What 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. They are eligible for special taxation treatment as they are governed by the Life Insurance Act of 1995. These bonds were traditionally referred to as Insurance Bonds.
Investment Bonds are held as a master trust structure and the assets held under custodianship. They are issued in the name of the investor, and can provide for a beneficiary other than the investor. Their structure facilitates their use in a range of investment strategies that are 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. Those options range from conservative fixed-interest type assets right up to funds that include growth-style assets such as property. Australian and international shares; ‘alternative’ assets; and any combination of asset classes are acceptable.
There are a number of providers of investment bonds in the Australian market. Each offer investment options 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). A key feature of these Bonds is that proceeds are returned tax-paid to the investor if withdrawn after 10 years.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. An important contributor being 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As owner of the bond, no tax is payable by the investor unless funds are withdrawn within ten years of commencement of the bond.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 is taxed at the recipient’s marginal tax rate. They will of course, benefit from 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. 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 (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 arising from a switch from one investment option to another (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, arrange an appointment with one of our advisers –
- phone our office (07-3421 3456) or
- use at your convenience, Make A Booking using the linked facility,
‘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. It has been occasionally refreshed/ updated most recently in October 2024.)