Investment bonds are a type of insurance policy that offer attractive tax benefits. There is usually a suite of underlying investments that an investor can choose from – run in much the same way as regular managed funds.
They are a unique type of asset offering a range of advantages.
The primary attraction of investment bonds is that earnings are taxed in the hands of the issuing company at a rate of 30%. Provided the bond is held for more than 10 years no further tax is payable when the bond is cashed in.
While 30% is more than the 15% tax rate that applies to superannuation, it is less than the marginal rates of 34.5% to 49%^1 that apply to people with an annual taxable income above $37,000. The higher your marginal tax rate the more attractive investment bonds become.
What’s more, investment bonds don’t lock up your money for the long term as super does. You can access your money whenever you like, though you do need to be aware of some rules.
If the bond is cashed out within eight years, all the growth in the value of the bond is included in your tax return. You will, however, receive a credit for the tax already paid by the issuing company. You won’t be double-taxed. Withdraw from a bond between eight and nine years and two-thirds of the gain is declarable; and between nine and ten years, one-third of the gain goes into your tax return.
Bonds can be purchased with a single lump sum or with regular additions. However, to keep the original start date, an annual contribution cannot exceed 125% of the previous year’s contribution.
If it does, the clock starts again for the 10-year rule. Another option is to simply purchase a new bond.
Insurance bonds can be useful estate planning tools. As a form of life insurance, if the owner dies the proceeds will be paid directly to nominated beneficiaries. The money doesn’t go through the estate and can be paid out quickly. In addition, the proceeds are not taxable in the hands of the beneficiaries, even if the bond is less than 10 years old.
Allowing for relevant tax rates, they may also be a good vehicle for saving for a child’s education or other long-term goal.
Due to their long-term nature, it isn’t just your current marginal tax rate that is important; it’s what your rate will be in the future. As many retirees pay little or no tax, particular consideration needs to be given to purchasing a bond that will be held until after retirement.
Investment bonds aren’t for everyone, but they may suit investors who:
- have reached their concessional cap for super contributions;
- do not wish to lock away their money in super;
- are saving for a long-term goal and have a marginal tax rate above 30%;
- have specific estate planning needs.
Including Medicare levy and Temporary Budget Repair Levy. ↩