Discussion Forum Forums Insurance Personal Insurance Everything you need to know about endownment plans

This topic contains 0 replies, has 1 voice, and was last updated by Investor Investor 1 year, 3 months ago.

Viewing 1 post (of 1 total)
  • Author
  • #266

    Endowment plan, savings plan, retirement plan, investment plan, annuity plan… whatever you want to call it, the purpose of these plans is to grow your wealth. Some of them also come with protection value.

    These plans are usually structured in a complicated way, and although the benefit illustration should explain the benefits clearly, investors who want to buy these plans often do not understand them. They rely on their financial advisor to explain the benefits to them.

    As I am in the financial education business, I can’t stress how important financial literary is. No matter how much you trust a financial advisor, you must understand the product before you commit into it.

    I am not here to deny or support any plan. I am here to share with you how you can interpret endowment plans. It is especially important to know how to calculate the exact returns from an endowment plan.

    The inspiration of writing this article came after meeting numerous clients. Most of them carry an endowment plan. Yet when I calculate the return of these plans, a lot of them are not giving very good returns.

    Some of the plans’s maturity value is even lower than the premium paid. This means that you will get back less than what you paid for over the years. In this article, I am going to explain how to read and calculate the actual return for your endowment plan.

    Guaranteed and non-guaranteed maturity value

    Endowment plans basically give you back a maturity value at the end of the policy term. Most of the plan provide maturity value in guaranteed and non-guaranteed format. This is because when you invest in an endowment plan, your money is actually pooled together with other investors’ money into the company fund. We can call it the Participating Fund (Par Fund).

    The guaranteed return is what you will get back from the plan, regardless of the performance of the fund. On the other hand, non-guaranteed value is dependent on the performance of the participating fund.

    As shown in the example above, non-guaranteed return are presented in two rates, 3.25% and 4.75%. This is standard presentation as regulated by MAS. Do take note that this is NOT the endowment returns for you. This is the return of the participating fund before any deduction in fees. For example shown in the plan above, the par fund must generate 4.75% per year ever year in order to give you $20,953 non-guaranteed value.

    Flexible Cash back Option

    Some of the endowment plans allow you to get back some cash during the policy term. For example, there are plans that give you 5% of the sum assured every year. This make things complicated.

    I have clients who thought that the guaranteed returns is at least 5% net for the plan because they receive 5% every year. The truth is that the 5% cash back actually comes from the premium paid.

    By choosing to receive the cash back option, the maturity value will drop because part of the cash back are distributed in advanced from the maturity value.

    Investment term (Policy Term)

    Buying an endowment plan is a long term commitment, if you want to get higher returns from the plan, the investment term must be long enough. I have heard people who say they do not want to lock in their money for long term, but they still want a high return of say 4% per year.

    There is no such endowment plan in the current market conditions. If you want high returns from a short term investment, then you must willing to take higher risk. You can choose to invest in stocks or bonds. They give you higher return in short term, but the chances of losing your money is also higher.

    Volatility in stock market can be up to 50% and the volatility for bonds may be 20%. In other words, if you want to invest in stocks and bonds, be prepared to lose up to 50% and 20% of your capital if the market goes against you.

    Even though endowment plans typically give lower return than stocks or bonds, they do provide certainty of return for the investor. In the event that stock or bond market do not perform well, the guaranteed returns will allow you to sleep easy at night.

    Protection value

    Most of the endowment plans in the market also provide protection value. However, the protection value is not free. There is a cost of protection you need to pay and it comes from the premium that you are paying.

    The higher the protection value, the higher the cost of protection and hence the lower the returns for your endowment plan. I am not saying that you should not get any plan that provide high protection value, but rather, ensue that the plan you are getting meets your objective.

    The actual return of endowment plan = Internal Rate of Return (IRR)

    So, how do we know the actual returns of an endowment plan? Because there are many stream of cash flow over different time periods when you invest in endowment plan, we cannot just use the total maturity value divided by the premium paid.

    The only way to measure the returns for an endowment plan is by using the Internal Rate of Return (IRR). Basically the concept of IRR is to measure the returns of your cash flow on the yearly basis. This means that the IRR gives you the compounding rate of return for your investment.

    The Endowment Calculator

    Because there are so many different structures about the endowment plan, there is no single way to calculate the actual return. Although some plans in the market now provide the IRR return, most of them do not. The best way is to ask your financial advisor to calculate the IRR return for you.

    To make things simple, I have created a comprehensive calculator that can calculate the return of your endowment plan. You can download it here. [Updated Version] This calculator will take care of different type of scenarios and structures such as the cash back options, limited premium, guaranteed income, and guaranteed maturity with or without cash back. All you need is to key in the information in the yellow boxes and the IRR return will be calculated in green box for you.

    If you need more help to calculate your actual returns, you can contact me at 81015331 or louis@bigfatpurse.com

    Source: http://www.bigfatpurse.com/2016/05/everything-you-need-to-know-about-endowment-plans/


Viewing 1 post (of 1 total)

You must be logged in to reply to this topic.