Insurance Bonds

By Sandy Naidu | September 11, 2008

Insurance Bonds are like unit trusts but with some special tax advantages. To enjoy these special tax advantages, the investment has to be held for a minimum of 10 years.
Insurance Bonds are coming back in vogue now. AMP and Commonwealth Insurance have recently launched a range of insurance bonds. Usually there is selection of different insurance bonds in offer from each issuer - example: capital guaranteed, growth, Australian equities etc. Switching between these funds is quite easy and free (no switching fee).

Taxation Advantages

1. The insurance company that issues the bonds will pay the tax on the income and gains of the bond. The tax will be paid at a company tax rate of 30% (of course the tax is coming out of the bond funds). Investors will have no additional tax to pay, provided the hold on to the investment for a minimum of ten years. You don’t even have to declare it in your tax return. So for someone on a high tax income bracket, these bonds can be quite a tax effective investment. If you however withdraw prior to ten years, then you will have to pay tax (there will tax offsets of 30% though).

2. You can make regular contributions but the contributions have to be only up to 125% of the previous year’s investment. The beauty of the insurance bonds is that these contributions also get the same tax treatment as the initial investment. Let me explain what I mean here:

Initial $1000
Year 1 $1250
Year 2 $1562
Year 3 $1952
Year 4 $2440

Year 5 $3050
Year 6 $3813
Year 7 $4766
Year 8 $5958
Year 9 $7448

So in the above scenario, the contributions you make in your ninth year will be invested only in one year but you don’t have to pay any tax. Imagine if your initial investment was $10,000.

If your contributions exceed the 125% rule then you will lose the tax benefits. So it is probably best to stick to 125% rule and if you need to make more contributions then may be just open another policy.

Perfect Situations

Here are some situations when insurance bonds can be an ideal investment:

Future Education needs of your child
You are in the high tax bracket and are looking for an effective tax investment vehicle
An investment with not much paper work. When it comes to tax return, there is hardly anything you need to do with insurance bonds.

A Couple Of Points To Be Noted

There is a contribution fee (for initial and regular contributions) and is usually around 4%.
If you are on a lower income tax bracket (anything lower than company tax rate) then the bonds don’t have any tax advantages.