Many drawbacks to policies that combine savings and risk cover
It may seem like a good idea to take out a life assurance endowment policy that commits you to setting aside money for your child’s education and guarantees your savings goals will be met if you die prematurely or become disabled and cannot earn a living. But you may, in fact, be better off providing for your savings and your life assurance needs separately.
One of the main reasons is that if you cannot afford the monthly premiums – because, for example, you lose your job – the life company may impose a penalty of up to 15 percent of your savings. This charge may reduce to nothing over five to 10 years, but until then you will be at risk.
A few life assurers offer a retrenchment waiver, which is a benefit that will pay your premiums for about a year if you are retrenched, or they will allow you to take a “premium holiday” of, for example, 12 months over the life of the policy in the event of a financial crisis, but these benefits add to the costs.
Natasja Norval-Hart, an independent financial planner with Sasfin, says premiums on endowments are low, but the costs are often high.
“My first advice to anyone looking at an education policy is: be very critical of the costs. You don’t want to be losing value because of costs.”
Jan-Carel Botha, an independent financial planner with Ultima Financial Planners in Pretoria, says another drawback of a policy that combines savings and risk cover is that you may not know what portion of your premiums is used for savings and what portion funds the risk premiums.
Life assurers pay tax on endowment policies on your behalf at 30 percent and then pay out a taxfree amount at the end of the investment term. But Botha and NorvalHart say that most young families who need to save for education are on marginal tax rates of below 30 percent, which makes an endowment an inappropriate vehicle.
If you separate your savings and life cover and use a discretionary product, such as a unit trust fund, to save for your children’s education, you must ensure that your risk life cover is sufficient to fund their education and other needs. Your need for this cover will be greatest when your children are young and will decrease as they get older.
Norval-Hart says she spends a lot of time with her clients with children looking at risk planning.
She says some companies offer an ancillary benefit to a life policy that pays tuition costs on the death or disability of a parent. The benefit is paid directly to the education institution – this avoids the problems of who will get the money or the money potentially ending up in the Guardian’s Fund (if parents leave their assets to minor children).
She says parents can pay for this cover as long as they need it.
Botha says that a discretionary investment such as a unit trust gives you the flexibility to use your savings as you wish. You may start to save for a child’s tertiary education but later use the savings for private schooling or pay for unexpected medical expenses, he says.
Life companies sometimes point out that their policies have guarantees on investment performance. However, in order to provide a guarantee, the life company will offer you a lower return.
Botha says that, because you are likely to save for education over a long period, you are unlikely to need a guarantee. The returns from the equity market can be volatile over shorter terms, but, on average, the equity market will seldom deliver negative returns over a longer term, such as five or 10 years.
If your term is shorter than five years, you can invest in an interestbearing unit trust fund that has no exposure to equities, he says.