investment bonds contractedWhat are Investment Bonds?

Investment bonds are financial securities provided in a specific form by life insurance companies and friendly societies. Although the term “bond” is used, each bond is essentially a sub-trust under a master trust; and eligible for special taxation treatment as they are issued under – and governed by  – the Life Insurance Act of 1995. These bonds were traditionally referred to as Insurance Bonds.

Whilst they are held as a master trust account and the assets held under custodianship, Investment Bonds are issued in the name of the investor, can provide for a beneficiary other than the investor, but their particular structure facilitates their use in a range of personal investment strategies that are respectively of more or less suited to ‘life phases’ such as providing for education, shielding assets from ‘incompetent’ beneficiaries – and legal tax minimisation.

How are the funds in investment bonds invested?

Investment (insurance) bonds offer a range of investment options, from the more conservative fixed-interest type assets right up to funds that include growth-style assets such as property, Australian and international shares; and ‘alternative’ assets – and combinations of asset classes.

There are a number of providers of investment bonds in the Australian market – and their investment options vary according to their preference for investment styles. Accordingly, investors need to consider their preferred style before committing to a particular provider.

How are investment bond earnings taxed?

Investment bonds are taxed internally on the taxable income they derive, at the prime rate of 30% (currently) with a key feature being that proceeds are returned tax-paid to the investor if withdrawn after 10 years. (Note that this rate can be reduced effectively by the way bond manager costs are offset against income, but most importantly, by receipt of any dividend imputation credits attached to Australian share dividends earned.)

As owner of the bond, no tax is payable by the investor unless funds are withdrawn within ten years of commencement of the bond. [Note further that any income component of a withdrawal prior to the ten-year anniversary will be taxed at the recipient’s marginal tax rate, with a credit for the internally-paid tax.]

Can I invest additional amounts into investment bonds without impacting the 10-year tax benefit rule?

Investment bonds can be issued as a once-off payment security, or can have additional contributions made regularly (usually annually). Subsequent investments into an existing bond can impact the operation of the taxation benefit of the bond and care needs to be taken in dealing with this inflexible rule:  – see Note 1 below.

What are some of the advantages – and disadvantages – of investment bonds?

Advantages

Simplicity (with no need to include earnings in the tax returns of either the investor or the beneficiary during the life of the bond)

Choice of underlying investments including growth assets

There are no capital gains tax consequences where the policy-owner 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 associated investors 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/investor, the bond does not form part of the estate assets: it goes directly to the child/ beneficiary

The child/ beneficiary 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 and overall cost/ tax/ benefit considerations need to be compared

Investment Bond Strategies

Education Bonds

The ‘education 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 sometimes referred to as a “child advancement policy” and has specific protective provisions under Division 6 of the Life Insurance Act 1995.

Family Trust-held Investment Bonds

Investment Bonds may be recommended to be held under a discretionary (or family) trust. A couple of situations where this ownership structure serves the investor well, include –

  • high net worth, high income earners (taxation minimisation benefits); and
  • prospective aged care residents (Centrelink Assets Test and Income Test benefits).

Can we help you?

If you believe that Investment Bonds may meet a specific need for you or your family, phone our office (07-3421 3456) or use our website contact us facility to arrange an appointment with one of our experienced advisers and explore the possibilities. ‘We listen, we understand; and we have solutions’ – that we deliver through personalised, professional wealth management advice.

Note 1: there are strict rules on how much can be contributed each year. 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 we are able to offer a strategy to avoid this issue, investors in this product need to be aware of that potential inflexibility – with rather difficult consequences.)

(We acknowledge the core information from Deutsche Bank through its Desk Caddie for preparation of this article, to which we added some additional information and posted in March 2010. The information has been further updated as at March 2014.)