Choosing between unit trusts and endowments

Stellenbosch - South Africans do not save much and therefore rely on credit instead of on savings during tough financial times.

The problem is that credit costs money or interest, which could be avoided if there was enough savings.

So, is there a solution?

According to PSG [JSE:PSG] Wealth technical sales analyst, Jabez Serfontein, there is a solution.

Unit trusts and endowments are the two most common discretionary (non-retirement funding) investment options and should be made use of.

But to choose the right one for specific financial needs requires a good understanding of the differences and similarities between the two.

Benefits of endowments

An endowment is ideal for those who want to minimise income tax liabilities.

It’s a five-year investment savings vehicle that offers income and capital gains tax advantages to those who are in the highest tax brackets.

They therefore typically pay income tax at a marginal rate of more than 30% and capital gains tax at an effective rate of more than 10%.

Other benefits are that, at death, no executor’s fees are levied if a beneficiary (other than the client’s estate) is nominated.

If a sinking fund (endowment without a life assured) is selected and the owner is a company, trust or closed corporation the investment can continue without being deemed to be property in the deceased’s estate.

Benefits of unit trusts

Unit trusts on the other hand are ideal for those who want to have direct access to the money invested.

Any interest, dividend or capital gains tax is taxed at the rate that is applicable to the specific investor.

Tax benefits

One of the major differences between endowments and unit trusts is the tax.

With endowments all individuals and trusts with only natural persons as beneficiaries are taxed on interest at a rate of 30%.

In the case of unit trusts the individual’s marginal tax rate applies.

While the maximum effective rate for unit trusts is 13.3%, the effective rate on capital gains for endowments is 10%, which could be a significant saving.

The effective tax rate for a trust (with only natural persons as beneficiaries) invested in unit trusts is 26.67%, compared to 10% for an endowment, which clearly makes the endowment the better option.

What to look out for

“What one should be looking for is whether the tax saving for investing in an endowment outweighs the administration cost saving for investing directly at a Manco," said Serfontein.

"Remember, the tax benefit of the endowment is only on interest and capital gains and the cost saving is on the entire investment of the unit trust."

In the case of investing directly in a unit trust, the tax is levied in the hands of the investor, which means investors have to declare it with their income tax return.

On the other hand, an endowment is taxed in the hands of the insurer, which means the insurer will pay all taxes to the SA Revenue Service (Sars) and investors don’t have to include it in their tax return, explained Serfontein.

Significant difference

The other significant difference between endowments and unit trusts is that an endowment has a restriction period of five years, during which time the investor is allowed one surrender and one interest free loan (capped at capital invested plus 5% growth per year).

Also, individuals invested in an endowment are subject to the 120% rule. This means they can only invest 120% of the higher amount invested in the previous two years respectively, unless they want to start a new restricted period.

Investing in a unit trust gives investors the flexibility to make additional contributions as they please.

What to choose:

How does one then choose between an endowment and a unit trust?

The table below illustrates the role of an individual’s tax bracket and whether it needs to use an investment as an estate planning tool.

Also, whether they appoint beneficiaries to their investment plays an important role in determining whether an endowment or unit trust is suitable.



In Scenario A, the client has a marginal tax rate of 40%, in Scenario B the client has a marginal tax rate of 22%, and in Scenario C the investment is a trust with only natural persons as beneficiaries.

“The important thing to remember is that unit trusts and endowments both offer advantages and disadvantages for different financial needs.

Choosing the most appropriate option is not easy and a financial adviser should be involved in the decision,” said Serfontein.

- Fin24

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