The above example brings to us an important function of the with-profit policy. Mr Drake may well decide to launch himself in business before his policy matures. In this case, he can borrow from the life insurance company. The company will lend him 85-90% of the surrender value of the policy. Thus, if he started his own business five years after taking out the policy it may at that stage have a surrender value of £16,000. He could borrow £15,400 from the insurance company, which would charge him the interest rate applicable at the time and expect repayment of the capital out of the maturity proceeds.
The interest rates charged by companies on policy loans, as they are called, vary, but they will usually be below the rates at which overdrafts can be obtained from the major banks. He may also, if he wishes, add the annual interest on the loan to the capital owed - a useful facility for Mr Drake, who does not wish to be burdened with interest payments when all his money is going into the development of the business.
The only provision the insurance company makes is that the total amount of indebtedness must not at any time exceed the loan value, but so long as Mr Drake keeps paying his premiums the loan value will usually increase more quickly than the amount owed. The less attractive alternative, if Mr Drake cannot afford to go on paying the premiums, is for him to surrender the policy, in which case he will get the full surrender value of £16,000.
But in these circumstances, because he is surrendering within the 10-year qualifying period, he might render himself liable to higher-rate tax on part of the gain he has made (policy proceeds £16,000 less total gross premiums paid £15,300 = £1700) and so he would be better off maintaining the policy if he could.
Versatile Endowment Policy - Example 9
Mr Crane is aged 45 and wants to retire early at 60. This will mean a lower pension from his firm than if he stayed until the normal retirement age, and so he decides to supplement it by taking out a 15-year with-profit endowment. He takes out a £16,000 sum assured policy at an annual cost of £1420 gross (£1346.5 after tax relief). Assuming that the company continues to pay the same rate of reversionary bonus, he will actually receive reversionary bonuses of £15,000 on top of the basic sum assured, and, if the company also continues... see: Versatile Endowment Policy