An endowment policy is a life insurance contract designed to pay a lump sum
after a specific term or on death. Typical maturities are ten, fifteen or
twenty years up to a certain age limit. Some policies also pay out in the case
of critical illness. Policies are typically traditional
with-profits or unit-linked. Endowments can be cashed in early and
the holder then receives the surrender value which is determined by the
insurance company depending on how long the policy has been running and how much
has been paid into it. Traditional With Profits Endowments
There is an amount guaranteed to be paid out called the sum assured and this can
be increased on the basis of investment performance through the addition of
periodic bonuses. Regular bonuses are guaranteed at maturity and a further
non-guarantee bonus may be paid at the end known as a terminal bonus. During
adverse investment conditions, the encashment value or surrender value may
be reduced by a 'Market Value Reduction' or MVR. The idea of such a measure is to
protect the investors who remain in the fund from others withdrawing funds with
notional values that are, or risk being, in excess of the value of underlying
assets at a time when stock markets are low. If an MVA applies an early
surrender would be reduced according to the policies adopted by the funds
managers at the time. Unit-linked endowment
Unit-linked endowments are investments where the premium is invested in units
of a unitised insurance fund. Units are encashed to cover the cost of the life
assurance. Policyholders can often choose which funds their premiums are
invested in and in what proportion. Unit prices are published on a regular basis
and the encashment value of the policy is the current value of the units. This
is the simplest definition. Another definition: -It is a Life
Insurance Policy whose value is expressed in terms of numbers of units
it holds and the prices of those units ; for example, a fund with 1000 units @
£10 each unit gives a fund value of £10,000. -The Policy Holder chooses
where to invest and he bears most of the risk. -A number of charges is deducted
from the fund on a regular basis. -Accumulated policy value depend on the
fund performance. Full endowments
A full endowment is a with-profits endowment where the basic sum assured is
equal to the death benefit at start of policy and, assuming growth, the final
payout would be much higher than the sum assured.
Low cost endowment A low cost endowment is a medley of: an
endowment where an estimated future growth rate will meet a target amount
and a decreasing life insurance element to ensure that the target amount will be
paid out as a minimum if death occurs. The main thing of a low cost endowment
has been for endowment mortgages to pay off interest only mortgage at maturity
or earlier death in favour of full endowment with the required premium
would be much higher. Traded endowments
Traded Endowment Policies or Second Hand Endowment Policies are conventional
with-profits endowments that have been sold to a new owner part way through
their term. The TEP market enables buyers to buy unwanted endowment
policies for more than the surrender value offered by the insurance company.
Investors will pay more than the surrender value because the policy has
greater value if it is kept in force than if it is terminated early.
When a policy is sold, all beneficial rights on the policy are transferred to
the new owner. The new owner takes on responsibility for future premium
payments and collects the maturity value when the policy matures or the death
benefit when the original life assured dies. Policyholders who sell their
policies no longer benefit from the life cover and should consider whether to
take out alternative cover. The TEP market deals almost exclusively
with conventional With Profits policies. The easiest way of determining whether
an endowment policy is in this category is to check to see whether your policy
document mentions units, indicating it is a Unitised With Profits or Unit
Linked policy. If bonuses are in sterling and there is no mention of
units then it is probably a conventional With Profits endowment policy. The other
types of policies - “Unit Linked” and “Unitised With Profits” have a
performance factor which is dependent directly on current investment market
conditions. These are not usually tradable as the guarantees on the policy
are often much lower, and the discount between the surrender value and Asset
Share is narrower. Modified endowments
Modified endowments were created in the Technical Corrections Act of 1988 in
response to single-premium life being used as tax shelters. The Act of 1988
established the 7-Pay Test, which is a stipulated premium that would create a
guaranteed paid up policy within 7 years from policy inception. If premiums paid
to the contract go beyond the premium amount stipulated then the contract has
failed the 7-Pay Test and is reclassified as a Modified Endowment
Contract. The following new tax rules apply to Modified Endowment Contracts:
Distributions will switch from a First In First Out basis to a Last In First
Out basis. This means that withdrawals will require the policy owner to
withdraw taxable gain before withdrawing untaxable basis.
Policy loans will be realized as ordinary income to the policy owner and
could be subject to income taxes in the year the loan is made.
Distributions that go beyond the policy basis will be subject to a 10% penalty
tax for policy owners under the age of 59.5 distribution)
Once a contract has violatrevocable. Transferring funds from a Modified
Endowment Contract to a new life insurance policy via the 1035 exchange
privilege will render the newly issued contract as Modified Endowment Contract
as well.