This fact sheet provides additional information to help with understanding the investment, tax and other financial planning concepts that we have discussed with you or included in your Statement of Advice.
Please contact your adviser if there is any aspect on which you need further information or clarification.
What is an investment bond?
An insurance or investment bond ("investment bond") is a type of life assurance contract between a life insurance company and a policyholder (investor), linked to one or more lives.
Investment bonds can be attractive, tax-efficient savings vehicles, particularly for high-income earners and, where issued offshore, new or returning residents. The insurance company is liable for tax on the earnings within the investment bond. If the policyholder holds the investment bond for at least ten years, then no further tax is payable by the policyholder on withdrawal.
Investing in an investment bond may involve a single premium payment (investment). Once the investor has paid the initial premium, they may make further contributions, capped at 125% of the previous year's contribution.
Investors use investment bonds for various purposes, including:
- To save for and fund education expenses
- To minimise personal tax liabilities from investment activities
- As an alternative retirement savings vehicle
- To transfer wealth to the next generation
- To save for children and grandchildren
Investment bonds have been part of the Australian financial marketplace for many years with Australia first introducing a provision for taxing amounts paid under investment bonds in 1984. Investment bonds, in the same or similar form, are also popular in many other parts of the world, specifically in the UK, European and Asian markets.
Investment
By investing in an investment bond, investors are effectively pooling their money with other investors, to be managed by professional asset managers.
In this sense, they operate similarly to managed funds. However, an investment bond may hold multiple managed funds and offers the ability to switch between managed funds without personal tax consequences for the policyholder.
Investment choice varies by provider, but typically a policyholder has the option of investing in active and passive managers, across all asset classes, e.g. cash, fixed interest, property, Australian and international shares.
This broad range of options provides the opportunity for diversification within a single investment structure.
Providers in some jurisdictions allow policyholders to hold other assets such as private equity, hedge funds and single-asset strategies within a life assurance wrapper. This flexibility is highly dependent on the jurisdiction of the insurance company and the policyholder, and applicable legislation in those jurisdictions. Obtaining local advice is critical before investing, and before becoming an Australian tax resident.
The 125% Rule
Each policy year, a policyholder can make additional contributions of up to 125% of the previous year's investment, throughout the life of the investment bond.
Additional contributions do not have to be invested for ten years to acquire tax paid status. This feature means that a modest initial contribution, with annual contributions growing with savings capacity each year, can result in a significant tax paid balance ten years after the investment bond commences.
However, if a policyholder does not invest in a given year, they cannot invest the following year without re-starting the ten years.
Taxation of Investment Bonds
An investment bond is a tax paid investment. It, therefore, does not generate any assessable income for an investor unless the investor makes a full or partial withdrawal within the first ten years.
Throughout the life of the investment bond, a 30% tax is applied to the income and capital gains. The receipt of dividend imputation credits and other offsets may reduce this tax, and there is no CGT discount. The insurance company reports earnings to policyholders net of tax.
Changing investment options within a bond does not usually change the tax status of the bond and therefore, generally has no tax consequence for the investor.
Taxation of Investment Bond Policyholders
With a maximum tax rate of 30% applied to income and capital gains, an investment bond may be an attractive savings vehicle for individuals on higher marginal tax rates.
The policyholder's taxation position depends on when they make withdrawals from the investment bond.
The 10-year rule
If the policyholder holds the investment bond for ten years or more, no additional tax is payable on investment earnings withdrawn.
If the policyholder makes a withdrawal from the bond within the first ten years, the tax treatment depends upon the timing of the withdrawal.
- Up to the 8th year, all of the gain is assessable
- During the 9th year, 2/3 of the gain is assessable
- During the 10th year, 1/3 of the gain is assessable
- After 10th year none of the gain is assessable
The assessable portion of the gain is added to the policyholder's taxable income and taxed at their marginal tax rate. The policyholder receives a tax offset of 30%, in acknowledgement of tax already paid.
Taxation of Offshore Investment Bond Policyholders
Some offshore investment bonds meet the 'eligible policy' definition that applies to investment bonds issued in Australia, and Australian legislation does not discriminate based on the jurisdiction of issue.
It is, therefore, possible for Australian expatriates or those immigrating to Australia to apply the provision to their offshore investment bond as if it were a bond issued by an Australian provider.
It is essential to understand the terms and conditions of the bond and the application of Australian tax provisions. The critical consideration is whether the offshore investment bond meets the 'eligible policy' definition per Australian legislation. If not, once holding the bond as an Australian resident, the policyholder stands to lose any beneficial tax treatment.
For example:
- David and Doris returned to Australia on 1 July 2020.
- David holds a 99-year term bond that does not meet the definition of an 'eligible policy' under Australian legislation. Doris's bond, linked to David's life, does meet the definition.
- The value of each bond on becoming an Australian tax resident is $500,000, with returns of approximately 5% per annum. All earnings are retained and reinvested within the bonds.
- Assuming that David is on the top marginal tax rate of 47%, the total personal tax payable over ten years would be $147,790.24 on earnings of $314,447.31.
- Doris, on the other hand, pays no Australian tax on the $314,447.31 of earnings generated within her 'eligible policy' over this period.
It is imperative that where you hold investment bonds, you seek tax advice to understand the implications and required actions, before becoming an Australian tax resident.
Important Information
Walbrook Wealth Management is a trading name of Barbacane Advisors Pty Ltd (ABN 32 626 694 139; AFSL No. 512465). Barbacane Advisors Pty Ltd is authorised to provide financial services and advice. This post is general information only and is not intended to provide you with financial advice as it does not consider your investment objectives, financial situation or needs, unless expressly indicated otherwise. You should consider whether the information is suitable for your circumstances and where uncertain, seek further professional advice. The author has based this communication on information from sources believed to be reliable at the time of its preparation. Despite our best efforts, no guarantee can be given that all information is accurate, reliable and complete. Any opinions expressed in this email are subject to change without notice, and we are not under any obligation to notify you with changes or updates to these opinions. To the extent permitted by law, we accept no liability for any loss or damage as a result of any reliance on this information.
