Insurance bonds revisited

With the restrictions currently in place on concessional contributions to superannuation, you may be looking for other tax-advantaged investments. Most of those available, such as geared investments, carry a higher level of risk than you may be willing to take.

Investment or insurance bonds are frequently overlooked as an investment class but they offer significant tax advantages. They are referred to as “tax-paid” investments because the fund manager is deemed to have paid tax on the earnings at the corporate tax rate of 30% (although the actual tax rate paid by the manager may be less as a result of tax-advantaged returns on the underlying investments).

You do not have to include earnings on insurance bonds in your tax return. If you hold the bond for 10 years or more, you do not have to pay tax on any capital gains. If you hold it for fewer than 8 years you pay tax on the capital gain but you receive a 30% rebate to compensate for the tax paid by the fund manager. 

For example, if you redeem the bond in the eighth year, you get a deduction of one-third of the capital gain and a 30% rebate on the rest. If you redeem in the ninth year, you get a deduction of two-thirds of the gain and a 30% rebate on the rest.

You can take advantage of the 125% rule, which allows you to make a contribution each year of 125% of the prior year’s contribution. Providing that you do not make any withdrawals, the additional contribution does not need to be held for 10 years to acquire the tax-paid status. However, if you miss a year, the next contribution will start the 10-year period for that and any subsequent contributions.

Because insurance bonds developed from insurance policies, an investment bond will be attached to a particular person. If that person dies before the bond is liquidated, the bond ‘surrender value’ passes to his or her beneficiary tax-free.

Insurance bonds are a good way of investing for children without having to pay the exorbitantly high tax rates that apply to minors. The income earned on the bond is taxed at the fund manager level, and after 10 years, the capital and earnings is returned tax free.

Education bonds are a variation of insurance bond that provides for future education expenses. However, you should be careful to read the conditions attached to the plan to ensure that you can redeem the bond if the child insured does not go on to tertiary education. Funeral bonds are another variation that provides for future funeral expenses and are not counted as assets for Centrelink purposes in determining eligibility for the age pension.

The investment styles of insurance bonds range from capital guaranteed to high growth and some sector-specific bonds.  Speak to an adviser about how they fit into your investment program.