Investing in unit trusts through an endowment can result in better after tax returns than simply investing in unit trusts, particularly for high tax-rate investors with an investment horizon of five years or more.

This is according to Richard Carter, head of product development at Allan Gray.

"Endowments fulfill a valuable role in meeting the needs of high tax-paying investors and also offer estate planning advantages as beneficiaries can be paid out straight away on the policyholder’s death, saving executor fees," says Carter.

He says the days of all endowments implying inbuilt, upfront fees and commission structures and opaque underlying investments are long gone. Investors may find endowments that invest in unit trusts appealing, particularly if they have a high tax burden and an investment horizon of at least five years. "The level of tax you pay depends on the investment return and the split between interest, dividends and capital gains as this determines how much of the return is taxable in your hands," says Carter.

With an endowment, the life company that issues the policy pays income and capital gains tax (CGT) on the investments in your policy. Income tax is recovered from the policy when income distributions from underlying unit trusts are received. The life company also pays tax on any capital gains that may arise when you switch between unit trusts. CGT is not paid until the units are redeemed, when the amount you receive may be reduced by a provision for tax. Endowments are taxed at a flat rate depending on the status of the investor. For individuals this is 30 percent and 25 percent of the capital gains is taxable which means you will pay CGT of 7.5 percent.

Endowment produced higher after-tax return

Allan Gray did an exercise comparing an investment of R100 000 in its Stable Fund with an investment in the same fund via an endowment policy and found that investing via an endowment policy produced a higher after-tax return.

They found that with a direct unit trust investment made on 1 June 2001 the after tax return over the five-year period was 13.77 percent per year. If the investor made the same investment, but chose to do so using an endowment policy, the after tax return would have been 14.58 percent. This amounts to a difference of 0.81 percent per year. This example assumes the investor is in the highest marginal tax bracket and redeems all units five years after the investment was made.

They then did the same exercise over rolling five-year periods since the Stable Fund’s inception in July 2000. "The increased return has averaged 0.74 percent per year which, on a five year investment of R100 000, would amount to an extra R6240,” says Carter.

In conclusion, he says that accessing unit trusts through other products, such as endowments, can be beneficial because they offer potential tax and estate planning benefits.

"When deciding on the best product investors should factor in when they will need to access their investment, the tax implications and any estate planning advantages. If you’re not sure which product best suits your needs, seek financial planning advice from a licensed Independent Financial Adviser."