Investment bonds explained
Investment bonds can be a handy investment option 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. They have some unique features which makes them very beneficial in the right circumstances.
What is an investment bond?
To understand an investment bond, you can think of it as a little like superannuation, a structure that holds assets with its own set of rules associated with its use.
Like superannuation, investment bonds are a ‘tax-paid’ investment where earnings are taxed at a maximum tax rate of 30%. A lower effective tax rate can apply, depending on the investment options chosen. The earnings are taxed within the fund and don’t form part of your tax return. This can be a big benefit if you don’t want the hassle of tracking and reporting income and capital gains yourself.
The bond’s tax efficiency is optimized once you hold it for at least 10 years, with no personal tax payable on withdrawals after this period.
What are your investment options?
Similar to superannuation funds, investment bonds have an investment menu for you to pick from.
Generally, you will have a choice of both growth and defensive assets and most bond providers give you sufficient options to put together a suitable portfolio when considering your investment objectives and risk tolerance.
Contributing to an investment bond
Unlike superannuation, there is no limit on how much you can contribute in the first year. You can make additional investments each year, either as regular savings or ad hoc contributions, of up to 125% of your previous year’s contributions without re-setting your investment’s 10-year period
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.
Tax benefits
The tax rate on an investment bond is anywhere up to 30%. However, most bond providers can reduce the effective rate of tax that they pay quite substantially. Utilising imputation credits and smart tax parcel management, some funds are paying an effective rate of tax in 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 your funds at any time.
Where a bond withdrawal is made within 10 years, the growth portion of the investment will be taxable. However, a 30% tax offset applies, so, in effect, an investor needs to only pay tax on the difference between their marginal tax rate and 30%.
This tax is applied on a sliding scale (see table below) until withdrawals become completely tax-free after the 10th year.
Investment bonds and estate planning
Similar to superannuation, you can nominate beneficiaries for your investment bond. By doing so, you can bypass your will and have the money paid directly to your intended beneficiary 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 any instance where you think your will might be challenged.
Alternatively, investors can nominate to transfer their bond ownership to an intended recipient at a nominated future date, which can be a specific date or upon death. The transfer happens tax-free for income and capital gains tax purposes and the 1- year period does not reset upon transfer.
There is also an option to place restrictions on access to funds by the recipient after the transfer has occurred.
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.
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.
Investment bonds and asset protection
Under the Bankruptcy Act, investment bond assets are protected from creditor claims in the event of bankruptcy. This may be of value to self-employed investors or those in litigious occupations.
Final thoughts
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!
