Everything You Need to Know about Endowment Plans

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02 May Everything You Need to Know about Endowment Plans

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.

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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.

sample maturity value with cash back

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.

sample maturity 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.
cashback

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 [email protected]

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11 Comments
  • robin
    Posted at 15:30h, 02 May Reply

    Hi Louis,
    Thanks for the very useful excel calculator!

    I think there’s an error in the formula used for the Non-Guaranteed Maturity Value. It is currently adding the Guaranteed Maturity Value, making the latter double-counted. Other than this minor error, this is a great tool!

    I have used it to calculate the IRR for CPF Life. It turned out that in order to beat the 4% CPF SA or RA rate, you need to live beyond 90 years old. Say if you live till 80, the IRR turns out to be about 2% (half of 4% !). If you don’t live beyond 75, the IRR will even be negative. I understand the “risk pooling” concept of insurance & annuity but at the current break-even of 90 years old, it probably makes more sense for most people to just draw down the CPF money from their SA while the balance makes 4% interest. We will end up with significantly more bequest for our loved ones when we pass away.

    • Louis Koay
      Posted at 18:45h, 02 May Reply

      Hi Robin,

      Thank you for using the calculator.

      For the calculator, I design the non-guaranteed maturity value is only the non-guaranteed part, that is why my calculator add the guaranteed and non-guaranteed value. Most of the endowment plans present the maturity value in this way.

      Thanks for calculating the CPF LIFE IRR return. I think the reason why CPF LIFE exist is to ensure that people will not outlive their retirement savings. If you want more certainty in cash flow, then keeping the CPF balance in RA or SA may be better.

  • Jun Yu
    Posted at 18:55h, 02 May Reply

    Hi Louis,

    I am not sure if i am using it correctly or if it is an error. In the total cash flow column it took the guaranteed Maturity Value + Non Guaranteed Maturity Value. Where the Non Guaranteed Maturity Value already took into account the Guaranteed Maturity Value in the IRR tab. Which effectively means it double added the Guaranteed amount?

    Regards

    • Louis Koay
      Posted at 19:50h, 02 May Reply

      Hi Jun Yu,

      You can just enter the non-guaranteed part of maturity value in the excel. Don’t enter the total guaranteed + non-guaranteed value. The calculator will add up for you.

      Thanks

      • Jun Yu
        Posted at 23:01h, 02 May Reply

        Hi Louis,

        By the way Great work on the article. My mother was almost cheated by the way everything is phrase. At 3.25% return my interest was effectively 0. I only took note when i minus the guaranteed maturity value – total premium paid. A total premium paid amount would be nice to see too as a comparison to how much you actually get back.

        Referring to IRR tab,

        Just a suggestion, would it be better if your Total Cash Flow formula be D1-F1-L1-M1, that way there will be less confusion. As now the formula is D1-F1-L1-M1-E1, which means the guaranteed part is counted twice, since F1 (Guaranteed + Non Guaranteed portion) already took into account E1 = Guaranteed.

        Eg.
        If I put 1000 as a premium amount for 10 years with guaranteed Maturity value of $10,000
        the non-guaranteed IRR is 12.3%, with $1000 Non-Guaranteed Maturity Value that value is 13.15% which is clearly too much.

  • Louis Koay
    Posted at 10:52h, 05 May Reply

    Hi Jun Yu,

    Thanks for suggesting the changes. I also realised that there is a confusion and potential double counted in the calculator. I have updated the calculator version 2 with the instructions. You can get the version 2 calculator here: http://bit.ly/1SPYU2N or the same link in the post.

    Even though I tried to create a calculator that can calculate the IRR return of all available endowment products in the market, but that is not possible. There are plans that still cannot use this calculator. Example, some plans provide survival benefit every 2 years, and every 15th year there is additional payout. These are the plans that the calculator cannot calculate.

    If you still do not know how to get the IRR return for you plan, you can send the benefit illustration to [email protected], I will calculate the IRR return for you. All the information provided from you is strictly private and confidential.

  • GT
    Posted at 21:11h, 16 August Reply

    Hi Louis, thanks for the informative article! I’m a noob / newbie here with a (possibly stupid) question. If one of my reasons for picking an endowment plan is to beat inflation rate (rather than let it erode my savings in a bank account), is it right to say that I have achieved my aim if the IRR is more than 3% (estimated inflation rate)? Thanks so much for the calculator btw, really makes things so much simpler esp for a noob like me! :)

    • Louis Koay
      Posted at 10:04h, 18 August Reply

      Hi GT,

      Yes, You should look for higher than 3% IRR return if you want to beat inflation. As far as I know, it is unlikely that you can find guaranteed IRR more than 3% at this moment, You should look for both guaranteed and non-guaranteed IRR return. Also, other things like maturity date, premium waiver in the event of death or CI is also important.

      There is no noob in this world, each of us has our own profession. Is just happen that I am in this industry so I can share what I know in this field.

      Do let me know if you have any more questions.

      Regards
      Louis

  • Cindy
    Posted at 14:58h, 25 August Reply

    Hi not sure what ‘Payout growth rate’ means. Do we leave it blank if the payout ( cashback) is a consistent value e.g. 5oo0 every year?

    ‘Non-Guaranteed Payout Amount’ should be left blank too?

  • Louis Koay
    Posted at 10:05h, 26 August Reply

    Hi Cindy,

    You can enter 0% for payout growth rate if the payout is consisten value.

    If all your payout are guaranteed, then enter zero in “non-guaranteed payout amount”. If all your payout are non-guaranteed, then you should enter zero in “guaranteed payout amount”

    Hope this helps.

    Louis

  • The Expected Risk and Return for Various Investments
    Posted at 12:45h, 12 October Reply

    […] endowment plan comes with guaranteed and non-guaranteed return. I have written an article on everything you need to know about endowment plan. I have also created a calculator to determine the returns of endowment. You can download the […]

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