Should You Ditch Your Endowment?
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Sadly many homeowners were advised to take out endowment mortgages back in the 80s and for many borrowers, that decision has proved to be an expensive mistake.
And a recent survey shows that the situation has got even worse for endowment policyholders. Those of you who have with-profits endowments may be alarmed to hear the vast majority of 25 year policies maturing now are producing lower returns than they did last year and the year before that*.
In fact, a recent survey by Money Management magazine reveals the worst-performing endowment policy returned a pitiful 3.9% a year for the last 25 years, falling short of the interest you would have earned on many standard savings accounts.
So should you ditch your endowment or stick with it? It's not an easy choice, but here are some points you should think about before you decide whether the time has come for you and your endowment to part ways. (Of course, not all endowment policies are linked to mortgages.)
Do you still need the endowment?
Is the policy being used to repay your mortgage? And, do you still need the life insurance that's built in? If so, you'll need to think twice before ditching it.
If your endowment is likely to fall short of its target, it may make sense to switch over to a repayment mortgage instead. In that case, you won't need the policy and you could possibly use the proceeds to pay off some of your mortgage early.
If you decide to surrender (cash in) your policy, you may need to arrange life insurance elsewhere. Getting cover can be expensive if you're a little older or you have health problems, so remember to take that into account.
Calculate a possible maturity value for your endowment
Much of your decision depends on how you think your policy might perform from now on. Returns from with-profits endowments are paid in the form of an annual and possibly a terminal - or final - bonus. Bonus rates are set each year at the discretion of the provider.
But that means it's difficult to estimate future growth as you don't know what bonuses will be declared in the coming years. You need to think about the potential value of your policy at maturity if you were to keep it.
The projections you receive from your provider are pretty useless for that, as they bear no relation to the level of bonus you might receive. Some of the worst-performing with-profits funds, for example, are currently paying bonus rates of 0%, whereas most projections are based around 6%.
To work out an estimate for a maturity value, ask your provider for the following information:
The last three year's annual bonus rates.
The current maturity value of policies which ran for the same term as your policy, but are maturing now.
The terminal bonus, if any, on similar maturing policies.
This information should give you a rough idea of the prospects for your policy going forward (although remember, as always, past performance isn't a guide to the future). If the last three year's bonuses have been 0% and maturity values including any terminal bonus are low, it's a reasonable assumption that your policy may not fare well either.
If you're good at number crunching, you can ‘guesstimate' how your endowment might grow to maturity based on a range of different assumed growth rates, as well as the bonus rate history and a range of estimated terminal bonuses.
Once you've got those figures, compare them with the value that would be achieved if you cashed in your endowment now and placed the surrender value - that's the amount you receive when you cash it in - in a savings account that pays say, 6% a year for the remainder of the policy term. This should give you an idea whether cashing in the policy now is a good move from a performance perspective.
If you don't feel confident doing your own calculations, it's best to take advice from an independent financial adviser and ask them to do the hard work for you.
Look at the Equity Backing Ratio (EBR)
That's just a fancy way of saying how much of your endowment is invested in shares. Your provider will be able to give you the EBR. If your endowment has a low exposure to shares, then the prospects for future growth could be pretty limited, and it may be time to think about surrendering it.
If you have a policy which is no longer sold to new customers, pay close attention to its underlying assets. Many of these so-called ‘closed funds' have little or no investment in shares. Meanwhile, a stronger endowment might have an EBR between 50% and 70%.
Is there a Market Value Reduction (MVR)?
The MVR is like a withdrawal penalty that may come into play if you choose to surrender your endowment early.
In simple terms, with-profits investments have come unstuck where the provider has paid out past bonuses which later turned out to be too generous. That means, the bonuses paid to investors were higher than the actual returns achieved by the with-profits fund itself.
Where this has happened, the provider may try to claw some of it back by applying an MVR on early encashment. An MVR can take a huge bite out of your surrender value. If this affects your policy, it may be worth sticking with it until the penalty is removed or is, at least, reduced. MVRs aren't always deducted, so check that out with your provider first.
That covers the key points to think about before you surrender. In a follow up article, I'll look at the benefits of selling your policy though the TEP (traded endowment policy) market, as an alternative to cashing it in or keeping it in place.
And on a final note, I would suggest if you're still unsure what to do with your endowment, it's important to speak to an independent financial adviser.
*According to a recent survey by Investment, Life & Pensions Moneyfacts.
More: Is Your Endowment A Letdown?
