Bonds are a form of managed fund operated by life insurance companies and friendly societies. An insurance or investment bond (referred to as a bond) is essentially a life insurance policy and provides a simple and flexible way to save for future goal. A bond may involve a once-only premium payment (or investment), alternatively investors may take advantage of the 125% rule (see below) and make regular “top- ups” once the initial premium has been paid.
By investing in a bond, investors pool monies and the funds are managed by investment professionals. In this sense they operate similarly to Managed funds the main difference being the tax treatment of investment earnings. Bonds also offer the ability to switch between different investment options.
Depending upon the product, monies may be invested in a range of investment options such as cash, fixed interest property, Australian shares and international shares. This provides the opportunity for diversification within a single investment structure.
The investment returns on a bond are taxed in the hands of the insurance company and the earnings are reported net of this tax.
The tax on investment earnings is 30%. This can be reduced by dividend imputations credits and other offsets where the underlying investment has an exposure to Australian shares and property.
As the life insurance company pays the tax on investment earnings, there is no need for an investor to make any annual Tax declarations or keep capital gains records from year to year.
The 10-year rule
If the bond is held for 10 years or more, no additional tax is payable on investment earnings. If the bond is withdrawn before the expiry of the 10-year period, the profit (proceeds less total amount invested )will be included in the investors assessable income and be taxed at their marginal tax rate. However, any profit that is assessable receives a tax offset of 30%.
The tax treatment of investment earnings from the bond depends upon the timing of the withdrawal as follows:
- Up to the 8thyear all earnings are assessable
- During the 9thyear2/3rd earnings are assessable
- During the 10thyear 1/3rd earnings are assessable
- After 10thyear all earnings are not assessable(tax paid)
Risks
Taxations and legislative risk
Our information is based on legislative practices of the Australian taxation office and other relevant government bodies as they presently exist. As with most financial related matters there is always legislative risk that provisions may be amended.
Investment risk
The value of an investment bond may fluctuate over time as a result of changes in the value of the underlying investment held.
Investors should be aware that the original capital is not guaranteed (unless the investment option selected offers a capital guarantee) and the value of the investment will rise and fall with prevailing market conditions. Investment values and returns are dependent upon the circumstances of individual investments included in the diversified portfolio, changes in interest rates and exchange rates, and the economic and investment cycles of different countries.
Summary
By investing in a bond, an investor has the potential benefit (depending upon the choices within the particular product) of being able to diversify their investment across all asset sectors and the ability to switch between investment options. A bond investment provides the investors with tax simplicity as the investor does not have to make any annual tax declarations or keep capital gains records from year to year unless a withdrawal is made within ten years. Bonds may also provide tax benefits to investors on marginal tax rates in excess of 19% as there is no capital gain tax or income tax payable on withdrawals after year 10.
