Endowment life insurance is a mix of term and whole life. It’s a flexible policy that also includes a savings account with guaranteed payouts on maturity. Endowment policies are low risk, and low reward. They typically last 10 – 20 years. They pay out death benefits in the event of death or payout a guaranteed lump-sum on maturity (sum assured). They are flexible allowing for the policy holder to adjust duration, premiums, and benefits up-front.
At one point endowment life insurance was popular, it was also used as a tax shelter… Due to regulation passed in the 80’s you wont’ find endowment policies on the Market anymore.
How Is Endowment Life Different From Whole Life or Term Life?
While a whole life policy typically lasts the insureds “whole life”, endowment is set to last for a period of 10 – 20 years more like “term life” insurance. The main difference is that endowment offers guaranteed payouts just like the “cash value” built in a whole life policy. The trade-off for the shorter term and guaranteed payouts is that premium payments can be high due to the shorter duration of the policy. Also the investment portion of the policy is toned down, so there is less risk/reward involved in endowment. In fact endowment life insurance policies are sometimes called “zero risk”, as they offer little risk and correspondingly little reward.
Endowment life insurance is flexible in terms of duration and payout allowing shoppers to “design” a policy that meets their needs. Endowment is often marketed as a “college savings account”, although this is semantics. It is truly just a life insurance policy with a guaranteed payout bridging the gap between a savings account and life insurance.
Important Endowment Life Terms
Surrender value – A policy holder can surrender a policy before it reaches maturity and take it’s surrender value (based on how much has been paid in and how long the policy has been going).
Sum assured – The guaranteed payout upon maturity of the contract
Regular Bonuses – Bonuses paid out periodically depending upon the performance of investments
Terminal Bonus – A Bonus paid at maturity depending upon proformance of investments
The Tax Ramifications of Endowment Life Insurance
Most life insurance types are tax-advantaged. In whole life your money builds tax-free in a tax-advantaged savings account. Term life and whole life insurance offer death benefits tax-free. However, in response to endowment life being used as tax shelters the The Tax Reform Act of 1984 stipulated that any life insurance policy issued after 2005 that endows, or pays the death benefit to the owner prior to the age of 95, results in the owner having to pay taxes on the death benefit and cash accumulation fund.
Given the above and the Technical Corrections Act of 1988 (which further limited the way endowments can be used) most life insurance types sold today are whole life and term life. That being said someone may still hold an old endowment life policy or may be buying a life insurance policy marketed as “endowment”.
Other Options for a Term Policy that Builds “Cash Value”
Since endowment policies aren’t on the table here in the 2010’s a shopper has other options for building cash value over their lifetime and having the protections of guaranteed payouts of death benefits with tax advantages in place. By using a mix of the following, consumers can build their own saving structures using investments and life policies. These can offer both tax advantages and death benefits, but they all have their own pros and cons.
Term life – Term life offers the guaranteed death benefits tax-free (but lacks the guaranteed payout on maturity).
Whole life – Offers a guaranteed cash value at old age or death (but there is a penalty for early withdrawal)
Regular Investments – Keeping your money in a traditional investment account allows you to build money (although the tax advantages aren’t there).
Tax Advantaged Savings Accounts – 401ks, HSAs, and universal life policies can be used to build money tax free (but there is a penalty for early withdrawal)
A common strategy in lieu of endowment products in todays market used is called a “buy term and invest the rest” strategy.