It is one of the great ironies of life that an investment vehicle that has withered on the vine for decades is suddenly being talked about as one of the answers to increased superannuation taxes.
The humble investment bond – also known as an insurance bond – was quite a popular choice way back before superannuation really took off but then sort of retreated back into mainly being a tax paid vehicle for putting aside money for children to avoid punishing children’s tax rates.
However, with tax rates on super rising to 30% for investments above $3 million and 40% above $10 million from the middle of this year under the new division 296 rules, there has been a real rethink about what other structures are around that might be an alternative to putting money into super.
Investors Showing Renewed Interest
One provider, Generation Life, said that inflows into its investment bonds have surged 57% in the year and a half since the super taxes were proposed.
Investment bonds are a tax-advantaged way to hold assets and while the tax advantages are not as good as super, the restrictions on withdrawal are far less onerous.
Like super you can choose the sort of investment options that are bought within the investment bond structure but the big advantage is that the rules that govern the bonds have remained virtually unchanged for decades – a very different situation to super.
How Do They Work?
So, what is an investment bond and how do they work?
Like super, it is best to think of investment bonds as a structure used to hold assets and not as an asset itself.
Most providers will offer an investment menu for you to pick from, with assets spread across various asset classes.
So familiar superannuation style labels like cash, fixed interest, balanced growth, high growth, Australian equities, international equities, and international property are often used.
Once inside the structure, you can access the money in the investment bond but if you hold it for ten years or longer, no capital gains tax is payable on the assets within the bond.
You are also free to move money between different options within the bond without triggering any sort of capital gains or other tax if you hold it for 10 years or more.
Tax-Paid Rather than Tax-Free
Tax is paid on the investment earnings at 30% but the effective tax rate can be much lower if the bond is earning franking credits from Australian shares.
Some investment bonds can end up with an effective tax rate closer to 15% if they have a high percentage of Australian shares.
That makes them a useful choice for people on the top rate of tax but less useful further down the tax scale.
Cascading Contributions
Investment bonds have a cascading method of contributions which is effectively set by the original amount invested.
Each subsequent year you can invest up to 125% of what you contributed the previous year, which enables you to build up the amount invested over time—all of which will be available tax paid after 10 years.
That means you can start with a lump sum and not add to it or begin smaller and keep making regular investments that can be increased, making it quite flexible.
Only Makes Sense for a High Tax Rate
However, the structure makes less sense if you are going to be on a low tax rate by the time the bond matures or if you are on a lower tax rate to start with.
In that case, making investments directly in the name of the taxpayer with the lower tax rate would make more sense.
Fees are a little on the high side due to the complexity of the structure – up to 60 basis points – although that won’t eat up all of the tax saved for someone on the highest tax rate.
Some Estate Planning Benefits
There are also some other advantages to investment bonds when it comes to estate planning.
Like superannuation, they sit outside the will and can be left to particular people such as children or grandchildren.
This means that they are less likely to be challenged like the contents of a will and can also be left to a charity or unrelated party directly.
Investors can also put other stipulations on investment bonds that limit when the beneficiary can access them, such as age.
In most circumstances, investment bonds cannot be accessed by creditors if the investor goes through bankruptcy.
Some financial planners are not keen on using investment bonds because they can be expensive and inflexible and prefer other structures such as trusts or companies for wealthy clients.
However, for the right person, investment bonds can be ideal.
One thing is for certain, given the changes to superannuation, an old investment choice that had gone out of fashion is now undergoing a new lease of life.
