Investment and insurance bonds

Investing for the long haul

Investment bonds, also known as insurance bonds or growth bonds, are investments offered by insurance companies and friendly societies. They have features similar to a managed fund combined with an insurance policy and can be a tax effective way to invest for the long-term if certain rules for making contributions and withdrawals are followed. 

Here we explain how investment bonds work so you can decide if they are right for you.

What is an investment bond?

Smart tip

If you are considering an investment bond make sure it offers investment options that suit your risk profile.

An investment bond is technically a life insurance policy so you need to nominate a life to be insured and a beneficiary. It is a long term investment with features similar to a managed fund combined with an insurance policy.

Investment bonds can be tax effective for long term investors with a marginal tax rate higher than 30%, as long as certain rules are followed.

Your money is pooled with money from other investors and a portion of the pooled funds is then invested in the investment options each investor chooses.

Most investment bonds offer investment options such as cash, fixed interest, shares, property, infrastructure or a range of diversified investment options, with risk levels ranging from low risk to high risk. The value of the investment bond will rise or fall with the performance of the underlying investments.

An investment bond is designed to be held for at least 10 years. You can make additional contributions over the life of the insurance bond. To make the most of the tax benefits, each year you can contribute up to 125% of your previous year's contribution.

Withdrawals

Money can be withdrawn from the investment bond at any time, however if you withdraw your money before the 10 years is up, some of the income may be taxable, depending on when the withdrawal is made.
If no withdrawals are made in the first 10 years any earnings on the bond will be tax free.

Estate planning

Insurance bonds may provide estate planning opportunities for some investors. When an investment bond is set up, you'll need to nominate a policy owner, a life or lives to be insured and beneficiaries. The policy owner may be the same as the life insured.

If the last insured person passes away, the beneficiary receives the proceeds from the insurance bond tax free. If there is no nominated beneficiary, the proceeds will go to the policy owner or the policy owner's estate.

Most investment bonds also offer a child advancement policy where ownership of the policy is able to be transferred to a child when they reach a nominated age. This can be a tax effective way to save for a child's future.

If you are considering using investment bonds for estate planning, seek professional legal advice first.

Rules for investment bonds

10 year rule

Investment bonds are tax paid investments. This means when earnings on the investment are received by the insurance company, they are taxed at the corporate tax rate (currently 30%) before being reinvested in the bond. This can make insurance bonds a tax effective long term investment for those with a marginal tax rate higher than 30%.

Try our income tax calculator to find out your marginal tax rate.

Income tax calculator

If you hold the bond for at least 10 years the returns on the entire investment, including additional contributions made, will be tax free subject to the 125% rule.

If you make a withdrawal within the first 10 years, the rate at which earnings in the investment bond are taxed will depend on when you make the withdrawal.

Tax treatment of investment bond withdrawals

Year withdrawal made Tax treatment
Withdrawals within 8 years  100% of the earnings on the investment bond are included in your assessable income and a 30% tax offset applies*.
Withdrawals in the 9th year  2/3 of earnings on the investment are included in your assessable income and a 30% tax offset applies.
Withdrawals in the 10th year 1/3 of earnings on the investment are included in your assessable income and a 30% tax offset applies.
Withdrawals after the 10th year All earnings on the investment are tax free and do not need to be included in your assessable income.

* The 30% tax offset compensates for the tax already paid on earnings by the insurance company or friendly society.

The 125% rule

Investors in investment bonds can make additional contributions each year. As long as the contribution does not exceed 125% of the previous year's contribution, it will be considered part of the initial investment. This means each additional contribution does not need to be invested for the full 10 years to receive the full tax benefits.

If contributions are made to the investment bond that exceed 125% of the previous year's investment, the start date of the 10 year period will reset to the start of the investment year in which the excess contributions are made. You will then have to wait a further 10 years from this date to gain the full tax benefits.

No contributions in a year

If you do not make a contribution to the investment bond in one year, any contributions in following years will reset the 10 year rule.

Case study: Alison's investment bond

lady looking at papersAlison's marginal tax rate is 37% so she decides set up an investment bond as a tax effective way to save for her young daughter's future education expenses.

When Alison sets up the investment bond, she contributes $10,000. In the following year the maximum she can contribute and still stay within 125% of the previous year's contribution is $12,500. In the third year the maximum she can contribute without restarting the 10-year period is $15,625.

The graph below shows the maximum Alison can contribute each year without restarting the 10-year period.

Alison's investment bond contributions graph

If Alison wanted to contribute more than $12,500 in the second year, she would have to wait 10 years from the second year, to get the full tax benefit. 

 Pros and cons of investment bonds 

Benefits of investment bonds 

Here are some of the benefits of investment bonds:

  • Can be a tax effective long term investment provided certain rules are followed.
  • Most offer a wide range of investment options to cater for different investment strategies and risk profiles.
  • Can be an effective way to save for a child's future.
  • Can be used as an estate planning tool.
  • May be useful for people who are unable to contribute to superannuation.
  • Investments are not normally subject to capital gains tax.

Risks of investment bonds 

Here are some of the risks of investment bonds:

  • You will pay fees, which vary widely depending on the issuer of the investment bond and the investment options chosen.
  • They can be slower than some investments to convert the balance to cash and some investment bonds have minimum balances that must be maintained.
  • You are relying on the skills of other people to manage your investment, and you do not have direct control over investment decisions.
  • If you need to withdraw some of your money before the 10-year period is reached some of the tax benefits will be lost.

Things to consider before taking on an investment bond 

If you are considering investing in an investment bond here are some things to think about:

  • Are you in it for the long haul? - The tax benefits from investment bonds are only realised if no withdrawals are made for 10 years and you comply with the 125% rule.
  • Are you able to make regular contributions? - These investments are particularly tax effective for people who make regular contributions over the life of the investment.
  • What investment options are available? - It is important to choose a product that offers investment options that are aligned with your risk tolerance and investment goals.
  • What are the fees on the investment bond? - Common fees you may pay include establishment fees, contribution fees, withdrawal fees, management fees, switching fees and adviser service fees. Shop around and compare the fees to similar products in the market.
  • Are you using the product for estate planning purposes? - Make sure it fits with your estate planning goals.

Make sure you read the product disclosure statement to get an understanding of the features, risks, costs and other considerations. If you are not sure about any aspect of the product, seek professional financial advice before investing.

Investment bonds may be suitable for people who are looking for long-term investments and are unlikely to need access to their funds for at least 10 years. They can be tax effective for high income earners as long as certain conditions are met. As always, read the product disclosure statement before investing.


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Last updated: 01 Aug 2016