Endowment policies were the early form of tax-deferred retirement plans and college savings. The policy provided insurance in the amount of money the client wished to accumulate by a specific date. If the insured predeceased that date, the family received a death benefit in the amount specified. If the insured survived, the policy "endowed" that same amount to the owner. The insured and the owner do not necessarily have to be the same people.
If the insured dies before the endowment period, the death benefit goes to the beneficiaries tax-free. All life insurance death benefits are tax-free unless the owner of the contract used the premium as a tax deduction, which is rare.
Endowment policies state when the contract endows in the name of the policy. For instance, if a policy is a 20-year endowment, the contract ends and the insured receives the face amount after 20 years. An endowment at age 65 pays the owner the money when the insured reaches 65. There's usually a bonus, or terminal payment, if the investment return is greater than the guarantee used to calculate the payment.
Tax laws allow a like-kind tax-deferred exchange of a life insurance contract for another life insurance policy, an annuity for an annuity or a life insurance or an endowment for an endowment or annuity. So if you select to roll the amount into another endowment contract, you defer the taxable amount until that contract endows or pays a death benefit.
If you choose a lump-sum distribution, you have to pay taxes on any amount in excess of the premiums paid. The easiest way to calculate the amount before you receive a tax form is to add all the premiums and subtract the total from the amount the company sends in the check. The difference is taxed as ordinary income as opposed to capital gain.
If you choose to purchase an annuity, the money can continue to grow or you can take payments. If you take payments, most companies offer flexible plans that allow you to select the number of years for payments or choose a lifetime benefit or lifetime with a guarantee of principle. When you select a payment option, the gain is spread out over several years, because part of the payment is gain and part of it is principal.