A common aim of financial planning is to grow your wealth. Endowment plans are one of the financial products aimed at helping you do that, and they’re considered low risk too, because you’re guaranteed to get back the amount of money invested into the product.
When you purchase an endowment plan, you commit to a predetermined period of typically between 3 and 25 years, where you’re required to stay invested in the plan. In most setups, the plan will earn you an interest of 0.5% – 4% per annum.
But unlike growing your money with stocks, ETFs, mutual funds and investment-linked plans where you can determine when to buy or sell the asset, you lose that control when you invest in an endowment plan. The money is used to invest in what is called a participating fund and the fund managers of the insurer (or one appointed by the insurer) takes on the job of growing your money and decides on the investment methodology.
Before you decide if an endowment plan suits you, here are some key details to look out for.
1. Period of premium payment and period of plan
Endowment plans can run as short as 3 years, or as long as 120 years. If you invest in a plan with a 3-year term, this means that the plan will mature after 3 years and you will get your money and returns on the maturity date.
In some instances, you can choose a shorter premium payment term. This means you could be contributing to the plan for the first 5 years, but the plan pays out only after 10 years when the period is the plan is reached, for example.
2. Guaranteed and non-guaranteed investment rate of return
Returns on investment in an endowment plan are made up of guaranteed and non-guaranteed components – together, they determine the total illustrated investment rate of return.
In Singapore, the Life Insurance Association Singapore (LIA) dictates that all insurers project the total return rate only at 3.25 percent and 4.75 percent.
This means that the benchmark return for the lower assumed rate of return is 3.25 percent, and the higher assumed return is 4.75 percent.
These values were determined based on the benchmark portfolio that LIA constructed according to the long-term investment market outlook. This sets the standards for the insurers’ fund managers to follow.
But you should note that these rates are used only for illustrative purposes and do not represent the upper and lower limits of the participating fund’s investment performance. These rates should be not taken as your actual rate of return on investment.
In this example, this endowment plan requires a 10 year premium payment term and matures after 25 years. The projected returns at the end of 25 years based on 3.75 percent and 4.25 percent total investment return is $30,121 and $38,208 respectively.
3. Total Internal Rate of Return
In some endowment plans, this value is provided and this gives you a clear indication on your actual rate of return on your investment. This rate is after deduction of all the expenses from the illustrated investment rate of return, which we discussed in the section before this.
Typically, the longer term of the endowment plan, the higher this total internal rate of return.
4. Guaranteed Internal Rate of Return
If you are concerned about the guaranteed sum that you would get in the ultimately worst scenario that the insurer goes bust, then you could refer to the guaranteed internal rate of return. If this rate is positive, the endowment plan will guarantee the principal plus part of the return; if the rate is negative, the endowment plan does not guarantee the principal. The principal is what you’ve paid.
5. Reversionary Bonus
The non-guaranteed portion of the return is distributed to the policy holder in the form of bonuses. There are two types of bonuses. The first type is a reversionary bonus.
This reversionary bonus is distributed to the policy account on a yearly basis. The bonuses will accumulate interest each year.
The reversionary bonus, once declared on a yearly basis, will form part of the guaranteed benefits of your policy. They are usually payable in full when a claim is paid or when the policy matures. However, when you surrender the policy or the reversionary bonuses, only a proportion of the reversionary bonuses will be payable since you did not hold your policy until a claim arises or until it matures.
The information about reversionary bonus is stated in the plan’s product summary. It is typically presented as: Based on illustrated investment rate of return of x.xx% per annum, the reversionary bonus rate is $x.xx per $1,000 sum assured, compounding at x.xx% per annum throughout the policy term.
6. Terminal Bonus
The other type of bonus is the terminal bonus. These are generally paid out when you surrender the policy, when a claim is paid, or when the policy matures.
The information about a plan’s terminal bonus is also stated in its product summary. It is presented as: Based on illustrated investment rate of return of x.xx% per annum, the terminal bonus is xx% of the value of the policy account (this is the accumulated reversionary bonus).
7. Smoothing process
A smoothing process is applied so that the bonus paid out over the years can be maintained. This means that bonuses may be held back in years when the performance of the fund has been good, so that the payout amount can be maintained when conditions are less favorable.
This means that in a good year, the insurer may choose to pay out its normal bonus rate and retain more surpluses. In a poor year, it may distribute more of the retained surplus as bonuses to maintain the bonus rate. The effect is a fairly smooth rate of return.
Hope these points help you understand endowment plans better. Deciding on whether an endowment plan suits you or your financial goal depends on how much risk you wish to take on a pool of money.
For some, they want to ensure a guaranteed sum of money will be available when their children need a sum for tertiary education, for example. For others who favour endowment plans, they prefer a passive approach to growing their money, coupled with a very low tolerance to risk.
In general, we noticed that the guaranteed component is the most attractive trait that most endowment investors appreciate.