Investment bonds are long-term investments that may offer tax efficiency to investors on a high marginal tax rate and those investing for children or grandchildren.
Unlike traditional investment products, such as managed funds, bonds are a ‘tax paid’ investment. This means that tax on investment earnings is paid at the applicable company rate of 30 per cent by the bond issuer – not by you, the investor.
Investors receive ‘tax paid’ returns provided they meet certain conditions – most notably that the investment is held for at least ten years and contributions do not exceed the 125% rule.
Bonds have a valuable taxation status; as long as any additional investments you make do not exceed 125 per cent of the investments made in the previous year, then the taxation status will not be jeopardised. This is called the 125% rule.
By using the 125% rule, a bond investment becomes even more tax effective because it gives you the opportunity to make additional investments (or contributions to a savings plan) each year. The level of additional contributions you can make continues to increase until the end of the tenth anniversary, after which all withdrawals from the bond are tax-free. For example, if you invest $10,000 in year one, then, using the 125% rule, $12,500 (125%* 10,000) may be invested in year 2, and so on.
A tax-effective alternative
The following table shows the tax benefits of an investment bond.
|Investment bond||Managed fund|
|Investment earnings||$10,000||Investment earnings||$10,000|
|Tax paid by bond manager||$3,000||Tax paid by fund manager||$0|
|Net return (at maturity)||$7,000||Assessable income||$10,000|
|Assessable income||$0||Tax paid by investor||$4,500|
|After tax return||$7,000||After tax return||$5,500|
What investment choices are available?
While different investment bonds have different investment menus, generally they include a wide range of diversified funds, multi-manager funds, Australian share funds, international shares, fixed income and capital guaranteed investments.
Who should consider an investment bond?
Investment bonds may be suitable for:
- investors with a long-term investment horizon (at least 10 years)
- investors who have contributed as much concessional contributions to super as possible
- parents or grandparents who wish to invest on behalf of the next generation
- investors who do not require access to their funds, as investment bonds re-invest distributions.