Q. I recently received an inheritance from my Grandmother’s estate of $60,000.  The money has been earmarked for my children’s education.  It has been recommended to me to invest the inheritance in Insurance Bonds.  My children are 8, 6 and 2. What is an Insurance Bond and why is this option attractive?

A. An Insurance 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 shares paying franked dividends.

From a tax perspective, they are ideally suited to those on higher taxable incomes as the tax paid internally (that is 30%) would be less than the individuals marginal 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.

And, even then:

  • The growth on Insurance Bonds held for more than 10 years is tax free.
  • If the bond is redeemed in the 10th year, only one third of the growth is assessable.
  • If the bond is redeemed in the 9th year, two thirds of the growth is assessable.
  • If redeemed in under 8 years, all growth is assessable.

Any assessable growth amounts 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.

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 income (Investment) Income up to $416 tax free. Tax is then levied as follows:

  1. Unearned income between $417 and $1,307 – 66% on amounts above $416, and
  2. Unearned income above $1,307 – 45% on the total unearned income.

There are a range of Insurance Bonds available in the market that provide a variety of investment options ranging from a very conservative investment mix through to 100% Growth. Some Bonds enable you to tailor a mix of funds across all asset classes from Cash to Australian and International Shares.

An alternative to an Insurance Bond could be an Investment Trusts. However as your children 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.

The Insurance Bond most likely would be owned by you or the Executor of the Estate depending on the terms of your Grandmother’s will. If you nominate a child as the life insured and an adult 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, the trustee has control.

Follow Andrew on Twitter @AndrewHeavenFP. This article was originally published in The Australian