Hi, my mum saw an adviser recently and they suggested she consider putting some of her money into an investment bond, as an alternative to super. What can you tell me about the pro's and con's of investment bonds? Thank you.
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I assume your mum’s objective was to invest some money outside super - where it’s fully accessible if needed (as opposed to being locked away in super until retirement).
Investment bond (also called insurance bond) can be a simple, and tax effective, way to invest in managed funds, build wealth and encourage investor discipline.
Similar to super, it takes advantage of a unique tax treatment – for as long as you hold it for at least 10 years. Tax on any earnings is generally paid inside the fund, at the company tax rate of 30%, so there’s no need to declare it on your personal tax return.
After 10 years is up, no additional tax is withdrawn (including no CGT), provided you complied with a disciplined contribution strategy and didn’t exceed the contribution limit (125% of previous year’s contribution) in any year within the 10-year period.
This concessional tax treatment makes them naturally attractive to people on high incomes with marginal tax rate over 30%.
From an investor behaviour perspective, the "tax lollipop" helps in forming positive habits and long-term investment attitudes – in that, as long as you stick to the disciplined contribution strategy, you won’t get additionally taxed.
Modern investment bonds are easily transferrable to children when they reach a nominated age (the kid is issued with a fancy gift certificate), which can make them attractive as education/kids’ future investments.
Money invested in these structures is not fully preserved like when investing in super. Therefore, they can be a good alternative, especially for people who are unable to contribute to super.
Anyone can be nominated as a beneficiary, and can potentially receive tax free payment on your death.
On the flip side, any potential advantage can be a disadvantage for someone with unfavourable circumstances or goals.
They are not as tax effective if your marginal tax rate is lower than 30%, as you end up paying more tax than necessary.
They are a little more complicated than simple managed funds – the tax effectiveness can be lost if the clients don’t receive the right guidance (or people will see it all just too hard and they never end up doing anything).
If the investment is accessed within 10-year period, the tax benefits will be lost.
Similarly, if you break the 125% contribution limit, the 10 year period re-starts.
As you can see, there are some great potential benefits to investment bonds, for particular group of people, with particular objectives. The key here is not try and fit the product to your circumstances.
Instead, just like with any other products, investment bonds should be considered as an after-thought, after you’re clear on your future plans and strategies. They should be considered as part of your overall long-term plans, and investing in them requires quality financial advice.
Michal Bodi – Financial Planner and Coach
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