Wednesday Wealth Dilemma: Old endowments….hold on or cash in?

by Andrew Morris on 14 April 2010  |  1 comment
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If you have a badly underperforming endowment policy, there's still an opportunity to turn it around.

The FSA recently announced the likely death knell for commission-based financial advice. It reminded me of all those dodgy old endowment policies. So-called independent financial advisors would receive huge up-front commissions from an insurance company for recommending a savings vehicle designed to pay off a mortgage. This also usually provided an extra lump sum for the homeowner to celebrate being mortgage-free.

Here’s the story of my own with-profits endowment policy track-record. Here are a few details:

• Property cost: £69,500
• Deposit: £13,900 or 20%
• Mortgage (repaid by 25-year endowment policy): £55,600
• Endowment guaranteed sum/minimum guaranteed pay out: £18,348
• Monthly premium: £70.90

The endowment initially blossomed, thanks to stock market growth and healthy annual bonuses. But black clouds gathered towards the end of the 1990s, annual bonuses tumbled as the dotcom bubble burst, and took markets down with it in the early 2000s.

Throughout the stagnant Noughties, as the insurance company sought to repair its own balance sheet and pay off maturing policies, I received a succession of red-alert letters warning me of the potential shortfall, should I still be relying on my endowment to pay off my £55,600 mortgage in 2013.

The following annual bonuses were granted by my insurance company between 1988 and 2007:

The real upside of a traditional endowment had always been the ‘terminal bonus’ which you hope to get at the end of the policy term. But the reality was rather different. Here’s a summary of the indicative terminal bonuses I was given over the years, had my adolescent endowment reached its 25th birthday:

• On inception in 1988: 92% of guaranteed sum = £16,880
• 1999: 390% of guaranteed sum = £71,557
• 2003: 144% of guaranteed sum = £26,421
• 2005: 84% of guaranteed sum = £15,412
• 2008: 6% of total plan benefits (guaranteed sum + annual bonuses) = £1,676

By early 2009 I wondered what to do with this dinosaur of a savings vehicle.

If I did nothing, I’d have to continue paying the monthly premium of £70.90 for another 4.5 years. Even if stock market performance recovered, as it has done significantly, I doubted the insurance company would pass on any recovery through increased annual bonuses, or a better terminal bonus.

So I could expect around £29,000 by 2013, for the guaranteed sum, annual bonuses and the terminal bonus. But I would have paid £21,270 in total premiums over 25 years.

If I decided to take control, I could cash in the policy and invest as I wanted to in a completely transparent way, rather than continue to rely on the insurance company’s opaque investment methodology.

I was quoted a surrender value of £22,867 in January 2009, as well as estimated maturity values of £31,500 (at a possibly optimistic 5.25% growth rate) and £29,700 (at 3.75%), both including projected terminal bonuses.

Traded Endowment Policies

For years there had been a vibrant market for second-hand endowments if you wanted to cash in a policy before maturity. The Traded Endowment Policy (TEP) market would often offer up to 30% more than the surrender value quoted by your insurance company.

But post credit crunch, the TEP market collapsed and nobody would offer anything for my poor unloved endowment from the class of ‘88.

I decided to liberate the stagnating investment, and took the surrender value of £23,024. We were in the fortunate position of having effectively paid off the original mortgage by then, so I chucked the surrender value into my SIPP and, reckoning that stock markets had much more upside opportunity than downside risk, invested it in a couple of funds recommended by Hargreaves Lansdown.

A short while later, I also received tax relief of £5,750 on the SIPP contribution and this went into the HSBC FTSE All-Share index tracker, my low-cost SIPP default option.

What lessons have I learned?

• Performance of the cashed-in endowment surrender value, together with the tax relief, inside the SIPP has been excellent - so far.
• I’m hopeful that the total value by 2013 will be a healthy improvement on what I would have received from the endowment….but it’s too early to tell.
• I don’t have to pay the monthly endowment premium of £70.90.   
• I’m aware of the tax implications. I can take a maximum of 25% out of my SIPP tax-free, but 100% of the endowment proceeds would have been tax-free. There are restrictions on what I can do with what’s left in my SIPP, but none on a maturing endowment.
• But the most important issue for me is that I took control. Inside the SIPP, I can choose where I want my pension fund to be invested.

Have you been mulling over what to do with your own ageing endowment? Hopefully this article has helped a little. Remember, you can always ask the opinion of other lovemoney.com users on our excellent interactive Q&A forum.