Question:
Would I get the highest interest investing in a second hand policy (click here to learn more about second hand endowment policies)? I have R600 000 that I won't need for five years. I also understand that my capital is safe.

If I'm mistaken, where would I get the best interest rate for such an investment?

Answer:
Getting 'bang for buck' is something most investors seek to attain. However, getting optimal returns (in this case interest) is more about the underlying assets and instruments and less about the vehicle through which you invest. In saying that, the question of liquidity needs and vehicle taxation are important factors if one is to succeed.

Second hand policies have gained some favour over the past few years. In essence, they are endowments (in force for longer than five years) that have been 'purchased' by the assurer from the original beneficial owner and then resold to a new investor.

Considering that taking out a 'new' endowment as the original beneficial owner comes with a restriction period of five years where access is restricted to access points via one loan and one surrender, one can easily appreciate the appeal of the 'unlimited access' that second hand policies offer. Unfortunately, this does not come as a free lunch and what must be appreciated is the potential double Capital Gains consequences. Let’s explore…

Endowments are governed by the Long-Term Insurance Act and are therefore taxed within the investment by what is known as the 'four-fund approach'. What this means for an individual investor is that all net rental income (if there is property in the portfolio) and interest (accrued from fixed instruments) will be taxed at a flat rate of 30 percent. This then means that all capital gains will attract Capital Gains Tax (CGT) at a rate of 7.5 percent. This tax is paid within the fund and on behalf of the investor. The result is that the proceeds will be free of any tax purely because it has already been paid within the fund. The exception to this is second-hand policies (where you are not the original beneficial owner). In this instance, CGT may also be payable by the investor on deemed disposal and on top of CGT already paid within the fund.

Considering that you intend to invest in interest bearing assets, the likelihood of any CGT consequences are unlikely and therefore the 'double taxation' scenario becomes muted. In the same breath, you do not need the money for five years and therefore have no need for the unlimited access of a second hand policy — nothing lost, but nothing gained.

What’s more, one should be very aware of the cost associated with a second hand policy.

With CGT and liquidity out the way, the aspect of interest, and more importantly the taxation thereof, becomes notable.

Interest earned (or accrued) within the second hand policy (endowment) is taxed at a flat rate of 30 percent. This may present as a perfect tax benefit for individuals on a high tax bracket with sizeable assets exposed to interest bearing assets, however, quite often it could eat up gains unnecessarily for those who have not made adequate use of the interest exemptions applicable to natural persons.

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