What are investment policies?

So what are investment policies? You know, those things that were sold to you about 30 years ago. Or if you’re too young for that, the things that your parents took out when you were small. Probably to save towards education or retirement.

I recall a statistic along the lines of South Africa having the highest level of ownership of policies per capita, anywhere in the world. (Don’t quote me on this, I don’t have a source. LOL)

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, an investment policy?

A policy is really just a wrapper of sorts. A rather complex one though with huge amounts of admin involved, and generally, high fees.

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.

If that all sounds complicated, just take this one thing. Investment policies are somewhat outdated and there are better ways to invest your money nowdays.

Who pays the tax on investment policies?

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 40%. Dividends Tax applies at 20% to dividend income accruing to the IPF. The fund pays the tax for you.

Whether you pay the tax at your marginal tax rates, or let the life company pay it, it gets paid. No getting out of that!

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 all comes at a price, 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.

Are investment policies 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 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. And the “value” that you’re getting from your policy.

Policies issued by life insurance companies are valuable tools in your personal finance landscape. They shouldn’t be used to plug every need though. 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.

But, pure investment policies may not necessarily be the easiest and best option. 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 as some of the older policies have punitive terms. Terms that could see you paying fees to cancel the policy or to mature early.

Wrapping it up

Policies had a time and place, but that the financial world has come a long way. There are other options that require your attention. Simpler products and even “DIY” options. Have a look at my first investment with Easy Equities to see what I mean.

You are no longer limited to investing via a broker and having to trust only what the glossy pamphlets say. You now have the internet, many financial insulation’s, ETF’s and handy comparison tools to help you find what you need.

As always, do you research, consult with a professional, and find what’s best for you.