This article was last updated by the author in October 2016.
A brief introduction to endowment policies.
An endowment policy can be described as a savings or investment
vehicle that includes an element of life cover. The policy is taken
out for a fixed term. It pays out a lump sum at the end of this
term, or on the life insured's death if that happens sooner.
Endowments have historically been available on a with-profits or
unit-linked basis. Premiums can be paid regularly or as a one-off
Endowment policies were one of the earliest forms of packaged
investment. They differ from other forms of packaged investments,
such as unit trusts and open-ended investment schemes (OEICs), in
that they provide built-in life cover, which reduces the amount
invested on the policyholder's behalf.
They are not usually suitable as a means of providing a
significant level of life cover where the policyholder's budget is
limited. This is because the bulk of the premium is directed
towards the savings element of the contract, with relatively little
providing the life cover. Surrender values are therefore likely to
be non-existent or very low in the early years.
Endowment policies have a fixed term of years chosen by the
policyholder at the outset. The term can be any number of years
chosen by the policyholder but most policies have terms of 10, 15,
20 or 25 years. The last day of the policy's term is known as the
The benefit of an endowment policy is the payment of the sum
assured at the maturity date or on the life assured's prior death.
Endowment policies are, therefore, long-term savings plans that
meet the policyholder's investment objectives whether they live to
see their fulfilment or not.
This lump sum will be paid out free from income tax and capital
gains tax if the endowment is a qualifying policy. Broadly
speaking, in order to be a qualifying policy, an endowment must
provide a minimum life insurance benefit of 75% of the premiums
payable over the term. This can be reduced for individuals over 55
years of age.
In exchange for following these rules, qualifying policies
receive beneficial tax treatment. Tax is payable on the underlying
assets of the fund at the life office's rate of up to 20%, but the
proceeds of the policy will not suffer further income tax or
capital gains tax unless the qualifying rules are broken or the
policy is sold on as a second hand endowment.
Main types of
These endowments typically have a 10 year term (the minimum to
be qualifying) with the policyholder paying level, regular
premiums. A guaranteed sum insured is paid on maturity or earlier
death. Bonuses are added each year at the life office's declared
rate. On maturity or earlier death, a terminal bonus is added based
on a percentage of the total annual bonuses already allocated.
Low cost endowments
A low-cost endowment policy is, as the name suggests, a low-cost
version of the with-profits endowment. The policy combines a
with-profits endowment and decreasing term insurance. These
policies were introduced as a cheaper way of covering house
purchase loans, with the guaranteed death sum insured being equal
to the loan. Although the term insurance element means there is a
guarantee that the loan will be repaid on death, there is no such
guarantee on maturity.
The amount payable on death is the greater of:
- The basic sum insured plus any bonuses added to the
- The guaranteed death sum insured.
The basic sum insured increases each year with the addition of
bonuses until it overtakes the guaranteed death sum insured. The
term insurance element, which is the difference between the basic
and guaranteed death sum insured, decreases as the bonuses are
added and will cease once the basic sum insured exceeds the
guaranteed death sum insured.
This is, essentially, a low-cost endowment but with premiums
starting at a low level and rising gradually over a number of years
to the full premium. This type of policy is aimed at the house
buyer who is working on a very tight budget but who has
expectations of pay rises in future years. The initial premium is
very low but this is balanced by a full premium which is somewhat
higher than that for an ordinary low-cost endowment for the same
Here, premiums buy units at the offer price in a unit-linked
fund or unitised with-profit fund (a fund split into units where
the unit price increases in line with bonuses declared and does not
fall or if additional units have been added these are not taken
away). The contract is a qualifying policy. On death, the amount
payable is either the guaranteed death sum insured or the bid value
of the units, whichever is the higher.
Guaranteed bonds (single premium
A guaranteed bond is a bond where the income or the capital
growth is guaranteed. It will usually be a single premium endowment
for a fixed period of three, four or five years.
Guaranteed income bond
This type of endowment provides a guaranteed level of
withdrawals for a fixed term, with the balance of the capital
payable on the maturity date. The amount of capital payable on
maturity will depend on the performance of the fund that the
product is linked to. The term 'guaranteed' refers to the income
and not the invested capital. Withdrawals are often annually in
arrears. It is a pure investment contract for clients wanting a
fixed income. Although the withdrawals are often thought of as
income, they are actually a return of capital.
Guaranteed growth bond
A guaranteed growth bond pays no annual withdrawals but provides
a guaranteed maturity value at the end of the term that is
effectively an accumulation of the single premium at the interest
rate on offer at the time. It is a pure investment contract for
clients wanting a fixed return but no income.
Historically, providers have issued a variety of regular and
single premium endowment policies. You should note, however, that
there is virtually no new business of with-profits endowments
(although many remain in force) and the market for unit linked
business is much smaller than in previous years. The introduction
of a £3,600 annual premium limit for qualifying policies effective
from 6 April 2013 saw most providers withdraw any remaining
qualifying policies from the market. Life offices market single
premium endowments contracts from time to time, usually in limited
amounts or for a limited period. The rates offered vary according
to the prevailing level of interest rates in the market.