Unit Trust Benefit vs Endowment Benefits

Which Is Best For You?

Feb 14-15, 2009. Does a unit trust benefit you more than an endowment?

Endowments and unit trusts are both popular after-tax investment vehicles, but how can you determine which one is most appropriate for you?

An endowment is a type of vehicle that often causes confusion. A common misconception is that an endowment is a type of investment. It is not an investment in itself – it is rather an investment vehicle that holds an underlying investment fund. A decision to use an endowment vehicle should primarily be made for tax and estate planning reasons, and not for investment reasons.

The tax treatment on investment income and capital gains within a unit trust and an endowment can be very different, so it is important to understand the basics of each vehicle.

Endowments are NOT Tax Free

In the case of an endowment, tax on investment income is withheld at source by the administrator at a rate of 30% for a natural person. This should put to rest the other common misconception that endowments are “tax free”. They have often been marketed on this basis over the years. Although the ultimate proceeds may not attract further tax in the owner’s hands upon maturity, be aware that tax has in fact been collected on the income over the years. Capital gains tax (CGT) will also be withheld by the administrator once the underlying investment within the endowment has matured. The tax rate will vary according to the nature of the endowment holder (natural person or company).

Unit Trust Benefit - some Capital Gains Tax Exemption

In the case of a unit trust investor, income tax will be levied at your marginal rate, up to a maximum of 40%. Assuming this maximum marginal rate, capital gains tax will also be levied at an effective rate of 10% on the gain made (40% of a 25% inclusion). There is a unit trust benefit in that investors do have a R12,500 CGT exemption in each tax year, which is not available within an endowment.

When Does An Endowment Make Sense?

An endowment may therefore make sense for an individual who has a marginal tax rate of greater than 30%. Before recommending the use of an endowment, a good financial planner would also check that the individual concerned has utilized his or her annual tax-free interest income exemption (currently R19,000 for taxpayers under the age of 65 and R27,500 for taxpayers over the age of 65). If the interest exemption has not been fully utilized, it may make sense to rather use a unit trust vehicle as interest earned on the underlying investment will qualify for the exemption. Interest earned within an endowment, on the other hand, will be taxed at the 30% rate from the first Rand.

Another situation in which an endowment could make sense would be for an offshore investment. Taxation on offshore investment earnings and capital gains can be very complex. Theoretically one should keep track of currency gains and losses over time – this is difficult and time consuming. Many investors are therefore happy to transfer the onus of the calculation and payment of tax on offshore investment earnings to an investment administrator.

There are some other subtleties and information to bear in mind. An endowment is a long-term investment vehicle by nature, with the minimum maturity period being five years. It is possible to access some funds before the five year period in the event of an emergency, but there are some restrictions. It is possible to withdraw contributions plus 5% compound interest, but there are limited withdrawal opportunities. The unit trust benefit there is that access to your funds is unlimited.

It is possible to appoint a beneficiary on an endowment policy. In the event of the owner’s death, proceeds could therefore be paid relatively quickly to a beneficiary, and no executor fees would be paid. This is not the case with a unit trust investment. It is also possible to cede an endowment policy as security for a loan, and it is possible to have joint owners on an endowment policy. Again, this option is not available with unit trusts.

It is important to note that endowments have changed over the years. In the past, they often included life and disability cover, and were generally long-term policies. “Black hole” policies were popular in the past, but they have largely fallen out of favour. These days they are usually investment-only products. The cost structures have also become more competitive over time. Be careful about cancelling an old endowment policy, however – there may be some valuable benefits that might make it worth keeping.

Still Not Sure About the Endowment vs Unit Trust Benefit?

If you are unsure whether an endowment or a unit trust will benefit your financial plan better, then my advice is to engage an independent, fee-based certified financial planner who is focused on your best interests and can provide impartial advice. If you do not have a certified financial planner, visit the website of the Financial Planning Institute on www.fpi.co.za to select one.

Netto-Jonker, CFP, is founder of Netto Financial Services and was financial planner of the year in 2001. Her business partner Ian Beere, CA(SA) CFP was the financial planner of the year in 2007.

Endowment vs Unit Trust Benefit