This article first appeared on DollarsAndSense.sg
Endowment plans are a common type of insurance marketed and sold by financial advisors. Some of our recent articles have discussed these policies. Previously, we also wrote an article about why Singaporeans can consider using the Singapore Savings Bonds rather putting money in an endowment plan for long-term savings.
Many people we have spoken to varying degrees of understanding about endowment plans. Some consider it a form of investing. Others see it as a savings plan or a hybrid between a saving and insurance plan. And there are those who don’t care what it is, because they have already sworn off these products completely.
Before you think about getting an endowment plan, perhaps it is best to first understand what an endowment plan actually is.
Endowment Plan For Saving
Most financial advisors market endowment plans as a form of savings. The term, “forced savings” is often used in the sales pitch.
When you buy an endowment plan, you can expect to contribute a regular amount to the plan for a designated time period. For example, you may opt to contribute $3,000 a year to a plan for 10 years. Alternatively, there are also single premium plans, where you put in a lump sum amount at the start of the policy.
The length of your contributions may not necessarily be the maturity of your endowment plan. You could be paying your premiums for 10 years and be expected to hold the policy for another 10 years before it matures, giving it a total duration of 20 years.
An endowment plan is frequently used when a policyholder intends to save up money towards some specific financial goals. For example, a 45-year old person who wants to save up for retirement may choose to buy a 20-year plan that matures when the person turns 65.
Endowment Plan As An Investment…
The main difference between an endowment plan and saving money in a bank account is the investment component of the plan.
The insurance company will use the premiums you contribute to invest in range of financial products. The objective of this is to earn higher returns on the money.
A typical endowment plan would usually consist of a guaranteed and a non-guaranteed return. You NEED to take note of this because a financial advisor may skim through the guaranteed portion and focus only on the non-guaranteed portion of the plan.
The guaranteed portion of the policy is what the insurance company is obliged to return to you, regardless of how badly the investment portfolio has performed.
Typically, if the guaranteed portion is higher, it also translates into the insurance company taking lower risks in their investments. It is also extremely important at this juncture to note that the guaranteed portion of certain policies may be lower than the premiums you have been putting in.
The non-guaranteed component of the policy is the additional returns you may receive if the portfolio performs well. The return rates that would be shown in the benefit illustration will be pegged at 3.25% and 4.75% respectively. This is standardised across the industry.
Two things to take note here.
Firstly, these two numbers do not necessarily represent what the insurance company is aiming for or hopes to get. It simply shows how much you will get if the participating fund achieve 3.25% or 4.75%. That’s all.
Secondly, if you do an excel table, you will quickly find that the actual returns shown in your benefit illustration does not tally with the 3.25% or 4.75% returns.
The table below shows the returns you should be getting if you put in $12,053 per year for a period of 5 years, and then hold on to the policy for another 5 years.
Table 2 shows the actual return you will get if the fund achieves a 4.75% return in its portfolio.
As you can see, the actual returns from this particular policy only gives an actual return of 1.8% per annum back to its policyholder, even though the portfolio gave a return of 4.75%. This is due to the “Effects Of Deduction”.
We won’t go into details of that today. The main thing you need to know is that the portfolio return does not equate to your actual returns, which are usually much lower.
Endowment Plan As Insurance…
Endowment plans may sometimes have an insurance component included. These plans would have a sum assured tag to the policy. This provides a payout in the event of death or permanent disability to the policyholder.
Due to the fact that endowment plans are mainly for the purpose of long-term savings, relying on them to provide coverage would usually be a costly option.
As with all insurance policies, cost of coverage will differ depending on the age, gender and health related issues of a policyholder.
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