What is an Investment Bond?
Investment Bonds (formerly known as Insurance Bonds) are a long term “tax paid” investment offered by some of Australia’s major financial institutions. Although funds can be accessed in the short term, these investments are ideally run for periods of ten years or more – this is for both taxation and investment performance purposes.
What are the major advantages and disadvantages of Investment Bonds?
Essentially it’s all about tax and how much or little of it you pay. Investment Bonds pay tax at the corporate tax rate, a maximum of 30%pa on profits. The manager of the fund can claim deductions for Imputation Credits on certain investments which has the effect of reducing the tax. After 10 years the investment owner ceases to have any liability for personal tax on their original investment. Provided the rules are adhered to, additions to the investment over the years may be tax free too. This is all especially attractive to high income earners.
Withdrawals in the first 10 years are subject to tax on profit made, but there is an offset for the 30% corporate tax already paid. What this means is that for many people there could well be a tax refund owing to them and that even someone earning taxable income in excess of $180,000 per annum would only pay 15% tax (plus Medicare levy).
An attractive feature is that unlike Shares, Property or Managed funds, the investor can change investments within the Investment Bond without triggering Capital Gains Tax.
Simplicity is another key feature of Investment Bonds because there is no annual tax reporting unless money has been withdrawn in that particular tax year, after 10 years all individual tax reporting in relation to the Investment Bond ceases as proceeds are tax free. This makes for an extremely easy investment for retirees to manage for grandchildren who may be subject to very high “children’s unearned income tax”. The investment can automatically transfer to the child at a predetermined date if so desired.
Contributions to Investment bonds are unlimited, unlike superannuation where there are very tightly monitored contribution limits. Investment Bonds can be cashed at any time – there are no restrictive age bands.
There are considerable tax concessions available where proceeds are used for educational purposes.
Estate Planning is especially easy as the Bond Owner can nominate that the proceeds go to whoever they wish and thus bypass the will. This is unrestricted, unlike superannuation where there is very limited scope as to who may receive benefits.
There are usually a full range of investment options including: Cash, Property, Australian Shares and International Shares. These typically complement Capital Stable, Balanced and Growth options. Other more exotic options may be available too.
Investment Bonds are long term investments, usually suited to periods of 5 – 7 years as a minimum. Whilst it is possible to do well over shorter periods than this, for a higher probability of a good outcome “the longer invested the better”. They are not a substitute for cash at hand or term deposits.
Some tax liability may occur if funds are withdrawn in the first ten years, although there is a tax rebate for corporate tax already paid which should ensure tax is at a minimal level compared to the owner’s marginal rate of tax.
For most retirement planning purposes Superannuation and Pension structures may be a better place to hold money, giving either lower or nil tax outcomes. There are however the previously mentioned age, contribution and estate planning restrictions.
A word a caution regarding holding investment bonds in a minor child’s name – where it is redeemed before the child reaches age 18, any assessable income would be taxed at the higher penalty tax rates applicable to unearned income. Also the low income tax offset will not apply (from 1 July 2011) unless the child comes under one of the unearned income exemptions or it is excepted assessable income.
Investment Bonds tend to suit investors who are either high taxable income earners or those people seeking a flexible yet simple investment for the medium to long term.
As always, speak to your professional adviser to ensure the suitability of any investment for your individual purposes.