Endowments are policy contracts which commit you to a minimum investment period of 5 years after which the proceeds are tax free. They basically provide a so called “wrapper” around various funds of choice which may be invested in various assets, such as, equities, property, bonds and cash. The returns from these assets (other than equities) are taxed inside the endowment at a flat rate of 30%.
Dividends from equities – 20%
Rental income from property – 30%
Interest from bonds – 30%
Interest from cash – 30%
Tax rate below 30%
The main why you should not have an endowment is if your tax rate is less than 30% you will be paying more than you should to SARS.
You would be better off investing in the same funds directly without the endowment wrapper.
Endowments don’t offer exemptions on interest
You get an exemption on your interest depending on your age. So if you invest in an endowment you get tax fully at 30% and no relief is given. So let’s say you have an endowment invested in a money market fund, the full amount will be taxed at 30%. If you rate of tax is below 30% you should invest directly into the fund and you will get.
Furthermore, when you cash in your endowment you pay capital gains tax. This rate of tax is favorable if your tax rate is higher than 30%. However, if it is lower, again, you will enjoy a better result on CGT as you get a deduction on your tax return of R40 000 on capital gains before paying the tax. The same fund inside and endowment doesn’t get this relief.
So do you home work carefully. Endowments are generally more beneficial for those with a higher tax rate of 30%.