A life assurer should not just sell you a product like an investment policy that you later find out is not suited to your needs, the financial advice ombud says. 

When the FAIS Ombud found this is what happened to a victim of motor vehicle accident who received a payout from the Road Accident Fund, the ombud politely told the life assurer it needed to fix the problem, the ombud’s officer reports in its latest newsletter.

The life assurer sold the consumer an endowment policy, an investment policy that obliged him to invest his money for five years despite the fact that it was the only investment he had and he needed to draw an income from it. 

When the consumer tried to withdraw from the investment, the life company told him he would incur penalties unless he waited five years. He then complained to the ombud. 

The life assurer responded to the complaint saying it had made all the relevant disclosures to the consumer, so he was aware of the penalties he could incur if he withdrew early. 

But the ombud told the life assurer that from the consumer’s circumstances it was obvious the product was not suitable – the man needed an investment that had no minimum term. The life assurer had to agree and refunded all the penalties. 

In the ombud’s newsletter, Marc Alves, the manager of the resolution team, says endowment policies are great for certain investors, but they are not appropriate if:

• You have a small amount to invest; 
• You need to draw an income from your investment;
• You may need the money in an emergency or before the term is up; or
• You have a marginal tax rate of below 30%.

 “The truth is that endowment policies, whilst providing benefits to a specific niche investor, are not appropriate for everyone,” he says.

He says a product provider or an adviser should tell you all the material terms about a financial product like an endowment so that you can make an informed decision as to whether or not it is a suitable investment for you.

A product provider or adviser should also get all the relevant information from you to ensure that any product recommended is appropriate for your needs and circumstances, Alves says.

An endowment policy is legally required to have a minimum five-year term. This is referred to as a “restriction period”, because it restricts the withdrawals you may make from the policy. This is one of the material terms of the policy, Alves says.

During this period, the maximum amount you may withdraw is the lesser of: the premiums you have paid plus 5% compound interest, or the market value of the investment less fees and charges, he says.

Any remaining balance (at least R2,500) must stay invested until the restriction period ends.

Alves also says if you are contributing regularly and your premiums increase sharply (by more than 20% of what you paid the past two times), a new five-year restriction will come into effect. 

These restrictions make endowments unsuitable for you if you need an income from your investment or will need to access it in an emergency, Alves says. 

Another misconception surrounding endowment policies is that they are tax-efficient - they are often sold as products that will give you a tax-free lump sum when they mature, Alves says. 

But, the reason you get a tax-free sum on maturity is that tax is paid on income and interest during the life of the policy, he says.

And importantly the tax levied in the endowment is not based on your marginal rate of tax (the highest tax rate applied to your income in your top income bracket). Instead, interest and income in the endowment is taxed at a maximum tax rate of 30% depending on the underlying investments. 

This is unlikely to be appropriate for you if your marginal rate of tax is lower than 30%, and, for example, you invest in an interest-earning money market portfolio within an endowment policy.

Gugu Sidaki, a financial planner who holds the Certified Financial Planner accreditation and a director at Wealth Creed, says it’s important for you to be upfront with your financial adviser and to make full disclosure regarding your financial standing, requirements and constraints to allow your adviser to provide appropriate investment products specifically suited to your needs. 

Endowments are popular with high income earners who want to invest for the long term and save on tax, but they must be willing to invest for at least five years without accessing the money and have income tax rate above 30%.