An endowment policy is a type of life insurance that doubles as an investment vehicle, which pays out a lump sum to you during your lifetime (i.e. when it matures).
The UK endowment policy earned itself a bad name in years past, following mis-selling of endowment mortgages and poor fund performance.
However, the product has had a bit of a rebirth and a few specialist providers are offering new endowment policies.
Whether you have an existing product and are not sure what to do with it, or are thinking of taking one out as a future investment, here’s what you need to know.
What is an endowment policy?
An endowment policy is a type of investment that you take out with a life insurance company.
You pay in money each month for a set period of time, and this money is invested. The policy will then pay you a lump sum at the end of the term – usually after ten to 25 years.
Many of these products now build in a life insurance element, so a beneficiary would receive the lump sum if you were to die before the end of the term.
How do endowment policies work?
Your regular payments (which may be monthly or annual) are used in two ways. Part of your payments are paid into a life insurance policy, and the remainder is invested – usually in stocks and shares.
If the investments perform well, you’ll be paid bonuses annually, intermittently or at the end of the term.
Once your policy ends (or you die), you’ll get a lump sum, the amount of which depends on how well the investments have performed.
If you die prematurely, the life insurance element also pays out to your beneficiaries.
What are the advantages of endowment policies?
An endowment policy gives you the opportunity to see your savings potentially grow higher than the rate of inflation.
Because the policies pay out a lump sum, they also suit those wanting to save for a particular goal. For this reason, they were once popular with people who had taken out interest-only mortgages.
But as fewer of these mortgages are around nowadays, and after a mis-selling scandal, popularity for endowment policies has dwindled.
However, they can still work as a supplement to pension saving, if set up to pay out a lump sum at the point of your retirement.
What are the disadvantages of endowment policies?
The overriding concern with endowment policies is that the lump sum isn’t guaranteed.
Although your policy might agree on an amount you’ll be paid, a poor investment performance could mean the lump sum isn’t the lofty amount you had in mind.
If you’re saving for a specific goal, to pay off your mortgage for example, there could be a shortfall. This happened notoriously in the UK, where payouts fell by 78 per cent over 25 years.
Mortgagees were left having to sell their homes, dip into their pension pots or rethink their retirement plans altogether as a result.
You’ll also be locked into the endowment for a long time. Technically, you can cancel the policy before the end of the term, but the payout is unlikely to be desirable. Alternatively, you could stop making payments, but again, the lump sum will drop.
If you want to cash in early (which lots of people do, given the drop in payout values), you could sell your policy.
Third parties are likely to offer you more money for it than your provider. Whoever buys it would own the policy and get the payout at the end, but it could give you the freedom to invest your money elsewhere.
Before moving your money from an endowment policy, you should speak to an independent financial adviser to make sure you get the most for your money.
There’s lots of benefits to using an IFA when dealing with insurance.
What are the different types of endowment policies?
Non-profit
These pay an agreed lump sum, which may be guaranteed. Because there isn’t the chance to earn more than the set amount, they’re generally cheaper than other products on the market.
With-profit
These aim to pay you an agreed lump sum, plus some extra if the fund performs well. They can generate higher returns, but are a riskier option because the maturity amount isn’t guaranteed.
Unit-linked
With this policy, your monthly instalments buy you units in investment funds, and the lump sum you receive depends on how well the funds have performed. You can usually choose the funds and swap between them throughout the term.
Whole-of-life
This policy is more closely linked to life insurance. Rather than having the policy for a term, you would hold it for the rest of your life. When you die, your beneficiaries would receive a lump sum.
How do you receive bonuses on endowment policies?
How or when you’re paid bonuses depends on the type of policy you have. The bonuses fall into these categories:
- Annually – As long as the fund has performed well, you would be paid monthly bonuses to bulk up your lump sum throughout the policy term.
- Intermittently – You may be paid a bonus if certain circumstances mean there is profit to be had.
- Terminal bonuses – These are added to your balance at the end of the term, as long as the fund has made a profit. They can make up as much as half of the maturity amount, which is why a poorly performing fund can have a significant impact on the money you receive.
How much do endowment policies cost?
You’ll be offered different maturity amounts from different providers depending on the performance of their funds. If you’re taking out a life insurance element, the proportion of your payments used to cover the policy will depend on your age, sex and the policy term.
What should I do with my endowment policy at maturity?
Broadly speaking, the idea with an endowment policy is that you take the lump sum and use the cash to pay off big sums like your mortgage, your child’s university fees or to enjoy some luxuries in retirement. Alternatively, you could invest the cash in a new product.
The other option is to extend your policy to save for something else on the horizon, but it might be more cost effective to move your money elsewhere.
Talk to a financial adviser about whether or not an endowment policy might be suited to your long-term life goals.
Find out if you’re saving enough and discover ways to boost your pension using the Unbiased pension calculator.
