Set and forget

This long-term saving option is simple and flexible

STORY ASSYAT DAVID

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INVESTORS LOOKING FOR A tax-effective means of saving often look to superannuation as the solution. An alternative structure that can be considered is an insurance bond, also known as an investment bond.

The term, “insurance bond”, is somewhat a misnomer, since often such funds provide no life insurance benefit. They are primarily used as a means of investing in the many asset classes provided by life insurance companies and friendly societies for non-superannuation savings and offer some specific advantages compared with other managed funds such as superannuation or unit trusts.

Investment options range from cash to Australian and international shares, as well as diversified portfolios, such as a balanced fund that provides a combination of shares, property, fixed interest and cash.

As with superannuation, tax is paid by the life insurance company rather than by the investor. The maximum tax paid on the earnings and capital gains within an insurance bond is 30%, although franking credits and tax deductions can reduce this effective tax rate.

A key feature of an insurance bond is that if it is redeemed after 10 years, no further tax is paid by the investor. However, if it is redeemed within the first 10 years, the investor will pay tax on the assessable portion of growth (see table below). The investor receives a 30% tax offset on the taxable amount.

Insurance bonds provide a tax-effective alternative or complement to superannuation, which is also considered to be a tax-effective structure. But the amount that can be invested in super is limited and hefty tax penalties apply if these limits are exceeded. Access to money in super is also limited, generally until retirement or death, for the estate.

Insurance bonds provide flexibility of access to money at any time. They can also be an effective means of avoiding excess contributions tax that may apply in superannuation.

With tax at only 30%, insurance bonds offer a tax-effective savings option for high-income earners, especially if the money can be left invested for at least 10 years. This may compare favourably with investing in a unit trust where earnings would be taxed at the marginal tax rate (as high as 45% plus Medicare levy).

On the flip side, insurance bonds may be less appropriate for people on lower marginal tax rates (less than 30%) as the 30% payable in the insurance bond may result in higher tax on earnings, compared with investing in unit trusts or directly in assets.

A key disadvantage is that the 50% capital gains tax discount on assets held for at least 12 months does not apply. This discount would, however, apply to individuals who invest through a unit trust or direct assets.

The insurance bond offers simplicity as earnings are automatically reinvested in the bond, so reinvestment dates do not need to be tracked for capital gains tax purposes. Investors can switch between investment options without triggering capital gains tax.

Insurance bonds can suit investors who want to invest with a lump sum or through a regular savings plan. Minimum investments are around $2500 for lump sums and $1000 with a savings plan. Provided deposits each year do not exceed 125% of the previous year’s contribution, the 10-year period for each additional investment is backdated to the original commencement date.

Insurance bonds may also suit parents and grandparent looking to invest for a child’s education. A child advancement policy is a variation on the life insurance bond. It is usually held by the parent(s) as trustee for the children, with actual ownership of the policy transferring outright to the child when they reach a certain age that is determined at the outset (generally between 16 and 25). Additional tax benefits may apply if the money is used for specified education purposes.

An additional advantage of insurance bonds is that they can be protected from creditors in the case of bankruptcy, although strict rules apply.

Organisations that currently offer insurance bonds include AMP, Austock, Centuria, Colonial First State, IOOF, Lifeplan, MLC, OnePath and Westpac.

Keep in mind that an investor needs to consider and understand their specific circumstances and objectives.

Assyat David is director at Strategy Steps.

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