Q: I would like to put aside an amount of $5,000 for each of my Grandchildren for their education. It has been recommended to me to invest the money into Insurance Bonds. My Grandchildren are 8, 7, 4 and 2. What is an Insurance Bond and why is this option attractive?
A: An Insurance Bond or Investment Bond is a “tax paid” investment issued by an Insurance company on the life of an individual investor.
Earnings derived on investments held within the bond are subject to tax at the Life Insurance Company tax rate of 30%. However, the effective tax rate within the fund can be lower, for example, if the assets held within the bond include investment with franked dividends.
From a tax perspective, they are better suited to those on higher taxable incomes as the tax paid internally (that is 30%) will generally be less than the individuals marginal income tax rate. However, it should also be noted that capital gains derived from investments held within the bond will not receive any CGT discount (whereas investments held in your individual name generally will).
Another advantage of insurance bonds is the simplicity of the investment. You are not required to report investment earnings in your tax return unless the bond is redeemed.
If an Insurance Bond is redeemed after 10 years of establishment, the proceeds are generally tax-free. If the bond is withdrawn within the first 8 years, 100% of the Growth in the bond is taxable. In year 9 of the bond, two-thirds is taxable. In year 10 of the bond, one-third is taxable. Where the bond is withdrawn within 10 years, the investor receives a 30% tax offset on the taxable growth in recognition of the tax paid within the bond.
Any assessable growth amounts withdrawn from an insurance bond will be taxed at the individual’s marginal tax rate at the time but will also attract a 30% tax offset based on the tax already paid internally.
Future contributions to a bond can be up to 125% of the previous year’s contribution without restarting the tax-free period.
Insurance Bonds can also be attractive investments for minors who may be subject to quite high marginal tax rates on their investment income. A minor is defined as an individual under 18. Broadly, a minor is able to derive unearned (Investment) income up to $416 tax-free. Unearned income between $417 and $1,307 is taxed at 66% on amounts above $416. Unearned income above $1,307 is taxed at 45% on the total unearned income.
There are a range of Insurance Bonds available in the market that provides a variety of investment options ranging from a very conservative investment mix through to 100% Growth.
From a Centrelink perspective, insurance bonds will be treated as financial investments in much the same way as cash or shares. That is, they will be assessed as an asset under the asset test and subject to deeming under the income test.
An alternative to an Insurance Bond could be an Investment Trust. However as your grandchildren are under age 18, the investment fund would be obliged to be held in trust on their behalf and investment earnings may need to be reported in tax returns.
I suspect Insurance Bonds have been recommended to you due to the longer term investment time frame you are looking for and the amount you are looking to invest.
If you nominate a child as the life insured and you as the policy owner, then ownership of the bond can be transferred to the child at a nominated age, generally between 10 and 25, without any capital gains tax payable. Until the nominated age is reached, you have control.
Q: Due to the value of our accumulated Superannuation, my wife and I cannot invest any more money into Super. Should I consider Investment Bonds?
A: Individuals who have in excess of $1,600,000 in Superannuation are ineligible to make further non-concessional contributions to Super. Employer or personal deductible contributions can still be made to your Superannuation fund but only up to the Concessional Contribution cap of $25,000 per financial year.
Notwithstanding this limitation, Superannuation remains a very tax effective way to save for retirement and to receive tax advantaged income in retirement. The maximum tax payable on earnings within superannuation is 15% when in accumulation mode and 0% when transferred to an account based pension in retirement. However, there are limits and constraints with Superannuation that you need to consider.
To contribute to superannuation an investor needs to meet eligibility rules. Currently, this requires the investor to be under age 65 or, if aged 65 to 75, they need to satisfy a work test of working 40 hours in a 30 day period within the financial year prior to a contribution being made.
An alternative or supplement to investing in Superannuation is to invest into Investment Bonds. Like superannuation, tax is typically paid within the Investment Bond rather than personally by the investor.
Investment Bonds can be an attractive option for investors with taxable income above $90,000 (whose Marginal tax rate is 32.5% or higher) or investors looking for simplicity. Earnings within Investment Bonds are automatically reinvested and tax is paid within the bond at no more than 30%.
Investment Bonds provide a range of investment options to tailor a portfolio to your needs. Investors can usually switch between a range of investment options within a bond without triggering Capital Gains tax.
There is generally no limit on how much can be invested into Investment bonds.
Unlike Superannuation which is subject to preservation rules, there are no restrictions on accessing the proceeds of an Investment bond. Proceeds can generally be withdrawn within 5 working days. Although there may be tax implications if withdrawing within the 10-year period.
On death, the proceeds of an Investment Bond can be directed to a nominated beneficiary or to your estate. Proceeds are tax-free to all beneficiaries.
If you are restricted in making future contributions to Super or have personal marginal tax rates above 30%, Investment Bonds may be worth considering.