Endowments are policy contracts which commit you to a minimum investment period of 5 years after which the proceeds are tax free. They basically provide a so called “wrapper” around various funds of choice which may be invested in various assets, such as, equities, property, bonds and cash. The returns from these assets (other than equities) are taxed inside the endowment at a flat rate of 30%.
Dividends from equities – 20%
Rental income from property – 30%
Interest from bonds – 30%
Interest from cash – 30%
REASON 1 – Tax rate lower than 30%
The first reason why you should not have an endowment is that if your tax rate is less than 30% you will pay more than you should to SARS. You would be better off investing in the same funds directly without the endowment wrapper.
REASON 2 – No cash fund in place
The restrictive period of 5 years ties your money up and if you need to access cash before hand then you could be penalised. A sound financial plan starts with cash fund which you can access for unforeseen expenses. The ideal balance in this account should cover your monthly expenses for between 3 to 6 months. If you don’t have access to enough cash for emergencies then you should not have an endowment.
REASON 3 – Debt not under control
If you have high interest bearing debts such as credit cards, personal loans, overdrafts and mortgage bonds then these should be tackled before investing in an endowment. The returns after tax, costs and fees from the funds in the endowment are unlikely to achieve the same rate as your credit card, for example, 22%. Paying off your debt is a sure thing, without risk of losing capital, effectively providing a guaranteed return at the rate the interest is being charged. Therefore, the third reason you should not invest in an endowment is if your debt isn’t under control.