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Getting tied up with Investment Bonds

Jul 25, 2018

Welcome to Finance and Fury’s ‘Say What Wednesday’ where we answer your questions on personal finance. Today’s question today comes from William who asked us to do an episode on Investment Bonds.

Investment bonds - What are they?

  1. Investment vehicle - Not to be confused with bonds which are a (Debt instrument) investment (just in case the question was asking to cover these, I’ll do another episode on these too)
  2. An investment bond is technically a life insurance policy
    • Nominate a beneficiary
  3. It is a long-term investment with features similar to a managed fund
    • money is pooled with money from other investors and invested
    • Designed to be held for at least 10 years
  4. Types
    • Traditional Investment Bonds – what we will focus on in this episode. There are also,
    • Education Bonds, and
    • Funeral Plan bonds

 

Tax Treatments

  1. Tax effective for individuals with higher Marginal Tax Rates
  2. Internal Tax of 30% - Tax paid at company rate by the insurance company
    • Net income reinvested
  3. If no withdrawals are made in the first 10 years earnings will be tax free

 

Investment options

  1. Investment options such as cash, fixed interest, shares, property, infrastructure or a range of diversified investment options
  2. Risks range from low to high – Depending on the requirement and timeframes, different investments will be better serving your situation

 

Withdrawals

  1. You can withdraw money at any time, BUT it comes at a cost
  2. If you withdraw before 10 years, tax may be payable
    • <8 years: 100% of the earnings on the investment bond are included in your assessable income and a 30% tax offset applies
    • 9th year: 2/3 of earnings on the investment are included in your assessable income and a 30% tax offset applies
    • 10th year: 1/3 of earnings on the investment are included in your assessable income and a 30% tax offset applies
    • After 10 year: All earnings on the investment are tax free and do not need to be included in your assessable income
  3. The 30% offset is due to the company already paying tax.

 

Investment Bondage Bonds 😉 ...There are strict, strict, rules and you really are tied up;

  1. 10-year rule - If you need to withdraw some of your money before the 10-year period is reached some of the tax benefits will be lost
    • If you hold the bond for at least 10 years the returns on the entire investment, including additional contributions made, will be tax free subject to the 125% rule.
  2. 125% rule – You can make additional contributions each year of any amount up to 125% maximum
    • i.e. $1,000 year 1, $1,250 year 2, $1,562.5 year 3
    • These are still treated as initial contributions – Allows each contribution to receive full tax benefits after 10 years
    • But don’t exceed 125% of previous year’s contributions – Otherwise your 10-year period restarts
    • Also, don’t forget to make a payment. 125% of $0 is still $0. If you miss one year’s payments you wont be able to contribute anything further in the future – and if you do it will start the 10-year period again.

The Pros:

  • Can be a tax effective long-term investment
    • Follow the 10-year rule and 125% rule
  • Can be an effective way to save for a child's future.
    • Especially with Education bonds which are similar. You can only use these funds for education but there is no “125% rule”
  • Can be used as an estate planning tool
    • Beneficiary benefits received tax free
  • Alternative to super caps
    • $1.6m in pension (tax free) – Start planning out from retirement > 10 years
  • Investments are not normally subject to capital gains tax due to ongoing tax treatment

The Cons:

  • The costs - You will pay fees, and they are fairly costly
    • Investment options – MERs are higher up to around 1-2%
    • Investment bond – admin fees of around 0.6%
  • To make it tax effective, it is locked away
  • Limited investment options – Multi managed and often limited to the company offering the bond.
    • Also, lower levels of transparency due to the pooled nature of investments

 

In Summary: You need to think about some things to determine if investment bonds are right for you

  • Are you in it for the long haul? - The tax benefits from investment bonds are only realised if no withdrawals are made for 10 years and you comply with the 125% rule.
  • Are you able to make regular contributions? - These investments are particularly tax effective for people who make regular contributions over the life of the investment.
  • What investment options are available? - It is important to choose a product that offers investment options that are aligned with your risk tolerance and investment goals.
  • What are the fees on the investment bond? - Common fees you may pay include establishment fees, contribution fees, withdrawal fees, management fees, switching fees and adviser service fees. Shop around and compare the fees to similar products in the market.
  • Are you using the product for estate planning purposes? - Make sure it fits with your estate planning goals.

Thanks for the question William!

I will do another episode on Bonds (the debt instrument kind) to make sure we’re covering off on that as well.

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