What is an Investment Bond?
An investment bond is a tax-efficient investment solution for investors with a marginal tax rate above 30% and a long-term investment horizon.
Investment Bonds 101
An investment bond is a structured fund provided by a life insurance company. The investor contributes savings to the bond, which are then invested into asset classes of your choice, including shares, property and fixed interest. The investment strategy within the bond can be changed at any time.
The bond can be held on behalf of another individual, such as a child or grandchild. In the event of death, the funds are paid directly to the beneficiary or their guardian. The beneficiary of an investment bond can be changed at any point in time.
The terms investment bond and insurance bond are interchangeable.
Taxation
Investment earnings from the bond are excluded from your personal tax return. Tax on earnings is paid by the life insurance company at the 30% corporate tax rate. The after-tax returns are reinvested back into the bond.
In most cases, franking credits and foreign tax credits materially decrease the effective tax rate. For example, the effective tax rate for investment bonds invested in the Vanguard Australian Shares Index was 19% in FY20.
Unlike superannuation where there are concessional and non-concessional contribution limits, there is no cap on how much you can contribute to the bond. There are also no conditions of release, however, an early withdrawal or irregular contributions could forego much of the intended benefits (see 10-year rule).
125% Rule
To optimise the benefits of an investment bond, investors should make annual contributions. However, it’s important to note that annual contributions cannot exceed 125% of the previous year’s investment.
For example, if you invested $10,000 in 2023, your total contributions would be capped at $12,500 in 2024. If you would like to contribute more or a lump sum, you can start a new bond.
If you fail to contribute for one year, the 10-year rule will reset for any future contributions.
10-Year Rule
Due to their structure, investment bonds are tax-free after a 10-year holding period. However, if any withdrawals are made before the 10 years are up, profits will be assessed in the investor’s assessable income, minus a 30% tax offset.
For that reason, investors are encouraged not to only invest savings that are not required over the lifetime of the bond.
In the event of death, any amount received is tax-free irrespective of the 10-year rule.
Early withdrawals:
If withdrawn in the first eight years, all earnings will be assessable.
If withdrawn in years eight to nine, two-thirds will be assessable.
If withdrawn in years nine to ten, one-third will be assessable.
After year 10, all earnings are tax-paid and therefore not assessable.
Suitability
An investment bond is suitable for a range of advice situations including:
Taxpayers with a marginal tax rate at or above 30%
Have a long-term investment strategy of more than 10 years
High-net-wealth individuals who have exhausted superannuation contributions
Planning an income stream when not yet eligible to access superannuation
Investors who require a loan facility (available with particular providers)
Investors who require asset protection that bypasses an estate
Case Study 1: High MTR Worker
John is a senior executive at a multinational consumer goods brand. He has a marginal tax rate of 42% and has already exhausted his total superannuation balance. John could benefit from allocating his savings into an investment bond to capitalise on the lower tax on investment earnings.
Case Study 2: Protecting Assets for Future Generations
Alison wants to provide a gratuity for each of her three grandchildren. She established three investment bonds with each grandchild listed as a beneficiary. She is comforted knowing the money will not form part of her estate or be meddled with once she passes.
Fees
There are two main fees for insurance bonds.
The first is an administration fee, paid to the life insurance company for the ongoing management of the bond. This is typically around 0.50% depending on the provider and insurance bond option.
The second is a management fee to the investment manager. This can range from 0.05% for low-cost index funds to 1.50% for active asset managers.
Other potential costs can include establishment, contribution, withdrawal, exit, transaction and switching fees. This should be explained clearly in the product disclosure statement.
Get in Touch
At Lawrance Private Wealth, we offer a range of investment bonds to cater to your financial situation. If you’d like to discuss investment bonds in further detail, don’t hesitate to reach out to us via email or arrange a conversation with one of our advisers at (02) 6185 2710.
