The typical structure for this product is an offshore unit linked insurance policy. Offshore means it is domiciled in a tax free jurisdiction such as the Isle of Man or Guernsey. Unit linked means that contributions are used to buy units in investment funds. A unit linked plan acts like a savings vehicle, but it also has the benefits of an insurance contract. The insurance part comes from the 101% (of policy value) death benefit attached to the policy. Although many of these contracts are now issued on a capital redemption basis, whereby there are no lives assured and the contract can be passed on to future generations. Capital redemption products have a slightly confusing 99 year maximum term, which facilitates the passing on of the investment to future generations – you do not have to keep it in force for 99 years though!
Typically these contracts are set up with a fixed savings term, usually aligned with the investors savings goal, such as their retirement age. If the policy is surrendered before this savings term is reached, early surrender penalties apply. The Isle of Man and Guernsey regulators each operate a policyholder protection scheme. In Guernsey insurers are required to hold assets representing at least 90% of liabilities in trust with an independent trustee. The Isle of Man Policyholder Protection Scheme levies all insurance companies operating on the island to pay into a Policyholders Compensation Fund, which will pay out a sum equal to 90% of the liability if an insurer is unable to meet it’s liabilities.
Note: What we are talking about here is protection if the insurance company itself “goes under”. In practice this is highly unlikely. If one of these companies started to get into trouble, it would most likely be swiftly bought out by one of it’s competitors and policyholders would be unaffected. Also, policyholder protection does not protect from losses in the underlying funds. If the fund goes down in value, so does your policy. If the fund itself fails, then your capital is at risk. Regular savings plans are typically used for saving for retirement or for children’s future education costs. Moreover they are popular with people who feel they need to get started saving and perhaps need some discipline to do so. Although it is getting much easier these days, it used to be quite difficult for expats to find an investment vehicle where you could invest a small amount of money each month and still be able to diversify into a range of asset classes. High investment minimums or high transfer costs would prevent the smaller saver from getting started. The ability to make automatic monthly collections from the customer’s credit card made all this easy, the money would simply be deducted every month and the investor didn’t have to go to the bank and send it. When you consider that in Japan, for example, making a $300 overseas bank transfer can cost up to $40, not to mention the time spent in the bank actually getting it done, credit card collection made these products easily accessible. The fees on these policies are relatively high. And with the advent of low cost brokerage accounts and ETFs it is getting harder to justify the cost of one of these vehicles. A typical fee structure looks something like this:
Initial unit charge: 1.5% per quarter, charged on contributions made in the first 18 months for the life of the policy.
Administration charge: 1.5% per year applied across both initial and accumulation units.
Policy fee: A fixed fee, usually around $8 per month.
These are the basic fees applied to the policy itself. The underlying investment funds also have their own management fee, which is typically 1.5% per year. There are generally no initial fees for accessing the funds.
These products are not sold directly by the life companies. They are distributed via financial advisers. The initial unit charges are largely used to pay commission to the adviser.
Usually these policies offer some kind of extra allocation as an incentive to get started, or a loyalty bonus to incentivise saving for the long term. The investment choice for these products is menu-driven. This means there is a fixed range of funds to choose from. These are mostly managed funds (mutual funds) and cover the full range of asset classes. You cannot access ETFs in these plans at present, although there are an increasing number of index tracker funds available. Switching between funds is free of charge.
Currency
Typically these plans are available in GBP, Euro and USD. Some accept contributions in JPY. In most cases, once you have selected the contribution currency, it cannot be changed. This means you need to think carefully about your base currency before getting started. Funds are available in multiple currencies, which is one way you can mitigate currency risk if need be.
Tax
As these policies are domiciled in “tax havens”, they are not subject to income or capital gains tax in those jurisdictions. This means they will grow without any tax being deducted at source. It does not necessarily mean that they are tax free for policyholders, as that will depend on their nationality, where they reside, and their own personal tax situation. Offshore life products were originally designed for British expats, and carry several potential benefits for them, even if they return to the UK with the policy. These include a 5% withdrawal allowance, time apportionment relief, top slicing relief, and clustering and segmentation. (I’m not going to get into the details here as this post will already be long enough as it is). Despite the high fees, these products can still be an effective long term savings vehicle if used properly. The most important thing here is to understand how the contract works and avoid the pitfalls.There are two types of units associated with these policies: initial units and accumulation units.
Initial units are units purchased during the Initial Allocation Period (IAP), which is typically 18 months, but can vary. These units are charged at a higher rate and must stay invested until the end of the selected savings term. If these units are withdrawn early, an early surrender penalty will apply. That penalty starts off large and gets smaller the closer you get to the maturity date.
Accumulation units are those purchased after the IAP. They are charged at a lower rate and can be withdrawn without penalty if necessary.
Once you have completed the initial unit allocation period, you have the option to reduce contributions, or take a break from contributions for a while.
DON’T mistake one of these products for an 18 month savings plan – if someone explains it to you as such, run a mile.
DON’T start with a higher premium level than you plan to contribute for the whole of your chosen term. One of the worst ways to use a plan like this is to start off contributing say $4,000 per month, and then reduce it to $300 per month after the IAP. You just end up paying high initial fees on the original amount in order to get a $300 per month savings plan.
DO start with an initial contribution amount that you are comfortable making for the whole investment term. This is the most efficient way to use these plans. The flexibility to take a break from paying premiums is there but it’s far better not to use it. Increasing contributions generates a new IAP on the increased amount and new initial charges, but you are not penalised for it. Reducing / stopping premiums effectively comes at a price.
DO read the product literature, especially the parts about fees and charges, the IAP, and maturity dates. Take responsibility for understanding the investment before you get started.
That said, if you are considering investing in one of these schemes, you are likely talking to a financial adviser. This is a long term investment and the adviser is well paid for it, so make sure you are talking to someone you think you can work with for the long term. How long have they been around already? Are they likely to stick around? Are they qualified? Do they have a plan for how to manage one of these policies through the three stages of capital accumulation, diversification, and pre-retirement? Find an adviser you can trust before making any hasty decisions.
By Brian Spence
Read more at vietnamnews.vn
For more information, contact S&P Investments.[/norebro_text]
