UK Endowments
Assumed policy growth rate
Aside from the bonuses that are added to most endowment policies,
the policy will grow more or less in line with the increasing
value of the investment fund. The rate at which it grows is
critical to the eventual cash-in value of your policy.
With all endowments, the provider will make some assumptions
about the growth rate of the investment at the beginning of
the policy. There are often a variety of different assumed
rates of growth for you to choose from. The rate is used to
calculate how much your repayments need to be in order to
have enough money to repay the loan at the end of the term.
Whether or not your repayments will actually be enough to
reach the level of your loan is not usually guaranteed by
the product provider.
The higher the growth rate assumed, the cheaper the premium
- you are relying more on favourable market conditions and
the prudent investment skills of the fund managers than on
the amount of money you pay in. However, a higher assumed
rate of growth brings a greater risk that the investment objectives
will not be reached.
If the assumption is that the growth will be slower, your
premiums will be more expensive, as you must contribute more
money to compensate for the inferior rate of growth. This
brings a greater likelihood that your fund will exceed the
performance necessary to repay the loan at the end of the
term. If this is the case, then there will be a cash surplus
left over, which you can keep - with no tax to pay!
During periods of low interest rates, a greater portion of
your fixed monthly repayment is going into your endowment
policy, as your payments on the loan amount will be lower.
This increases the likelihood of there being a surplus at
the end of the mortgage term. This means that endowments can
be more attractive when base rates are low.
The corollary of course, is that during periods of high interest
rates, a large portion of your monthly repayment is taken
up with interest. This may mean that less is being paid into
your endowment than is necessary to meet the investment objective.
Some people temporarily stop paying into their endowment
if it has substantially exceeded their expectation of growth.
If you do stop your payments into the endowment, then your
policy value may still increase, as the underlying fund should
still be growing. Unfortunately, this will not be nearly as
fast as it would be under normal circumstances because:
- No further regular payments are being added to the fund.
- Investments grow cumulatively - the more there is, the
faster it should grow.
- Management charges are deducted from the fund, reducing
your growth.
However, much of the news headlines relating to endowments
over the last few years has been dominated by those policies
where the assumed growth rate was insufficient to meet the
investment objectives, meaning that the fund would not perform
well enough to cover the capital lent to for the mortgage.
Most endowments that are used to repay mortgages cannot guarantee
that you will not be left with a shortfall, meaning that the
eventual size of your fund is dependent on your insurance
company's ability to invest your money wisely.
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