Investment Bonds – When the old becomes new again - Financial Services Melbourne | Kuda Wealth

Investment Bonds – When the old becomes new again

by Michael Davie (Practice Principal)

I was recently lucky enough to attend a breakfast meeting hosted by my mad “Liverpudlian” friend Dave from Centurion in relation to Investment Bonds and the role that they play in growing wealth in a tax-effective manner.

We have historically used investment bonds as the vehicle of choice for long-term (non-super) investments for children, particularly as a supplement to their education costs and long-term savings.

Investment bonds have been around since the pre-internet halcyon days of trusted bank managers and elbow patches. They have been one of the most consistent investment structures both from a taxation and legislative angle and, as they are essentially a life insurance policy, they were sold during the era of the old “foot in the door” insurance salesperson. Sadly, they have been placed on the shelf collecting dust during the rise of superannuation as the primary investment vehicle of choice.

However, with the recent changes to superannuation and the limits now imposed upon the amount of money that can be contributed to this environment, the old investment bond is once again experiencing a rise in popularity like an aging Keanu Reeves.

Investment bonds are a tax-paid investment. Essentially, this means that the taxation considerations for these investments are handled within the fund itself, similar to the way superannuation works, i.e. superannuation makes money on our behalf, however we don’t apply those earnings to our own taxable position and pay tax directly; it done for us within the fund or via our accountant in terms of an SMSF. Basically, the same applies to an investment bond, although these don’t attract quite the same tax incentives as superannuation.

Generally speaking, earnings inside superannuation are taxed at 15%, whereas earnings from the investment bond are taxed at the company rate of 30%. This is the main reason that they have taken a backward step over recent years as superannuation provides a greater benefit from both the tax-planning and retirement planning point of view.

However, when you consider the rate of tax at 30%, it’s clear that the investment bond is a great alternative vehicle for high income earners. The investment bond also works well for children as ordinarily they are penalised at the highest tax rate of 45% if they earn more than $1,307 from assets held in their own name (for the 2018-19 financial year).

When you own an investment bond, your money you contribute is pooled with money from other investors. A portion of the pooled funds is then allocated to the investment options chosen by each investor. Most investment bonds offer single-asset investment options such as cash, fixed interest, shares, property infrastructure, etc or a range of diversified options, with risk levels ranging from low to high risk. The value of the investment bond will rise or fall with the performance of the underlying investments.

An investment bond is designed to be held for at least 10 years. You can make additional contributions over the life of the insurance bond and to maximise the available tax benefit, each year you can contribute up to 125% of your previous year's contribution.

The single biggest advantage investment bonds have over superannuation is that they can be accessed at any time. Whereas in order to utilise the funds held in the super environment, you must reach your preservation age as determined by government legislation or meet an extremely restrictive condition of release defined by the ATO

There is a significant tax advantage available to the investor if they are prepared to leave the money in for a period of greater than 10 years as any withdrawals made after this timeframe are tax-free. This timing works extremely well with young children when preparing for future education costs and this is also a good option for people in their 20’s, 30’s and 40’s who have quite a few years ahead of them before they are able to access their superannuation.

If you take your money out of the investment bond before the 10-year tax-free withdrawal period, you may be required to pay top-up tax at your marginal rate of tax. That is essentially the difference between the 30% and your marginal tax rate.

I have clients deploying investment bond strategies for their kids, their grandkids and themselves. The superannuation contribution restrictions are giving rise to the renewed focus of investment bonds as an alternate wealth creation vehicle. They are extremely unique, often misunderstood and have received next to no advertising, meaning that many people are unaware of the wealth creation opportunity offered via these platforms.

Investment bonds are often called insurance bonds and they may provide estate planning opportunities for some investors. When an investment bond is set up, you'll need to nominate a policy owner, a life or lives to be insured and beneficiaries. The policy owner may be the same as the life insured.

If the last insured person passes away, the beneficiary receives the proceeds from the insurance bond tax free. If there is no nominated beneficiary, the proceeds will go to the policy owner or the policy owner's estate.

Most investment bonds also offer a child advancement policy where ownership of the policy can be transferred to a child when they reach a nominated age. This can be a tax effective way to save for a child's future.

10-year rule

Investment bonds are tax paid investments. This means when earnings on the investment are received by the insurance company, they are taxed at the corporate tax rate (currently 30%) before being reinvested in the bond. This can make insurance bonds a tax effective long-term investment for those with a marginal rate of tax higher than 30%.

If you hold the bond for at least 10 years the returns on the entire investment, including additional contributions made, will be tax free subject to the 125% rule.

If you make a withdrawal within the first 10 years, the rate at which earnings in the investment bond are taxed will depend on when you make the withdrawal.

Year withdrawal made     Tax treatment
Withdrawals within 8 years   100% of the earnings on the investment bond are included in your assessable income and a 30% tax offset applies*.
Withdrawals in the 9th year   2/3 of earnings on the investment are included in your assessable income and a 30% tax offset applies.
Withdrawals in the 10th year   1/3 of earnings on the investment are included in your assessable income and a 30% tax offset applies.
Withdrawals after the 10th year   All earnings on the investment are tax free and do not need to be included in your assessable income.

Tax treatment of investment bond withdrawals

* The 30% tax offset compensates for the tax already paid on earnings by the insurance company or friendly society.


The 125% rule

Investors in investment bonds can make additional contributions each year. Provided the contribution does not exceed 125% of the previous year's contribution, it will be considered part of the initial investment. This means each additional contribution does not need to be invested for the full 10 years to receive the full tax benefits.

If contributions are made to the investment bond that exceed 125% of the previous year's investment, the start date of the 10-year period will reset to the start of the investment year in which the excess contributions are made. You will then have to wait a further 10 years from this date to gain the full tax benefits.

Benefits of investment bonds

Here are some of the benefits of investment bonds:

  • Can be a tax effective long-term investment provided certain rules are followed.
  • Most offer a wide range of investment options to cater for different investment strategies and risk profiles.
  • Can be an effective way to save for a child's future.
  • Can be used as an estate planning tool.
  • May be useful for people who are unable to contribute to superannuation.

Risks of investment bonds

Here are some of the risks of investment bonds:

  • You will pay fees, which vary widely depending on the issuer of the investment bond and the investment options chosen.
  • They can be slower than some investments to convert the balance to cash and some investment bonds have minimum balances that must be maintained.
  • You are relying on the skills of other people to manage your investment, and you do not have direct control over investment decisions.
  • If you need to withdraw some of your money before the 10-year period is reached some of the tax benefits will be lost.

Things to consider before buying an investment bond

If you are considering investing in an investment bond here are some things to think about:

Have you spoken to us? – Speak to your financial planner to determine whether this is the most appropriate strategy for your personal circumstances, compare products available in the marketplace and consider possible alternatives.

Are you in it for the long haul? - The tax benefits from investment bonds are only realised if no withdrawals are made for 10 years and you comply with the 125% rule.

  • Are you able to make regular contributions? - These investments are particularly tax effective for people who make regular contributions over the life of the investment.
  • What investment options are available? - It is important to choose a product that offers investment options that align with your risk tolerance and investment goals.
  • What are the fees on the investment bond? - Common fees you may pay include establishment fees, contribution fees, withdrawal fees, management fees, switching fees and adviser service fees. Shop around and compare the fees to similar products in the market.
  • Are you using the product for estate planning purposes? - Make sure it fits with your estate planning goals.

Before making any decisions, please ensure you seek advice and read the relevant product disclosure statement for an understanding of the features, risks, costs and other considerations.

If you have any questions, please don’t hesitate to contact us on 1300 KUDA WEALTH (1300 583 293)