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Mortgage Information - Endowment Policies


Endowment Policies - Mortgage Information


What is an Endowment Policy?

Endowments act as a wrapper for basic investments. They are savings plans in which payments are made monthly for a minimum of ten years. The money is invested, usually in stocks and shares, and at the end of the agreed period the investor receives a lump sum, free from all taxes.

Endowments also provide 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 endowment plan, as this enables the plan to be qualifying for Inland Revenue purposes and therefore free of taxes when the policy matures.

Different types of endowment:

  • With-profit
  • Unit-linked
  • Low-cost
  • With-profit endowments

With-profit Endowments
A normal with-profit fund takes premiums from the members of the fund and invests them in a range of investments. In exchange for an agreed premium the insurer will guarantee a certain sum of money on the maturity date of the plan or earlier death of the policyholder. This is normally 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 endowment 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 popular, 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 a longer term. Unlike traditional endowments unit-linked with-profit funds only have a sum assured for death-benefit purposes. Funds invested buys units within the with-profit fund. When the endowment provider declares the reversionary bonus it is expressed either by a rise in the value of the with-profit unit price, or it purchases additional units where the units are all valued at £1.

Usually with-profits funds provide a final 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 up to 60% of the total return on with-profit endowments - this means that savers who cash in their plans early miss out on the benefit of being in a with-profits fund. But the saver has no guarantee what the terminal bonus will be until the maturity proceeds are paid.

Unit-linked endowments
A unit-linked endowment puts the saver's money into the insurance company's range of unit-linked funds. When the endowment plan is first taken out, the saver is given a choice of funds from which to choose, but nearly everyone chooses 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 endowment 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 withdrawn, equity-backed endowments provide no guarantees as to what benefits will be achieved. Therefore unit-linked endowments have a higher risk than with-profits endowments.

Low-cost endowments and endowment mortgages
low-cost endowments are 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, this may also be called a house purchase endowment.

A saver who takes out an endowment mortgage pays only the interest on the mortgage, not the capital sum. The endowment, which ois usually a 25 year savings plan, is then used to build up 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 80s as a way to pay off a mortgage, but declined during the 90s as interest rates fell and the endowment 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 they will write to the investor to ask them to increase the premium.

Surrendering an endowment
With 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 sometimes even less. Savers should aim to keep making payments until the end of the specified term, and collect the valuable terminal bonus. If you do have to cash in the policy early, contact 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. Click here for a list of dealers in second-hand policies.

There are many different endowment plans offered by providers in the UK, and their record in building up a cash lump sum varies dramatically. Ask an independent financial adviser (IFA) to recommend a policy.

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