Investment bonds are a unique financial product that provides investors with flexibility, tax efficiency, and estate planning benefits. But what exactly is an investment bond, and is it the right investment option for you? This comprehensive guide will explain everything you need to know about investment bonds.
An investment bond, also known as a life bond, is a tax-efficient investment wrapper offered by life insurance companies. It allows you to invest a lump sum into a range of managed funds, similar to a managed fund portfolio. However, unlike investing directly in managed funds, the earnings and capital gains generated within an investment bond are taxed at a maximum rate of 30% by the life insurance company rather than your marginal income tax rate.
In simple terms, an investment bond is like a tax-paid managed fund. The life insurer pays tax on the earnings at a flat rate, while the investor is not personally taxed on any income or capital gains from the investment bond. It makes them popular among higher-income earners who want to minimize their tax liability.
When you invest in an investment bond, you are allocated ‘units’ in your chosen investment option or managed fund. The value of these units will fluctuate based on the performance of the underlying assets. The life insurer bundles together all investors’ contributions and collectively invests them.
While you ‘own’ units in the investment bond, the life insurer legally owns the portfolio of assets. So you do not personally receive any income or capital gains from the investments – the insurer receives all earnings and then passes on returns to you by increasing the unit price of your investment options.
This structure means you are not personally taxed on any investment earnings generated within the bond. The life insurer pays tax on the collective earnings at the current company tax rate of 30%. The unit price of your investment options is increased to reflect after-tax returns.
Several benefits make investment bonds an attractive investment option:
The 30% tax rate paid by the life insurer is typically lower than most individual marginal tax rates, providing a tax advantage. Capital gains are also taxed at the lower 30% rate rather than your income tax rate.
Investment bonds allow you to nominate beneficiaries who can receive your investment directly as a non-assessable payment. It can help minimize tax and avoid lengthy estate processes.
Most investment bonds allow you to switch between investment options without triggering personal capital gains tax liabilities. You can also make partial withdrawals when needed.
Assets held within an investment bond are legally owned by the life insurer rather than the individual. It makes them effective for asset protection purposes.
You must not include any investment earnings in your personal tax return annually. Tax is deferred until money is withdrawn from the bond.
While investment bonds can be very tax-effective, there are some downsides to consider:
Investment bonds can be a suitable investment option for:
Conversely, investment bonds may only be appropriate for some low-income earners under the 30% tax rate threshold or those wanting short-term access to investment earnings.
Most investment bond providers will allow minimum initial investments between $5,000 and $10,000. There is usually no maximum limit, so you can invest as much as you want over time. Just be aware that investment bonds are considered medium to long-term investments, so they should align with an appropriate investment timeframe.
There are a few main structures of investment bonds to choose from:
When choosing an investment bond provider, key factors to consider include:
Investment bonds can be an excellent investment choice for certain investors due to their tax efficiency and flexibility. By paying tax at a maximum of 30% on earnings, they provide a tax advantage compared to marginal income tax rates over 30%.
However, they are complex products with conditions around withdrawals. They are suited to long-term investors who do not need regular access to investment earnings.
Short-term investors or those wanting to claim personal tax deductions may be better off investing directly in managed funds.
Like any investment, investment bonds have pros and cons. Weigh up the benefits and downsides relative to your specific investment objectives and circumstances to determine if they are a suitable addition to your portfolio. Consulting a financial adviser can help analyze their suitability for your situation.
Some bond providers may allow you to borrow funds via a margin loan to invest in an investment bond. However, strict conditions normally apply, and fees are charged on the loan. Borrowing to invest also increases your investment risk.
No, investment bonds do not provide guaranteed earnings on your capital. As you are investing in managed funds, the value of your investment can rise and fall. Some bonds may offer capital guarantees, but earnings can still fluctuate based on investment markets.
No, investment bonds are exempt from the Centrelink assets and income tests. The value of the bond is not included in your assessable assets. Payments made from the bond are also not considered income for Centrelink purposes.
In summary, an investment bond is a tax-paid managed fund offered by life insurers. While complex, investment bonds can provide tax efficiency for savvy investors. Weigh up the pros and cons relative to your circumstances when deciding if they are the right investment vehicle for you.
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Disclaimer
*The information this blog provides is for general informational purposes only and is not intended as financial or professional advice. The information may not reflect current developments and may be changed or updated without notice. Any opinions expressed on this blog are the author’s own and do not necessarily reflect the views of the author’s employer or any other organization. You should not act or rely on any information contained in this blog without first seeking the advice of a professional. No representation or warranty, express or implied, is made as to the accuracy or completeness of the information contained in this blog. The author and affiliated parties assume no liability for any errors or omissions.
