Search
Close this search box.

What is an Investment Bond?

Written by Aaron Alston

Investment bonds are life insurance policies with an investment component.  They are tax-paid investments where all earnings are taxed at a maximum rate of 30% within each investment option.  The level of tax paid within each investment option will vary and can be lower than 30%.  There is no personal tax to pay provided you don’t make any withdrawals within the 10-year eligible period.

Key features and benefits of Investment Bonds

Pooled Investment – The investment component is very similar to a pooled investment structure of a managed fund.

Tax paid at a maximum rate of 30% – Investment bonds are taxed at a corporate rate of 30%.  No income is assessable unless you make a withdrawal within a 10-year period.

125% rule – A policy holder must not invest more than 125% of the investments made in the previous policy year. Example – If you invest $10 000 in year 1, you are unable to invest any more than $12 500 in year 2, $15,625 in year 3 and so forth.

Access to capital – Can surrender all or part of the bond at any time.  If a withdrawal is made within the 10-year period, part or all of the earnings component of any withdrawals will be assessable income.

Assessable income for policyholder – The following tax rates apply if you make a withdrawal within a 10-year period.

Within the first 8 years – 100% of earnings component is assessable at the client’s marginal tax rate (MTR).

In the 9th year – 2/3 of the earnings component is assessable at a clients MTR.

In the 10th year – 1/3 of the earnings component is assessable at a clients MTR.

After the 10th year – Tax free

Ease of administration – Investors do not have to declare investment bonds on their personal tax returns unless a withdrawal is made within the 10-year period.

30% tax offset – A non-refundable offset is available of 30% of the assessable amount of a withdrawal.

Estate Planning benefits – Investment bonds allow the nomination of beneficiaries and allow investors to keep the process of an investment bond separate from their estate assets.  There are no restrictions on who can be the beneficiary, which means an adult non-dependant can receive the proceeds upon death tax-free (this is not the case in super).

Bankruptcy protection – Investment bonds are generally protected in bankruptcy cases where the life insured is the bankrupt individual, however, creditors will claw back transfers if the investment bond was established to intentionally (whereby creditors can prove this is the case) due to impending bankruptcy.

Investing for children – A bond can be flexible and tax-effective way for families to provide for a child’s future financial needs (university, first car, marriage etc).

Example 1

John earns $100 000 p/and Mary earns $110 000 p/a.  They have a paid-off home and an investment property worth $550 000 with $400 000 owing rented at $450 p/w paying 4.5% interest ($18 000 interest paid p/a).  They have $25 000 surplus p/a that they wish to invest each year for the next 15 years.  The below options have generally been the traditional solutions for clients to better utilise their surplus cash.

Traditional solution 1 – Make additional repayments to the investment loan.

Considerations – Interest cost tax reduction over time.

Traditional solution 2 – Invest $25 000 annually into direct shares or a managed fund.

Considerations – Taxable income increases each year along with their future CGT liability.

Traditional solution 3 – Utilise the equity to purchase a 2nd investment property.

Considerations – If there is a future interest rate rise is there sufficient cash flow to meet their long-term needs?

Traditional solution 4 – Invest $25 000 annually into superannuation.

Considerations – Contribution cap and pension limits.

Whilst the above solutions all may be suitable for clients depending on their financial position, needs, objectives and risk profile, there is an alternative solution.

Alternative solution – Invest $25 000 annually into an investment bond

Benefits

  • The bond maintains liquidity and flexibility as the funds are not preserved within the bond.
  • There is no additional tax payable whilst the funds are invested.
  • If held and sold after 10 years, there is no negative tax consequence as the investment bond has passed its 10th anniversary and withdrawals are not tax assessable.
  • Assuming a 6% annual rate of return, the accumulated benefit within the bond would be sufficient to clear the debt.

Example 2 – Taxable superannuation and adult beneficiaries

Leanne is aged 72 and is recently retired.  She has 2 non-dependent adult children and has $500 000 invested in an account-based pension (100% taxable).  Leanne’s health outlook is not great, and she has been considering her options.  If she dies and leave her super to her adult children, the death benefit would be reduced by $85,000 (due to 17% tax payable on the taxable component).  Leanne could withdraw a lump sum amount tax-free and distribute to her adult children now, however she does not know exactly how her health will progress, future medical costs and how long she will need her pension.

An alternate strategy may be to commute her $500 000 account-based pension and re-contribute $330 000 to super under the bring forward rule to commence a new pension of $330 000 (100% tax-free).

The balance of $170 000 could then be invested in alternative investments such as a managed fund or an investment bond.  If Leanne nominated her children as beneficiaries, the earnings would be taxed at 30%, however any payments to her nominated beneficiaries upon her death would be tax-free.  Leanne would not have any additional assessable income unless she withdrew funds from the bond within 10 years.

If the bond earned 5% p/a, Leanne would incur an additional $2,550 (30% x 5% x $170 000) tax in year 1 and subsequent years compared to an account-based pension where all investment earnings are tax-free.  Assuming a 5% rate of return each year, there would still be a larger net death benefit payable to her adult children for many years, compared to leaving the money to be paid to her children directly from her account-based pension.

Alternatively, she could invest in managed funds in her personal name.  She would pay minimal tax as earnings on the managed funds would be taxed at her marginal rate.  Considerations would need to be given to the capital gains tax implications on death.

Summary

  • Investment bonds are tax-paid investments at a maximum 30%. There is no tax payable on withdrawal when held for at least 10 years.
  • The investment options available are very similar to a managed fund.
  • The value of the bond can be paid directly to beneficiaries tax-free upon death of the life insured.
  • A bond may suit high income earners looking for a non-super investment, estate planning or investing for a child.

 

Book a FREE 15 minute meeting

Plant a tree with us today, to sit in the shade in the future.

More From Hudson Financial

Understanding the Benefits of Lenders Mortgage Insurance (LMI) – Why paying LMI might be the best financial decision you ever make!

What often gets overlooked is the significant advantages that come with embracing Lenders Mortgage Insurance (LMI). In this article, we'll delve into why viewing LMI...

Considering Buying a Commercial Property for Your Business or Wanting to Transfer One to a Self-Managed Super Fund (SMSF)? The Pros and Cons of Owning a Commercial Building within a SMSF.

Congratulations, your business is reaching the size and profitability to consider buying your own commercial business premises! Maybe you own your business premises already and...

Share Market Update April 2024

The upward trend in the US markets that began in November 2023 appears to finally be coming to an end, with the SP500 falling nearly...
Scroll to Top