How to invest: Pros and cons of investment bonds

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June 17 2019
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Many investment professionals consider investment bonds as a great tax-effective investment outside of super, but it’s important to consider that it may not be for everyone.

Here’s what you need to know about this complex investment product to help you decide whether it’s appropriate for your circumstance.

What are investment bonds?

An investment bond is essentially a life insurance policy combined with a tax-effective investment portfolio of your choice when you enrol in the policy.

You don’t need to make investment decisions other than the type of fund your money will be invested in (i.e. growth, balanced, conservative or cash). The investment portfolio is managed by the provider or its fund manager. Just make sure to read the product disclosure statement so you know your portfolio’s allocation from the stock market, individual bonds, mutual funds and other assets.

As the policy owner, you may nominate a beneficiary who will receive the insurance payout and investment, as well as any income it earns, upon your death.

Investment bonds are ideally held for a 10-year period. But if you hold your contributions and the income that your portfolio generates without withdrawal for 10 years, they gain a tax-free status.

Pros and cons of investment bonds

Investment bonds may not be suitable for all types of investors. Consider the pros and cons before deciding whether it’s right for you.

Pros

Tax-effective
Investment bonds are tax-effective because the investments are held within the insurance policy. Earnings from the invested money are taxed at the corporate rate of 30 per cent, which means individuals with a marginal tax rate greater than 30 per cent can benefit from the lower taxation.

You don’t have to declare your earnings in your income tax return – unless you make a withdrawal before the 10-year period ends.

You will be able to take all the earnings tax-free once the 10-year period is over.

Liquidity
The 10-year lock-in period is more of a guideline than a prevailing rule since you can still withdraw your earnings or contribution at any time.

However, early withdrawal may have tax implications depending on how far along you are on the 10-year holding period. That is, a withdrawal made on your fifth year of holding the policy has a different tax treatment than a withdrawal made on the ninth year due to the available tax concession.

Estate planning tool
As a life insurance policy, your contributions and any earnings will be given to your nominated beneficiary tax-free upon your death.

This means you can nominate your child or children as your beneficiary and contribute what would be their inheritance. Some policies also allow the policy owner to nominate when ownership will be transferred, which means you can still determine when your beneficiary will receive the money.

If you want better control over your beneficiary’s inheritance, you may also nominate a trust as the policy owner or beneficiary so that it can take care of the inheritance money according to your will.

Cons

Tax-effective but only under limited circumstances

Marginal tax rates above 30 per cent
Professionals recommend investment bonds as a good alternative to super because it is tax-effective. However, its tax concessions only benefit those with marginal tax rates above 30 per cent.
No withdrawals
Any withdrawal within the first eight years counts towards your assessable income, while a portion of the withdrawn amount is still subject to your marginal tax rate within the ninth and 10th year. The money only becomes tax-free once the 10th year closes.
Maximise 125 per cent rule
You have to make extra contributions to further grow your invested money. If you break the 125 per cent rule, the 10-year cycle restarts, which means you will have to wait another full 10 years before the money becomes tax-free.

If you don’t make an extra contribution in any one year, you can no longer contribute in the following years. If you still contribute, the 10-year cycle will restart.

No tax concessions
Since investment bonds are taxed at the fund manager level, any tax concessions it may be eligible for also remain at that level. That is, franking credits, capital gains tax and capital loss cannot be applied by individual policyholders in their tax return.

Seek professional advice

If you’re still unsure about getting an investment bond, we recommend seeking the advice of a licensed professional who can take your personal circumstances into consideration.

About the author

Louise is a content producer for Momentum Media’s nestegg who likes keeping up-to-date with all the ways people can work towards financial stability in 2019. She also enjoys turning complex information into easy-to-digest, practical tips to help those who want to achieve financial independence.

About the author

Louise is a content producer for Momentum Media’s nestegg who likes keeping up-to-date with all the ways people can work towards financial stability in 2019. She also enjoys turning complex information into easy-to-digest, practical tips to help those who want to achieve financial independence.

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