Are investment bonds worth considering?
Popular in the days before compulsory superannuation, investment bonds fell out of favour as super became the preferred tax-advantaged environment. Investment bonds can be a cost-effective, tax-effective, and convenient way to pass on your wealth, and with tighter restrictions on super contributions and increased market uncertainty, bonds might be worth a fresh look.
Investment bonds (also known as insurance bonds) are a combination of an investment portfolio and a life insurance policy. Available from a range of providers, investors can choose from a suite of underlying investments in much the same way as regular managed funds. Investment bonds shouldn’t be confused with interest-paying government or corporate bonds. They are a unique type of asset offering a range of advantages.
Tax advantages
The primary attraction of investment bonds is that earnings are taxed in the hands of the issuing company at a rate of 30%. Unlike traditional investments, bonds are a ‘tax paid’ investment. Provided the bond is held for more than 10 years no further tax is payable when the bond is cashed in.
While 30% is more than the 15% tax rate that applies to superannuation, it is less than the marginal rates of 34.5 to 47% (including Medicare levy) that apply to people with an annual taxable income above $45,000. The higher your marginal tax rate the more attractive investment bonds become.
What’s more, investment bonds don’t lock up your money for the long term as super does. You can access your money, though you do need to be aware of some rules, particularly if you are looking to access it in less than 10 years.
Bonds can be purchased with a single lump sum or with regular additions. However, to keep the original start date, an annual contribution cannot exceed 125% of the previous year’s contribution. If it does, the clock starts again for the 10-year rule. Another option is to simply purchase a new bond.
Additional benefits
Insurance bonds can be useful estate planning tools, or they can help with long-term saving for big-ticket items such as education. Investment bonds let you invest on behalf of a child (or grandchild). As a form of life insurance, if the owner dies the proceeds will be paid directly to nominated beneficiaries. The money doesn’t go through the estate and can be paid out quickly. In addition, the proceeds are not taxable in the hands of the beneficiaries, even if the bond is less than 10 years old.
Allowing for relevant tax rates, they may also be a good vehicle for saving for a child’s education or another long-term goal.
Timing
Due to their long-term nature, it isn’t just your current marginal tax rate that is important; it’s what your rate will be in the future. As many retirees pay little or no tax, particular consideration needs to be given to purchasing a bond that will be held until after retirement.
Suitability
Investment bonds aren’t for everyone, but they may suit investors who:
- have reached their concessional cap for super contributions;
- do not wish to lock away their money in super;
- are saving for a long-term goal and have a marginal tax rate above 30%;
- have specific estate planning needs.
There is much more about investment bonds than we can cover here. As with any type of investing, there are risks involved with bonds and these must be considered. Contact us if you would like to learn more.