Investment bonds are rapidly growing in popularity as super loses some of its appeal as a tax-saving tool – and with tax paid by the provider, no Medicare Levy, no limit on contributions and access to your money at any stage, it’s easy to understand why.
Also known as insurance bonds, investment bonds can be classified as ‘tax-paid’ investments since the provider pays the tax on investment earnings. The rate of tax paid is generally up to the current company tax rate of 30%. There is no Medicare Levy, no limit on contributions and you can access your money at any stage. For clients particularly on a high income, this can be a tax-effective1 way to invest.
The 125% rule and withdrawal periods
Investment bonds are also very simple at tax time. Clients don’t include investment earnings in their tax return unless a withdrawal is made in the first 10 years. After 10 years, if the client has adhered to the 125% rule (where each year’s contributions did not exceed 125% of the previous year’s), any withdrawals made will not attract personal income tax or capital gains tax. Capital gains tax is also not applicable when switching between investment options.
For clients that do withdraw before the 10-year period is satisfied, all or part of the profit portion or investment earnings will be included in their assessable income. The amount of profit included in the client’s assessable income depends on when they make a withdrawal. For example, if a client withdraws:
within eight years, all of the profit is included as assessable income;
during the ninth year, two-thirds of the profit is included as assessable income;
during the 10th year, one-third of the profit is included as assessable income; and
after the 10th year, no personal tax is payable.
· A 30% tax offset is available and can be used against any tax payable on the withdrawal amount. Any residual tax offset may also be used against tax(es) on other income.
Estate planning benefits
· Taxation upon death is a large consideration for advisers, clients and beneficiaries, particularly when clients have non-dependent children as beneficiaries. In the superannuation environment, death benefits that are paid to non-dependants risk tax of up to 32%. Insurance bonds offer an alternative in these situations as they allow proceeds to be paid to any beneficiary (including non-dependants) tax free.
· Leaving the tax benefits aside, these bonds can also be structured in a number of ways to solve estate-planning problems. Clients can nominate more than one beneficiary and can stipulate the percentage or amount that each will receive. When a beneficiary is nominated, the proceeds will not be subject to challenges to the client’s estate (except in NSW), as they will not form part of the estate assets.
· Further, for clients with children with a marriage at risk, bonds can provide a level of asset protection. Upon death of the client (i.e. the parent), bond proceeds can be paid to their estate and included in the creation of a discretionary trust in their will for the benefit of children and grandchildren.
· In other situations where the client only wants to provide for grandchildren, the bond can be set up as a Child Advancement Policy. Ownership would automatically transfer to the grandchild at a stipulated age, generally without capital gains tax consequences.
· Safety and security are important considerations for many clients, especially when the market is volatile.
· The potential taxation concessions and estate planning benefits alone mean that investment bonds can be a very important tool for advisers and their clients. Whilst individual needs are to be considered, these bonds continue to provide an attractive investment option for high-net-worth clients.
Advantages for high income earners
1. Tax paid at up to the company rate of 30% by the life company. To compare, earnings from a managed fund could be taxed at up to 49% (inclusive of Medicare Levy and applicable charges).
If part of a withdrawal is required to be included in assessable income, a tax offset of 30% is available to compensate for the tax paid. This may be used to offset tax on other income.
Unlike direct investments, personal capital gains tax is not relevant to insurance bonds.
No need to declare earnings in personal tax returns while the money is invested in the investment bond.
Withdrawals from the bond are free from personal income tax after 10 years.
The start date of the 10 year tax period remains unchanged if the contributions in each policy year do not exceed 125% of the previous year’s contributions.
Can be used as an alternative to super to build wealth for retirement. Contribution limits within the super environment minimise the amount of money your clients can concessionally invest, and the preservation rules may restrict access to funds.
General Advice Disclaimer
This information provided on this website has been provided as general advice only. We have not considered your financial circumstances, needs or objectives and you should seek the assistance of your Adviser before you make any decision regarding any products mentioned in this communication. Whilst all care has been taken in the preparation of this material, no warranty is given in respect of the information provided and accordingly neither we nor its related entities, employees or agents shall be liable on any ground whatsoever with respect to decisions or actions taken as a result of you acting upon such information.