Endowment Longfall 10 years early

Matthew44

Hi.

I'm facing an endowment 'longfall' ... my endowment has reached its target value 10 years early and the value exactly matches the outstanding mortgage (£140K). If I pay off the mortgage now, then the amount I'll save in mortgage and endowment payments over the next 10 years will roughly equal the surplus I'd get in 10 years time ... only I'll see that money a lot sooner by terminating it now.

What are the implications of terminating it now?
I assume that I'll lose life assurance, final bonus (if any) and future growth. But the main question is: by terminating it early, will I have to pay tax on the £140K I take to pay off the outstanding mortgage?

Thanks,
Matthew

Voyager2002

Matthew44 said:

But the main question is: by terminating it early, will I have to pay tax on the £140K I take to pay off the outstanding mortgage?

Thanks,
Matthew

That is a question for your endowment provider: the answer obviously depends on when the policy was taken out. (I think, but am not sure, that the tax relief only applies to policies that have been held for at least ten years.)

Be aware that there is a market for second-hand endowment policies, and you might well be paid more for your policy than you would realise by surrendering it.

dunstonh

I'm facing an endowment 'longfall' ... my endowment has reached its target value 10 years early and the value exactly matches the outstanding mortgage (£140K). If I pay off the mortgage now, then the amount I'll save in mortgage and endowment payments over the next 10 years will roughly equal the surplus I'd get in 10 years time ... only I'll see that money a lot sooner by terminating it now.

How do you know what surplus you will get in 10 years time?  (don't rely on the projections as they use pessimistic rates).

What are the implications of terminating it now?

Is it a qualifying endowment policy or a non-qualifying endowment policy?

I assume that I'll lose life assurance, final bonus (if any) and future growth. But the main question is: by terminating it early, will I have to pay tax on the £140K I take to pay off the outstanding mortgage?

You will obviously lose the life assurance.   Final bonus accrued to date wont be lost.  However, there is usually a surrender penalty.   So, you will need to compare the current value with the surrender value to see that that cost is.

Matthew44

So, yes ... the policy is 25 years old (10 years remain). As far as I can tell (whether or not I get a good deal) selling a policy results in a 20% taxation.

I believe it would be regarded as "non-qualifying" if I were to end it early ... I think that is one of the conditions of qualifying.

Even if the surrender value was zero, it still doesn't make it worth holding onto it for another 10 years, unless the projections turn out to be much better than predicted (which I seriously doubt, give that the projections have been in freefall for the past 10 years! The optimistic projection has dropped £180K.) 

I didn't know that final bonus was 'accrued' ... that seems to contradict the definition of 'final', but I guess that's a question for the provider.

As far as my maths is concerned (for which I must have overlooked something):

Target amount: £140K
Current value: £140K
Remaining mortgage payments and endowment contributions: £192K
Mid rate (4.5%) growth projection: £237K
Mid rate (4.5%) surplus: £97K
Final bonus: unknown
Endowment termination penalty: unknown
Mortgage early repayment penalty: £0K

Option 1: Terminate now and pay off mortgage. I make £192K over 10 years.
Option 2: Pay £192K over 10 years and get £97K back. I lose £95K.

... what am I missing?

Matthew44

(^^ I meant "even if the surrender penalty was zero...")

dunstonh

So, yes ... the policy is 25 years old (10 years remain). As far as I can tell (whether or not I get a good deal) selling a policy results in a 20% taxation.

I believe it would be regarded as "non-qualifying" if I were to end it early ... I think that is one of the conditions of qualifying.

With 15 years completed, a qualifying policy would be free of further tax.  A non-qualifying policy would be subject to income tax at the appropriate rates.

Even if the surrender value was zero, it still doesn't make it worth holding onto it for another 10 years, unless the projections turn out to be much better than predicted (which I seriously doubt, give that the projections have been in freefall for the past 10 years! The optimistic projection has dropped £180K.) 

That is an unsafe assumption.   Projections have been in freefall due to changes in the projection assumptions.   Projections are synthetic assumptions.    A fund performing at 3% a year would have the same projection rates applied to it as one performing at 9% a year.   

Plus, projection growth rates are before charges whereas most people (including fund factsheets) look at returns net of charges.   i.e. if your plan has a charge of 1% p.a. and the projection shows a 5% growth rate, then it really means 4%.     If your plan has been returning, say, 6% p.a., then the projection would need to be 7.1% to accurately reflect that growth.

Projections in the old days overstated the likely outcome.   They now understate the likely outcome (and have done for some time).

So, that drop in £180k is purely a synthetic difference and doesn't change the actual outcome in any way.

The old higher projection rates needed to be lowered, but they went too far, and this is known to cause people to make bad decisions because they don't understand how synthetic projections work. There's a bit of an FAQ in the pensions section of this board.

in some cases, some providers project from the basic sum insured plus annual bonuses accrued to date and do not include the final bonus accrued to date.   This led to the bizarre situation where their projections were actually lower than the current surrender value.  

I didn't know that final bonus was 'accrued' ... that seems to contradict the definition of 'final', but I guess that's a question for the provider.

Yep, the final bonus accrues as you go along and potentially go up and down daily.  That is the bit that is subject more to investment movements in the markets.  You need to remember that WP funds are a yesteryear way of investing.  However, they are required to be shoehorned into modern disclosure and transparency requirements.  So, you get to see the final bonus accrued so far (although some providers don't go out of their way to show it on consumer documents but happily show it on adviser systems).

Target amount: £140K
Current value: £140K
Remaining mortgage payments and endowment contributions: £192K
Mid rate (4.5%) growth projection: £237K
Mid rate (4.5%) surplus: £97K
Final bonus: unknown
Endowment termination penalty: unknown
Mortgage early repayment penalty: £0K

Option 1: Terminate now and pay off mortgage. I make £192K over 10 years.
Option 2: Pay £192K over 10 years and get £97K back. I lose £95K.

... what am I missing?

Is the mid rate projection realistic?   if the AMC is 1.5% then you are only looking at an annual annual net return of 3%.    Most mainstream funds do better than that.  (the historic issue with endowments wasn't the actual returns they got but the target growth rate they were set up at.  e.g the monthly premium was based on achieving x% p.a.   If that target was high, the premium would be lower or vice versa - too many were set too high and had little hope of hitting target).

So, if your asset mix and returns are such that 6% net p.a. is the a sensible projection, then you would be looking at a growth rate projection of around 7.1%.    

Is the final bonus accrued to date included in the projection?
What is the surrender value?
What is the current value?  (you say £140k but you don't know the final bonus figure.  So, £140k in unreliable. Is the £140k the surrender value rather than the current position?).

Matthew44

Wow - thanks for all that feedback @dunstonh!

It's all so complicated! But I can see there are some direct questions I can ask my provider:

1. What is the final bonus accrued so far?
2. What is today's surrender value?
3. Is it a qualifying policy?

However, the statement does say "what you'd get if you cashed in your plan", so I'm guessing the £140K is the surrender value.
The statement also says "in the five years leading to maturity assume that the growth rates will be lower" ... which is not particularly encouraging ... I think I understand why, but it gives more weight to the argument for cashing-in early.
Also, even at the high rate (7.5%) projection, I'd still be £15K out of pocket compared to cashing-in now.

I'm just not sure how this scenario can arise ... why on earth would a savings policy ever make a lower return (like 50% lower!) than just stuffing the cash under my mattress?

dunstonh

However, the statement does say "what you'd get if you cashed in your plan", so I'm guessing the £140K is the surrender value.

That would be the surrender value. 
To see if there is a surrender penalty, you need to add the annual bonus acrrued to date, final bonus accrued to date and any basic sum insured that the bonuses are added onto.  (the basic sum insured is often around a quarter to half of the target value - some unitised with profits funds do not have a basic sum insured.  It tends to be those that existed in between the period of conventional with profits plans and unitised with profits plans).

The statement also says "in the five years leading to maturity assume that the growth rates will be lower" ... which is not particularly encouraging ... I think I understand why, but it gives more weight to the argument for cashing-in early.
Also, even at the high rate (7.5%) projection, I'd still be £15K out of pocket compared to cashing-in now.

It sounds like it has some lifestyling risk reduction linked to it.   That does lean more towards exiting and clearing the mortgage.

I'm just not sure how this scenario can arise ... why on earth would a savings policy ever make a lower return (like 50% lower!) than just stuffing the cash under my mattress?

It won't.  It's just a quirk of the projections.  The projections for the final five years will probably be using a negative figure.   You should also check the assumptions on the projections to see if they are inflation adjusted.   ie. they are showing the figures in today's spending power and not monetary terms.  i.e. they deduct a further 2% a year off the return to reflect inflation.     That is another one that is often missed and with lower projections, can result in the fund value going down on the projection, even though it is going up in real life.

silvercar

Even with all the calculations on future projections, there is something to be said for clearing your mortgage early and knowing for certain that the house is yours and you will save on future mortgage payments. 

Matthew44

To see if there is a surrender penalty, you need to add the annual bonus acrrued to date, final bonus accrued to date and any basic sum insured that the bonuses are added onto.

It won't.  It's just a quirk of the projections.  The projections for the final five years will probably be using a negative figure.   You should also check the assumptions on the projections to see if they are inflation adjusted.

There is no mention of annual bonus, final bonus or basic sum, but if I just apply a simple compound interest calculation to the current surrender value, I get almost exactly the same as the projection value, so I think it is in monetary value. In fact, it says ...

"inflation in the future would reduce what you could buy in the future with the amounts shown."

Sorry - I appreciate this is all a bit 'black box' given that I've not shared the full details of my policy, but you've helped check that I've probably not missed something obvious in my maths! I think that the summary is that I have been lucky and because my fund has done so well to meet the target early then it's not really beneficial to stay in. I guess under normal circumstances, most people are forced to wait until the end just to try and hit the target.