating inflation over the same period.

Broadly speaking, there are two types of endowment policies — policies that guarantee a certain return in the future but may be topped up by bonuses from time to time (depending on the investment performance of the insurance company), and market-linked policies. Market-linked policies have a greater degree of risk but their performance is directly linked to the performance of investments like the stock market or property.

Investors often compare the superior returns of most unit trust investments with that of endowment policies. While there is no disputing the better returns enjoyed by most unit trust funds, it is a case of comparing apples with pears in certain instances: these two types of investments show a high degree of similarity, but there are important differences that need highlighting.

Unit trusts are far more liquid than endowment policies as the investor can sell his units immediately at any time whereas with endowment policies this is often not possible without incurring a tax liability. This liquidity can be to the detriment of the average investor should the necessary discipline not be exercised. Many unit trust holders are not used to the cyclical nature of stock markets and can easily be frightened into selling every time the stock market takes a knock. This can be a costly exercise. Inexperienced investors in unit trusts may be tempted to cash in some of their profits every time the market soars. Once again this can reduce the overall return in the long run.

Endowment policies may be used as collateral in times of emergency. They may be ceded to a bank or building society as a guarantee for a loan without touching the underlying value of the investments. It is highly unlikely that a bank will accept unit trusts as collateral as there is no guaranteed value.

Endowment policies, like unit trusts, have the great advantage that the investor is benefitting from the knowledge of investment specialists employed by the life insurance companies. By pooling huge amounts from policy holders, insurance companies can invest in areas generally not available to individuals.

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