Investment / insurance bonds

Insurance bonds, sometimes also known as investment bonds, seem to be enjoying a resurgence in popularity of late, possibly due to the many changes to laws governing superannuation contributions. For investors who previously would have sought the taxation shelter of superannuation, insurance bonds provide another tax-effective avenue without contribution limits. However, these products can be used for a multitude of other purposes, such as solving certain estate planning issues; increasing the age pension for retirees; and as an investment alternative for people who are seeking to preserve their capital without receiving income payments.

Insurance bonds are simple because investment earnings do not have to be declared in personal tax return unless a withdrawal is made within the first 10 years. Insurance bonds are classified as ‘tax-paid’ investments, as the provider pays the tax on investment earnings. The rate of tax paid is generally the current company tax rate of 30 per cent, although this can be reduced through the use of imputation credits. For clients on high incomes, this can be a tax-effective way to invest.

After 10 years, if the client has adhered to the 125% rule (where each year’s contributions did not exceed 125 per cent of the previous year’s), any withdrawals made will not attract personal income tax or capital gains tax. Capital gains tax is also not applicable when switching between investment options.

For clients that do withdraw before the 10-year period is satisfied, all or part of the profit portion or investment earnings will be included in their assessable income. The amount of profit included in the client’s assessable income depends on when they make a withdrawal.

The 125% Rule

The 125% rule can make insurance bonds an even more tax-effective investment strategy. In subsequent years, additional investments of up to 125% of the previous year can be made to an investment bond, and provided the investor does not make any withdrawals, the additional contributions to an investment bond do not need to be invested for a full 10 years before acquiring a tax paid status.

Life Insurance & Estate Planning

An added feature of insurance bonds is that they developed from, and still are, a form of life insurance (hence their name). When an insurance bond is taken out, a life to be insured and a beneficiary are nominated, and if the life insured dies, the full surrender value is paid to either the policy owner (if different from life insured) or to nominated beneficiaries (if the policy owner is the same as the life insured). In the event that the life insured dies, there will be no tax liability for the beneficiary.

Taxation upon death is a significant risk, particularly to those with non-dependent children as beneficiaries. In the superannuation environment, death benefits that are paid to non-dependants risk tax of up to 31.5 per cent. Insurance bonds offer an alternative in these situations as they allow proceeds to be paid to any beneficiary (including non-dependants) tax free.

Leaving the tax benefits aside, these bonds can also be structured in a number of ways to solve estate-planning problems. Investors can nominate more than one beneficiary and can stipulate the percentage or amount that each will receive. When a beneficiary is nominated, the proceeds will not be subject to challenges to the client’s estate, as they will not form part of the estate assets. Complex family situations can also be accommodated.

For investors with children with a marriage at risk, bonds can provide a level of asset protection from the child’s spouse. Upon death of the parent, bond proceeds can be paid to their estate and included in the creation of a discretionary trust in their will for the benefit of children and grandchildren.
In other situations where the investor only wants to provide for grandchildren, the bonds can be set up as advancement policies. Ownership would automatically transfer to the grandchild at a stipulated age, generally without capital gains tax consequences

Investing for Children

A special tax scale is applied by the government to the taxable income of a child as a way of discouraging adults from transferring assets to their child’s name to reduce tax payable. For a child the first $416 of ‘unearned’ income is tax-free, but amounts over $416 and up to $1444 can be taxed as high as 66%, and amounts over $1445 are taxed at 47%. By investing in an investment bond the special tax scale applied to a child’s investment income can be avoided. As detailed above, investment earnings on insurance bonds would be taxed a fund manager level, and at the end of the 10 year term all proceeds would be tax free.

Boosting the age pension

Insurance bonds offer unique opportunities to increase some investors age pension if structured appropriately, depending on the client’s individual circumstances. One such strategy is to have the insurance bond owned by a family trust. This can potentially offer some relief under the income test and may reduce aged care costs.

Other benefits

There are other worthwhile benefits at a product level that can be sought by advisers and clients that should be mentioned. Some bonds offer guaranteed investment options, which are very relevant given current market conditions. Similarly, the provision of death benefit guarantees, if offered, can ensure the estate and/or beneficiaries are paid at least the amount the deceased contributed (less any withdrawals) regardless of market movements. These two features are not offered by all providers.