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Understanding investment bonds

19 April 2021 | Julie Berry, GAICD, CFP®, Technical Specialist, Doctors Wealth Management

An investment bond, also known as an insurance bond, can provide for a wide range of investment needs such as tax-effective wealth creation, retirement planning, estate planning and asset protection. These bonds are investment instruments where investors’ money is pooled with others in a managed investment portfolio, a bit like superannuation or a managed fund but with specific differences and benefits.

Potential benefits

Investment bonds can supplement superannuation and may be particularly beneficial for high-income doctors restricted by contribution caps and condition of release rules. Unlike superannuation, the funds invested into investment bonds are not locked in for a specific period of time, so funds can be withdrawn as needed, though the tax advantages are lessened if the holding period is less than 10 years.

The owner of the bond and the beneficiary of the bond can be one and the same, or different. This allows them to be set up for children, grandchildren and on behalf of trusts or for specific purposes such as education, wedding or funeral costs. Multiple bene­­ficiaries are allowed, which is a boon in estate planning.

Tax-effective investing

Bonds are favoured by some as a tax-effective wealth growth strategy.1

Bonds have tax paid on investment earnings at 30% (the current life company tax rate) within the bond. This is the maximum rate of tax applicable to investment earnings or capital gains, although the actual rate may be lower depending on the level of imputation tax credits generated from the underlying investments applied.

A tax file number is not required and the income does not need to be declared as no distributions are made during the life of the bond. Your investment benefits from the power of compounding as earnings are re-invested on an ongoing basis.

As a general rule, investment/insurance bonds can also be cashed in tax-free once the holder has kept it for 10 years.

If withdrawals are made before the 10-year period, then a tax offset is applied to any applicable tax that may need to be paid.  For specifics, read the Product Disclosure Statement (PDS) carefully and seek financial advice if anything is unclear before making the decision to invest.

Investor flexibility

There can be up to three parties to the bond – the policy owner, life insured and beneficiary(ies), which allows tailoring of the investment approach to suit specific personal needs.

Investors can also choose from varying levels of risk exposure and/or can specify investment options, which invest in a particular asset class, such as property, shares, fixed interest or cash. Switching between these investment options can usually be done without triggering a capital gains tax event and transfer of ownership is permissible within certain criteria.

Investing on behalf of minors

Investment bonds provide a tax-advantaged and long-term investing option for use as a savings plan for children or grandchildren. An investment bond is like a fund in that it can be set up with a one-off contribution or ongoing contributions.

A key benefit is that earnings are taxed up to a maximum rate of 30% (life company tax rate) rather than the maximum rate applicable to minors (which can vary between 47% and 66%).

The bond owner is also able to nominate the age at which beneficiaries will receive proceeds and this can be altered to suit the parties’ ongoing needs.

As control of the fund is with the owner, this provides added peace of mind for some as funds are not locked in. For example, if circumstances change, the owner is able to withdraw funds at any time and receive a 30% tax credit on investment earnings but won’t necessarily get the earnings tax-free (depending on how much is withdrawn and the marginal tax rate applicable to the individual at the time). It is highly recommended to seek the advice of your financial professional before deciding on the best course of action if this situation applies to you.

Estate planning

As investment bonds are a type of life insurance bond, they are a contract-based product with an investor who is the owner but not necessarily the life insured or beneficiary.

You can nominate one or more beneficiaries to receive the proceeds in the event of death of the nominated life insured. The proceeds will be received tax free regardless of who the beneficiary is.

An investment bond can also be used as a funeral bond and may assist those looking to reduce their assessable assets and income for the government means tests.

Trusts

Investment bonds can be held by trusts and may provide a tax-advantaged investing option as the income is not distributed annually and can be withdrawn free of tax once the rules of the fund have been satisfied (being the 10-year rule and 125% rule).

Next steps

To find out more about the suitability of using investment bonds in your specific situation please consult with your financial advisor.

Reference

1 Depending on market conditions, fees and charges; and subject to the 10-year rule and 125% rule. See your PDS for a thorough explanation of these terms.

Important: The material contained in this publication is of a general nature only. It is not, nor is intended to be legal, accounting, tax or financial advice. Doctors Financial Services Pty Ltd (DFS) and its related entities have not considered your individual objectives, financial situation and needs in providing this information. If you wish to take any action based on the content of this publication we recommend that you seek appropriate professional advice. While we endeavour to ensure that this information is as current as possible at the time of publication, we take no responsibility for matters arising from changed circumstances, information or material. DFS and its related entities will not be liable for any loss or damage, however caused (including through negligence), that may be directly or indirectly suffered by you or anyone else in connection with the use of information provided. Doctors Wealth Management is a registered business name of Doctors Financial Services Pty Ltd ABN 56 610 510 328, AFSL 487758. Doctors Wealth Management Financial Advisers are Authorised Representatives of DFS.

© Doctors Financial Services Pty Limited 2021

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