Investment bonds: what you need to know Investment bonds can provide you with a simple, tax-effective, long term investment. This fact file looks at the benefits of investment bonds and highlights tax and contribution considerations, such as the 10 year investment period and 125% rule. What are the advantages of an investment bond? Investment bonds, also known as insurance bonds, are ‘tax-paid’ life policy investments. This means the life company pays the tax on the investment earnings, making them a tax-effective way to invest. There are considerable advantages associated with investment bonds, including; Tax advantages One of the most significant benefits of investing in bonds is the tax advantages, particularly for investors on a marginal tax rate greater than 30% as this is the maximum rate the life company pays on our investment earnings. Another benefit is that Personal Capital Gains Tax (CGT) doesn’t apply when you withdraw or if you switch between investment options. Benefits are tax free upon death. Investing for children Bonds can be used as an investment vehicle for children without incurring a penalty tax rate. A bond can be set up in a child’s name (ages 10–16) or you can invest on a child’s behalf (under 10 years of age) and transfer the ownership when the child reaches a certain age. Estate planning benefits Bonds are an attractive investment for estate planning as proceeds can be paid to any beneficiary (not just dependents) tax free. Bonds are flexible as you can nominate more than one beneficiary and stipulate the percentage paid to each upon your death. Increased age pension The amount of your aged pension depends on your family circumstances, income and assets. A bond, held through a family trust, may provide significant advantages by maximising aged pension payments if they’re calculated under the Centrelink Income Test. They may also reduce aged care facility costs. How are they tax effective? Investment bonds are very simple at tax time. The earnings on your investment generally don’t need to be declared in tax returns unless you make a withdrawal in the first 10 years. The life company pays tax on the investment earnings, at the company rate of 30%. After 10 years, if you stick to the 125% rule (more on this below), any withdrawals made will not attract personal income tax or CGT. You also have the flexibility of switching between investment options during your 10 year investment term and there is no requirement to pay CGT. For example, at any time you can switch your investment bond from an Australian Equities Fund to a Fixed Interest fund and your initial investment timeframe still applies for tax purposes. Investment bonds can have a number of investment options to choose from. What if I withdraw before the end of the 10 year period? You can make withdrawals at any time, however if you withdraw within the first 10 years, all or part of the earnings need to be included in your assessable income. The amount of the profit you need to declare in your assessable income depends on when you make the withdrawal: •• within eight years, all of the profit is included as assessable income •• during the ninth year, two thirds of the profit is included as assessable income •• during the 10th year, one third of profit is included in assessable income •• after the 10th year, none of the profit needs to be included as assessable income. Tax concessions also apply and you may be able to take advantage of a 30% tax offset for assessable withdrawal amounts. If some of the tax offset remains, it can be used to offset tax on other income. However any unused tax offset will be disregarded and is not refundable. page 1 of 2 What is the 125% rule? The 125% rule can make investment bonds even more tax-effective. As long as your annual contributions to the bond don’t exceed 125% of the previous year’s contributions, the 10 year period for calculating assessable withdrawal amounts will not be disturbed. In other words, additional contributions don’t have to be invested for the full 10 years for your profit to be treated as tax free. The graph below shows how on an initial investment of $10,000, an investor can take advantage of the 125% rule by making additional investments of up to 125% of the previous year’s contribution. So $74,506 can be invested into the bond in the 10th year and any withdrawals will still be tax free after just one year. 80,000 74,506 70,000 59,605 Contribution ($) 60,000 47,684 50,000 38,147 40,000 30,518 30,000 24,414 19,531 20,000 10,000 10,000 12,500 What happens if you exceed the 125% rule? If you make contributions to your investment bond that exceed the 125% rule, the 10 year time period will start again for the whole investment. The new start date will be the policy year in which the excess contribution was made. If no contributions are made in any one year, any subsequent contributions would cause the 10 year period to restart. For this reason, you need to be very mindful of the 125% rule. What type of investor are they suitable for? Investment bonds offer many benefits and can be suitable for many different types of investors, such as those who are: •• looking for a simple, tax-effective, longer term investment •• in a higher marginal tax bracket •• seeking a savings vehicle for a child’s future financial needs, such as education •• seeking certainty in estate planning and wealth transfer looking for an investment with little annual tax reporting and paperwork •• limited by superannuation contribution limits and looking for another tax-effective way to invest. 15,625 0 1 2 3 4 5 6 7 8 9 10 Year Speak to us for more information Important Information This document has been prepared by Financial Wisdom Limited ABN 70 006 646 108, AFSL 231138, (Financial Wisdom) a wholly-owned, non-guaranteed subsidiary of Commonwealth Bank of Australia ABN 48 123 123 124. Financial Wisdom advisers are authorised representatives of Financial Wisdom. Information in this document is based on regulatory requirements and laws, as at 27 June 2012, which may be subject to change. While care has been taken in the preparation of this document, no liability is accepted by Financial Wisdom, its related entities, agents and employees for any loss arising from reliance on this document. This document contains general advice. It does not take account of your individual objectives, financial situation or needs. You should consider talking to a financial adviser before making a financial decision. Taxation considerations are general and based on present taxation laws, rulings and their interpretation and may be subject to change. You should seek independent, professional tax advice before making any decision based on this information. page 2 of 2 17787/0612 If you would like to know more about the benefits of investing in bonds and to see whether they are a suitable investment option for you, contact us. We can give you more detailed information on the best approach for your situation.