Investing

Investment policies explained

Those things that were sold to you 30 years ago

No personal finance makeover would be complete without a discussion on investment policies. You know – those things that your parents took out when you were small, that gave them a sense of comfort that they’d have enough money to pay for your education one day.

We recall a statistic which we cannot track down, but it was along the lines of South Africa having the highest level of ownership of policies per capita, anywhere in the world.

The fact that South Africa has such a high rate of policy ownership should not be too startling. Our financial services landscape was for a very long time (and to some extent still is), dominated by the large long-term insurance industry.

Coupled with the minimal regulatory oversight and ease of selling policies, not to mention the large upfront incentives that brokers received, made force-feeding policies down naïve people’s throats the staple diet of anyone who sold long-term savings and investment products in this country.

Unit Trusts, ETFs, and all those good things we now enjoy, had not yet made an appearance. Policies were the be-all, and end-all of long-term investing.

Thankfully, the manner in which policies or any investment product for that matter, are now sold to the public is much more heavily regulated, such that the mis-selling of inappropriate products and the taking of large upfront fees, should no longer be possible – at least not without pain of massive sanction and judgment.

Death to the policy

So what is – or was, a policy?

A policy is really just a wrapper of sorts. We explained previously how a Retirement Annuity or a unit trust was a wrapper that housed your asset classes, well a policy is nothing more than a wrapper too – just a largely more complex one, with huge amounts of admin involved.

Life insurance companies would issue you with an investment policy, and chances are that the return on that policy would be linked to the performance of some underlying assets, or funds. The life company owned all those assets. All you owned was an I.O.U, that promised to pay you an ‘amount’ one day, equal to the return on any underlying assets – less fees of course.

Life companies became specialists in matching their liabilities to you, against what they owned (asset classes). Sometimes they guaranteed you a return (but it would not have been high), and sometimes they guaranteed nothing.

Who pays the tax?

Without getting too complex, if you ‘Joe Reader’ were the ultimate beneficial owner of the policy, then your policy would sit within what is called the Individual Policyholder Fund (IPF).

The IPF pays tax as a separate taxpayer – just like a company would, or like you do.

All of your assets that sit within the IPF generate returns, like asset classes typically do. Rental income, dividends, interest, and capital gains – these are all taxed within the IPF. When your policy ultimately matures, or you decide to withdraw, the proceeds are paid to you free from any tax.

This does not mean that you never paid tax on any of the investment returns.

Not at all.

Rather, the IPF pays tax at a rate of 30% on its net income, and pays capital gains tax at a rate of just over 13%. Dividends Tax applies at 15% to dividend income accruing to the IPF.

Whether you yourself pay the tax at your marginal tax rates, or let the life company pay it, it still gets paid.

In layman’s terms please

So what investment policies really are, is a convenient way to let a large financial services company manage your long-term investments, pay tax on your behalf, and manage all the admin. This comes at a price through, and when you consider the administration and policy charges associated with investing in a policy, you will hopefully be reminded of just how important it is to manage costs for the sake of your long-term investing performance.

Worth your while?

As new legislation came in to effect, so it became easier to invest your wealth in vehicles or wrappers, other than policies.

Long term investment policies do still exist, and the legislation that governs them is evolving, but be very sure you understand the terms and conditions associated with investing in a new policy. Things like liquidity and fees need to be understood in full.

Policies issued by life insurance companies are valuable tools in your personal finance landscape, but they shouldn’t be used to plug every need. Disability cover, life insurance and other forms of personal cover are all issued in the form of policies issued by a life company – and those are definitely not products to be shunned.

If you do have investment policies in issue and maybe you’ve forgotten why you took them out in the first place, it might be worth your while to get in touch with a financial advisor and interrogate their existence. Be warned though, some of the older policies do have punitive terms that could see you paying fees to cancel the policy or to mature early.

Wrapping it up

If anything, all we want to do is stress to you that policies had a time and place, but that the financial world has come a long way. There are other options that require your attention. And remember that if a policy is simply a wrapper to house your asset classes, then it shouldn’t matter which life insurance company you use, but for their proven admin track record and the fees they charge.

The underlying asset classes will drive your policy returns – nothing else.

The Editors

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