Investment bonds can be a handy tool to keep in your toolbox when it comes to building and managing your wealth, offering some pretty unique benefits from a tax, asset protection and estate planning perspective.
Unfortunately, investment bonds aren’t very well understood by most people – let’s fix this!
Today I want to cover off the key information you need to know when considering an investment bond. They have some pretty unique features which means they won’t be the right fit for everyone, but they can be very beneficial in the right circumstances.
What is an investment bond?
To understand what an investment bond is, you can think of it a bit like superannuation. It is a structure that holds assets and has its own set of rules associated with its use.
Investment bonds are sometimes referred to as an insurance bond because they are a type of life insurance investment contract whereby you can list a policy owner and a life insured – more on this later.
Again, like superannuation, investment bonds are a tax paid investment. This means that earnings are taxed within the fund, they don’t form part of your personal tax return. This can be a big benefit if you don’t want the hassle of tracking and reporting income and capital gains yourself.
So, to put it very simply, an investment bond is a bucket that holds investments.
What are your investment options?
What you can invest in via an investment bond is going to be dictated by the bond provider you choose. A bit like superannuation funds, they will have an investment menu for you to pick from to put together a portfolio.
Generally, you will have a choice of both growth and defensive assets and, in my experience, most bond providers give you sufficient options to put together a suitable portfolio when taking into account your investment objectives and risk tolerance.
Before picking a bond provider, check out their investment menu to see if it suits you. There are definitely some providers that offer a much wider array of investments than others.
Contributing to an investment bond
One of the key rules you have to be aware of when it comes to investment bonds is the 125% rule on contributions. That is, you can’t contribute more than 1.25 times (125%) of what you contributed the year before.
As an example, if in the first year you contributed $10,000. Then in the second year you can contribute anywhere up to $12,500.
If in any year you do not make a contribution to your investment bond, you will not be able to make any further contributions in future years as 125% of $0 is $0. If you want to make additional contributions, you will need to either start a new investment bond or restart your 10-year period (more on this later).
Given this restriction, I often consider the use of an investment bond where either there is a one-off lump sum to be invested, with little likelihood that future investments will be made, or they can also be great if you want to set up a regular investment plan.
Most bond providers will allow you to set up a regular investment plan subject to a minimum investment amount. The minimum is normally reasonably low and can be a cost-effective way to dollar-cost average small amounts of money with low transaction fees.
Accessing the money
Unlike superannuation, there are no conditions of release in order to access the money in your investment bond. You can access any amount at any time.
Just be aware, the funds will be invested so it can take some time for a redemption to be processed. It is not like withdrawing money from a cash account, it may take over a week for your investments to be liquidated and funds sent. Given this, an investment bond doesn’t replace the need to hold an emergency fund.
There will be tax implications if you withdraw the money within the first 10 years from inception of the bond. With that segue, let’s talk about investment bonds from a tax perspective now.
Potential tax benefits
Often an investment bond is created to help save tax and it can potentially do this in two ways.
Firstly, as we already touched on, investment bonds are a tax paid investment. The tax rate on an investment bond is anywhere up to 30%. However, most bond providers can reduce the effective rate of tax they pay quite substantially by utilising imputation credits and smart tax parcel management. This can see the tax rate drop on some bonds into the low teens.
Obviously, this is not quite as tax effective as superannuation, which has a maximum tax rate of 15%, but the trade-off is you have access to the money (as mentioned previously).
Given an investment bonds 30% tax rate, it may be a tax effective structure for you to invest if your marginal tax rate is above 30%. Just bear in mind that investment bonds don’t attract the 50% general discount for capital gains tax purposes.
The second reason why an investment bond can be tax effective is because after 8 years, there are tax concessions on the withdrawal from an investment bond. This is summarised in the table below. Most notably, withdrawals become tax free after 10 years!
|Amount assessed for income tax purposes
|During first 8 years
|100% of the earnings on the investment bond are included in your assessable income and a 30% tax offset applies
|During 9th year
|2/3 of earnings on the investment are included in your assessable income and a 30% tax offset applies
|During 10th year
|1/3 of earnings on the investment are included in your assessable income and a 30% tax offset applies
|After 10 years
|All earnings on the investment are tax free and do not need to be included in your assessable income.
If your intention is to invest for 10+ years, and your marginal tax rate is above 30%, then an investment bond can provide some pretty good tax benefits.
Also, earlier I mentioned about listing a “life insured” under your investment bond. Well, investment bonds can also be paid out tax free if the life insured were to pass away, even if the 10-year window hasn’t been met.
This opens up a whole new world of strategies whereby you can list someone with a short life expectancy and if they were to pass away prior to the 10-years, the investment bond can still be distributed tax free. I know it’s a bit morbid, but that’s estate planning for you!
Investment bonds can have other estate panning benefits as well so let’s consider those now.
Investment bonds and estate planning
Like with superannuation, you can nominate a beneficiary on your investment bond. By doing so, you can bypass the will and have the money paid directly to the intended person upon death. This can be an efficient and cost-effective way for estate planning and intergenerational wealth planning.
By sitting outside of the will, the nomination can’t be challenged. This may be particularly useful if you have a blended family, want to leave money to a charity, want to leave money to a non-related party or friend or any other instance where you think your will might be challenged.
The payment process can also be faster under an investment bond because there is no need to wait for probate or the administration of the estate.
In addition, you can pre-determine when and how the money can be accessed. For example, if you have young children and you list them as the beneficiary on your investment bond, you can stipulate that they can’t access the bond until 21 (or any other age of your choosing). You can also stipulate a withdrawal limit each year to ensure they don’t waste the money.
I have also heard of a pretty unique scenario where an investment bond was used by an elderly man to gift his estate to his adult daughter. He knew his daughter was in a toxic relationship and was concerned that if he were to pass away, her husband would claim half of the estate and then leave.
To prevent this, he instructed his bond provider to transfer the bond to his daughter after her retirement. This transfer could occur even if he had already passed away; thus the bond would survive his death, with the instruction still intact. He figured by this time, the relationship would have ended and the then ex-husband would have no claim to the estate.
Investment bonds and children’s savings
Investment bonds are a common structure used to save for children, whether that be savings for the child’s education or simply to gift them some assets at an appropriate age.
The reason why its popular? Well, we have already touched on most of the benefits. Potential tax saving and ability to dollar-cost average are a relatively cheap rate.
For example, if your child is 10 and you want to gift them a house deposit when they are 21, you can start investing money in an investment bond and by the time they are 21 you have exceeded the 10-year window and can gift that investment to them tax free.
Most bond providers have an option to set up a child specific bond. However, I often recommend against this option.
Under a child specific bond, you list an age between 10 and 25 for the ownership of the investment bond to automatically transfer to the child. The reason why I don’t like this is because life throws up some unexpected curve balls and you might not want to gift the money to your child during this period.
For example, let’s say your child is 24 and has a drug problem. The last thing you want to do at this stage is gift them a whole heap of money! Under a child bond, the money would go to them on their 25th birthday.
My preference is to keep the parents as the owners of the bond and go with a bond provider that allows you to transfer the ownership of the bond at any time you feel is appropriate.
Investment bonds and asset protection
Subject to certain rules, creditors can’t access your investment bond in the event of bankruptcy. If you work in a highly litigious industry, then an investment bond may be used as a way of protecting your assets.
Please be aware that if it is deemed that the transfer into the investment bond was done intentionally to defeat creditors then it may not help. You should seek specialised legal advice in this regard.
As you can see, there are many facets to an investment bond, and you need to determine their appropriateness by taking into consideration your financial position and your anticipated future financial position. In the right circumstances, they can be a great tool to help you build, protect and transfer wealth!