ISAs offer escape from the endowment trap

Our warning to Britain's five million endowment holders last week, was well-timed. The letters from the insurers have been arriving through letter-boxes, many with a sickening thud, after pressure applied by the regulator, the Financial Services Authority (FSA).

Some were happy to hear their policy is on course to pay off their mortgage. But three million were expected to have learned their investment will fall short. The FSA offers them four possible solutions: increasing monthly savings to make up the difference; extending the term of the endowment; repaying some of the mortgage by lump sum; changing part of the mortgage loan to a repayment loan, and the option of another type of investment, say, an ISA.

They may seem a bewildering array, but every adviser the The Independent spoke to agreed - do not extend your endowment. Yet not all endowments are in trouble. Andrew Merricks, a partner at independent financial adviser (IFA) Simpsons of Brighton, cites Scottish Life's endowment policy, with a 12.5 per cent growth rate over the past 10 years, making its investors unlikely to need to top up their policy.

Mr Merricks warns that it would be unwise for a new customer to buy into another company's endowment policies, however successful. "You will already have life assurance cover with the first endowment. It would be a waste to buy another endowment because you are duplicating that."

Changing the terms of the endowment can also incur tax. Martyn Laverick, of Chartwell Investment Management, says: "If you have 10 years or less to go, you shouldn't alter your policy because this changes the qualifying terms and could mean a tax levy on maturity. This is also the case if you have more than doubled your contributions in the last year."

You may escape the tax, but you probably won't get round the extra insurance charges. Mr Laverick adds: "As yet, most life insurance companies and IFAs have not offered special terms on any increase.

"It would be the same if you increased your endowment for, say, 10 years, as if you bought a new one. About 50 per cent of your first year premium would go in commission charges." The solution may be to wipe the slate clean and sell the policy back to your life firm or to one of the booming second-hand endowment policy businesses. Beale Dobie buys with-profits endowments policies at least five years old. "We can offer 15 per cent more than people will get from their insurer," says Tracey Merritt, a Beale Dobie investment manager.

But Philip Telford, senior money policy adviser for the Consumers' Association, says: "The worst people can do is to terminate the policy. Unless they can no longer pay the premiums they should continue, because many commission charges are eaten in the early years and often they get a negligible amount back."

Another factor is whether your policy is with a mutual organisation. Mr Merricks says: "If your policy is with, say, Scottish Life, it is well worth hanging on, because if it demutualises you are in line for a windfall."

Another option is to repay some and continue the endowment. And the last alternative is another form of investment. This could be direct buying on the stock market, unit trusts or individual savings accounts (ISAs). But ISAs are the only ones free of capital gains and income tax. Mr Merricks reckons they are best.

"They can be bought and sold any time," he says. "If they perform well, the mortgage can be paid early, unlike many endowment policies." Do not, he says, cash in your ISA simply for a holiday or new car.

Philip Telford says endowment holders should not react instantly:"The endowment isn't going away. "

FSA consumer helpline forendowment problems:0845 606 1234