Ask Sindie: 'Will I beat the policy returns if I sell my endowment and save on the side?'

Q. I have four endowment policies bought to pay off my mortgage. Not surprisingly, they are all projected to produce a significant shortfall at the end of the term.

I'm considering selling at least one of the policies but don't know if this is the right option.

For instance, I have a Friends Provident [FP] policy due to mature at the end of July 2017, and pay in a monthly premium of £40.60.

The surrender value [now] is £7,169 and the expected maturity value, assuming the fund grows at 4 per cent a year, is given by the company as £15,800.

Yet I have calculated that if I were to surrender the policy - and I know I may or may not get more selling it on the open market - and then save £40.60 a month at an interest rate of 4 per cent, I would have £17,606 by 2017. That's well in excess of the projected endowment value.

Am I making assumptions that I ought not to?

Duncan Porter, via email

A. Endowments have had a rocky ride over the past decade. Many were sold - and some mis-sold - in the 1980s and 1990s as a vehicle that invested in stock markets to pay off the capital value of a home. The borrower, meanwhile, simply paid the interest on a linked mortgage.

But due to falling stock market returns, many have turned out to be poor value. This has left policyholders with shortfalls and unable to clear their home loans from the proceeds.

Additionally, many with-profits funds used for endowments acted on regulatory concerns by switching their investments into the safer havens of fixed-interest securities. As a result, they haven't benefited from the recent recovery of stock markets around the world.

It therefore makes sense for anyone concerned about their endowment returns to consider other options. As you've noted, these include trying to sell the policy to professional investors on the market for traded endowment policies. Again as you point out, you won't always get as much money as if you simply surrendered it to your own life insurer.

Whoever you sell to, the next step might be to reinvest the proceeds and the equivalent of the monthly premium elsewhere for the next 11 years - to see if you could do better.

Here, though, your assumptions do need some clarifying. Hugo Shaw of independent financial adviser Bestinvest says: "You have assumed a growth rate of 4 per cent a year - the same as in the FP projection - and I agree with your calculation of around £17,600.

"As for your query over why this figure differs so much from FP's expected £15,800 maturity value, the quick answer is that FP will be including costs - whereas your calculation allows for no drag at all."

This is the mistake, he stresses. "In reality, your return [by investing elsewhere] will probably be less than 4 per cent a year.

"For example, only the best cash accounts pay over 5 per cent gross and this may change for the worse. However, even if they do stay at 5 per cent, this will drop to 4 per cent after tax if you're a basic-rate payer. And if you're a higher-rate tax payer, that return drops to 3 per cent."

Another important point, he says, is that when the endowment matures, there is usually no tax payable on the proceeds. "This means that FP's £15,800 maturity value is equivalent to a gross return of £19,750 for a standard-rate taxpayer, or £26,333 for a higher-rate payer."

One way round this is to use your annual individual savings account (ISA) allowance. Mr Shaw says that if you put your monthly sums into a cash ISA - you're allowed up to £3,000 a year - the returns will be tax-free.

It's also worth considering FP's own policy projection. Over the past six years to the end of 2005, FP's with-profits fund performance was 20.4 per cent - equivalent to 3.1 per cent a year, reports Cazalet Consulting.

This is slightly poorer than the sector average, says Mr Shaw. "Equities are the favoured asset class for long-term investment since they should provide the highest return. But the FP with-profits fund is only half invested in equities." This will hamper fund growth and affect your policy returns.

It's also worth noting, adds Mr Shaw, that FP, like other providers, has lots of different endowment policies in various with-profits funds. So there will be lots of different bonus rates - annual and terminal - that will also have an impact on what you get back in 2017.

"This makes it a little difficult to comment too specifically," he says, "but the concerns surrounding the future returns from many life firms' with-profits funds is well known."

The alternative way to try to beat the endowment policy returns is to buy shares. "You could take the surrender proceeds and invest this, and your monthly £40.60, in the stock market.

"You would have to accept the risk of losing some or all of this money, but it would present you with the possibility of generating more than 4 per cent."

If you need help from our consumer champion, write to Sindie at The Independent on Sunday, Independent House, 191 Marsh Wall, London E14 9RS or email sindie@independent.co.uk. We cannot return documents, give personal replies or guarantee to answer letters. We accept no legal responsibility for advice given