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Australians can take advantage of investment bonds to further grow their nest egg or grow their savings in a tax-effective environment for a minimum of 10 years. It is one of the most viable tax-effective investments that high-income earners may consider for their portfolio.

Nest Egg explains what investment bonds are and how they work to help investors understand its potential benefits.


Investment bonds

  • What are investment bonds?
  • Are investment bonds taxable?
  • How do investment bonds treat death benefits?
  • Planning to invest in an investment bond?
Investment bonds

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What are investment bonds?

Investment bonds are complex investments offered by insurance companies which comprise of two main parts: a life insurance policy and a managed investment portfolio.

  • Policy owners nominate the insured who will be covered by the policy, as well as the beneficiaries who would receive the money once the policy is terminated or the insured dies.
  • The policy owner also enrols in an investment portfolio managed by the insurance provider.

Investment bond portfolios are ideally held for at least 10 years and taxed at the corporate tax rate of 30 per cent. However income generated by investment assets after a decade becomes tax-exempt if certain conditions are met.


Are investment bonds taxable?

Investment bonds are tax-effective investment vehicles because income generated from investment bonds are taxed at the corporate tax rate of 30 per cent. This allows individuals with marginal tax rates above 30 per cent to pay lower tax for their investment income if they retain earnings within the fund.

Franking credits, capital gains tax (CGT) and capital loss remain at the fund manager level, which means individual policyholders can’t apply tax concessions from their investment bond portfolio in their tax return. However, all redeemed income from the fund will count as assessable income if withdrawn before it satisfies the 10-year rule.

Investment bonds tax benefits

If the policy owner withdraws their contributions or investment earnings within the first eight years of holding the investment bond, the full withdrawn amount must form part of their assessable income. It will also be subject to their individual marginal tax rate with a 30 per cent tax offset applied.

Other tax concessions are as follows:

Year of withdrawal

Treatment

Tax concession

Year 9

2/3 of investment earnings forms part of the individual’s assessable income

30 per cent tax offset applies

Year 10

1/3 of investment earnings forms part of the individual’s assessable income

After year 10

Investment earnings don’t count as assessable income

Tax exempt


Investment bonds can benefit individuals with marginal tax rates above 30 per cent. However, those with lower tax rates are at a disadvantage because their investment would be taxed at a higher rate but they can’t claim a tax offset or rebate on the difference. Individuals with lower marginal tax rates may wish to consider maximising their super instead.

What are the conditions for tax exemption of investment bonds?

Policy owners must meet two main conditions in order for investment bond earnings to gain a tax-exempt status: the 125 per cent rule and the 10-year rule.

  • The 125 per cent rule states that investors can make additional contributions of up to 125 per cent of their previous year’s contribution.
  • The 10-year rule dictates that investment bonds, including earnings and contributions, must be held for 10 years before it can gain a tax-exempt status. However, if the policy owner breaches the 125 per cent rule, the 10-year rule will restart—forcing the policy owner to hold the investment bond for another 10 years before it gains a tax exempt status.

What restarts the 10-year rule?

The 10-year rule’s continuity depends on whether the policy owner meets the conditions of the 125 per cent rule.

There are two important conditions to avoid restarting the 10-year rule.

  1. The maximum amount that they can contribute is 125 per cent of their previous year’s contribution, regardless of how much the allowable contribution was; and,
  2. If they did not contribute in any year within the 10-year period, any future contribution will restart the 10-year rule.

For instance, if Anne contributed $12,500 on the second year, she may only contribute up to $15,625 in the third year. If Anne’s contribution exceeds this amount on the third year, she will automatically reset the 10-year rule. This means Anne would have to hold her investment bond for a total of 13 years before it becomes tax-exempt—provided she doesn’t trigger another 10-year rule restart.

Likewise, if Anne only contributed $1,000 despite the allowable $15,625 on the third year, she can only contribute $1,250 on the fourth year.


How do investment bonds treat death benefits?

Investment bond death benefits are given the same tax-free treatment irrespective of the 10-year rule. Although investment bonds  are technically life insurance policies, the insured’s will may not always be followed when distributing benefits.

As a rule:

  • If the insured isn’t the policy owner, all benefits will be given to the policy owner.
  • If the insured is the policy owner, death benefits will be paid out to their nominated beneficiaries.

Planning to invest in an investment bond?

There’s no single standard in measuring and determining the best investment bond available in the Australian market. Before signing on for an investment bond, however, it is recommended that all policyholders evaluate their personal circumstances to determine the most appropriate combination of insurance cover and investment portfolio.

For those who are still unsure, it is best to seek investment advice from licenced professionals who can take their personal circumstances into consideration and determine whether an investment bond would suit their needs.