Last month we looked at the advantages of an endowment policy. This month we analyse the advantages and disadvantages of a unit trust investment. Note that a unit trust is not a policy and therefore does not fall under the Long Term Insurance Act.
Advantages
With a unit trust investment, you the taxpayer are the investor. This means that your individual tax rate would be used to calculate any tax, unlike the fund rate in an endowment policy. For those with lower tax rates (below 30%) it therefore makes sense to take out a unit trust as opposed to an endowment policy. As an example, an investment for a child would make more tax sense in a unit trust, as that would allow the child's lower tax rate to be used.
You can make use of your R23,800 interest rebate (assuming you are under 65) and your annual R40,000 capital gains tax (CGT) exclusion if you are in a unit trust. This means unless you are in a money market-type unit trust, the interest earned in a unit trust should be lower than the rebate and you should not pay any tax on interest earned (unless you have invested a very large sum into the unit trust).
You will also only start paying CGT on gains made in the year if you switch or sell units and the profits made are in excess of R40,000 (assuming the rebate has not been used already).
So, in a unit trust you are able to make use of your interest and CGT rebates, unlike an endowment policy.
Unlike an endowment policy, access to funds in a unit trust are immediately available, and there is no limit or period before the units can be cashed in - apart from the administration requirements of the investment company, which are normally a few days.
There is also no limit on how much can be received on cashing in, unlike an endowment where the amount is limited by a formula in the first five years.
If you make any losses on selling units, you can use that capital loss above the R40,000 abatement.
You would carry that forward into the following tax year, to be set off against future capital gains made.
Disadvantages
Unlike an endowment policy, a unit trust cannot have a life assured or a beneficiary. This means that when you, as the owner, die, the proceeds/units are physically part of your estate, and therefore subject to executor's fees. They also have to be wound up as part of the estate.
If you are paying tax at the top marginal rate, you will be taxed on any income or capital gains made above the rebates at your top rate, as you are the taxpayer.
If you make switches during the tax year, CGT will be payable if gains have been made above the R40,000 abatement. This means that tax will be payable even though the units have been switched into another fund, and you have no actual cash. This could cause a cash flow problem.
If you, as an individual, are invested in multiple unit trusts there are tax-compliance issues. Your tax return at tax year-end will be extremely complex, as you will have to declare all the taxable interest, foreign dividends and any capital gains made on all the different funds.
Because a unit trust is not a life policy, you do not enjoy protection against creditors as provided in section 63(1) of the Long Term Insurance Act in the event that you, as the owner of the investment, go insolvent. This is not the case with an endowment policy with a life assured.
Conclusion
Both an endowment policy and a unit trust have their own advantages and disadvantages. A unit trust is more tax efficient for those with a marginal rate below 30%, and for those who still have their interest and CGT rebates available and wish to make use of them. It also makes more sense if you are investing smaller amounts, as there would be very little, or no, tax payable then.
It also allows immediate access to the cash invested without restriction.
An endowment policy, on the other hand, has tax benefits for those at the top marginal rate, and is a useful way to ensure proceeds pay directly to beneficiaries and avoid the whole estate winding-up process.
The tax and regulatory issues around investing in a particular wrapper (such as an endowment, unit trust, or retirement annuity) are complex, and it is very much a case of "horses for courses". See which issues are more important to you and then decide which wrapper is more appropriate to your needs, after discussing with your financial adviser.
• Joffe is head of legal services at Discovery Life..