Should you invest in an endowment policy to save tax as is so often recommended?
The answer lies in understanding the difference between your MARGINAL and EFFECTIVE tax rates.
The type of account you hold your investments in determines how you are taxed. Endowments are taxable accounts.
Tax is taxing at the best of times.
The one thing we can all agree on is that we would like to pay less of it.
Many people are advised to invest in an endowment policy when their MARGINAL RATE of tax is above 30%.
This is because your investments in an endowment policy are essentially still the life company’s and so you are taxed at the flat rate of 30% on all income.
What is your marginal tax rate?
Your MARGINAL RATE of tax is easy to determine. Just consult the Individual Income Tax Tables that SARS publishes annually (see graphic below), see where your income fits into the scale of income bands. That % number under ‘Rates of Tax’ is your marginal rate of tax.
‘Marginal’ meaning each additional Rand of income is taxed by that percentage.
What is your effective tax rate?
The taxman allows certain deductions which impact on the income tax you pay each year.
Some of the more common ones that are applicable to most individuals include:
– Individual rebates. These increase with age. Under 65. 65>75. Older than 75
– Medical tax credits which include payments for medical aid premiums and other medical costs.
– Interest income allowance.
– Capital Gains Tax allowance.
The table below illustrates how deductions can change a persons effective tax rate. This is how the exact same income, for 3 individuals of different ages, would be taxed in practice.
You will note that each individual has the same marginal tax rate, but the older you get the more deductions you are allowed. This reduces the amount of income tax you pay.
The amount of tax you actually pay as a proportion of your income is called your EFFECTIVE TAX RATE.
At lower income levels, the EFFECTIVE RATE of tax is significantly lower than the MARGINAL RATE.
In fact the tax paid by someone who is 75 years old is R2,655 per month less than a 64 year old. That’s almost R32,000 per year. (2025 Tax tables)
This would not be the case if your money was invested in an endowment.
How much income would it take to get to an effective tax rate of 30% in your personal capacity?
About R1,350,000 of income. This is a marginal rate of 41% by the way.
Anything below that number would mean you pay more income tax in an endowment structure than if you held the investments in your personal capacity.
Estate planning
For completeness, an endowment can be useful as an estate planning tool, and I am not implying you should never own one. But that is a potential topic for another time.
Just be sure if you do own an endowment, it is doing the job you intended it to do!
*Assumptions in the tax calculations: An income of R514,500 plus interest income of R40,000 per year. Medical aid premiums of R8,800 per month with R2,000 in additional medical expenses.
Reach out if you have any questions on the above or if you would like help making progress in your financial life.
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