Insurance/Investment bonds

Written on the 11th of March 2010 by Continuum Financial Planners Pty Ltd

Investment bonds are provided by life insurance companies and friendly societies. Although the term “bond” is used, they are essentially like managed funds and receive special taxation treatment.

Insurance bonds have a range of investment options ranging from the more conservative fixed-interest type assets right up to funds that include growth-style assets such as property, Australian and international shares.

The bond is usually held by the parent/s as trustee for the children, with actual ownership of the policy transferring outright to the child upon reaching a certain age that is determined at the outset (generally between age 16 and 25). This type of insurance bond is called a "child advancement policy" and has specific protective provisions under Division 6 of the Life Insurance Act 1995.

Insurance bonds are taxed internally at the rate of 30% with a key feature being that proceeds are returned tax-paid to the investor if withdrawn after 10 years. The bonds can be taken as a once-off payment, or can have additional contributions made regularly (usually annually).

[Note that there are strict rules on how much can be contributed each year and the ‘125%-rule’ applies in that regard – the maximum contribution for any year is limited to an amount no more than 25% in excess of the previous year’s contribution. If this rule is broken (eg. no contribution in a year, followed by a new contribution in the following year), the 10 year period after which proceeds are tax -paid commences again. (Whilst there is a strategy to avoid this issue, investors in this product need to be aware of that potential inflexibility – with rather difficult consequences.)]

Advantages

Simplicity (with no need to include earnings in the tax returns of either parent or child)

Choice of underlying investments including growth assets

There are no capital gains tax consequences where the policyowner decides to switch from one investment option to another under the bond (in most circumstances)

Tax paid internally at 30%, so may be an attractive option where (both) parents have a marginal tax rate above this

No taxation implications upon withdrawal (anytime) after 10 years, providing the 125% annual contribution limit referred to above, has been complied with

Upon death of the parent, the bond does not form part of the estate and it goes directly to the child

Child can continue to make contributions to the bond after it has transferred into their name

The bond may be able to be assigned or used as security for a mortgage or charge (subject to the terms of the policy)

Disadvantages

The issuer is not eligible for the 50% CGT discount on assets supporting the bond

Inflexibility in relation to the 125% annual contribution rule - it remains even after a ten year period has been attained

If the bond is redeemed before 10 years, some or all of the income will be taxed, but the client will receive a rebate of tax

Can be relatively high-fee products

If you believe that this type of product would be helpful to meet a specific need within your family, contact us for an appointment with one of our experienced advisers and explore the possibilities.

We acknowledge the contribution from Deutsche Bank through its Desk Caddie for the core content of this article, to which we have added some additional information.