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Beyond super: tax effective investing for flexibility, return – and paying less tax

Why investment bonds are the next big thing in investing for flexibility, return – and paying less tax

When it comes to investing and saving for retirement, the more you have, the better your retirement choices. Problem is, super limits how much we can set aside while still getting tax benefits. Enter the search for tax-effective investment strategies outside super.

Superannuation is the most tax-effective savings mechanism out there, no question. But tax concessions don’t come for free. Your money is tied up until you are 55 or 60, depending on your age now; there are strict eligibility rules relating to age and work; and tax-advantaged contributions are capped at $35,000 per year. While it is possible to contribute in excess of the super caps up to $180,000 in a year, this is only on a post-tax basis. And your excess contributions stay locked up.

In other words, as well as offering its benefits, superannuation can be limiting. That means it should not be considered as the only tax effective option for long term investors who want the additional benefits of flexibility and choice.

Investment bonds offer flexible investment choices, within a tax-effective structure

An investment bond, or insurance bond, is technically an insurance policy, and in the past incorporated a life insurance element. However, they are now used primarily as long-term investment vehicles underpinned by different investment portfolios. Depending on the issuer, investors have access to a wide range of options, in line with their investment objectives and risk appetite.

So what’s the catch – why is an investment bond tax-effective?

Investment bonds are designed to be held for 10 years, and are at their most tax-effective if they are. This is because income from investments within the bond structure is not distributed to the investor. Instead, it is taxed at the corporate rate of 30% and re-invested within the bond structure. In addition, if there are franking credits or tax deductions associated with the underlying investments, these will also be passed on, and total tax payable may end up less than 30%.

Investors do not need to include this re-invested income in annual tax returns.

There is no limit to the amount an investor can invest in a bond initially, and it is possible to contribute additional funds, up to 125% of the amount added in the previous year. If the bond is held for more than 10 years, earnings distributed do not need to be declared and no additional personal income tax or capital gains tax is payable. This means that after 10 years, investors have paid a maximum 30% tax on their investment returns, very attractive to investors in the highest tax bracket and currently paying up to 49% tax.

If funds are required prior to the 10 year period, they can be accessed, but the investor must declare the earnings, with certain tax offsets, depending on the timing.

Who should consider an investment bond?

For maximum tax advantage, investors must be willing to leave their investment within the bond structure for a minimum of 10 years, and forego income distributions during that period. For this reason, investment bonds are often most suitable for high net worth investors, or those who would otherwise contribute to super, but have reached their cap, or do not meet the work test so cannot contribute more at a tax-advantaged rate.

A second group for whom an investment bond can have attractive benefits is grandparents or parents saving and investing on behalf of children for future expenses such as school fees or other long term goals.

Investment bonds can also be an excellent estate planning option. Because an investment bond is technically an insurance policy, on the death of the policy holder, death benefits can be directed tax free to a nominated beneficiary and will not be included in the estate.

The bottom line? Investors considering tax-effective investment options outside super should look at investment bonds. Offering a range of investment portfolio options to suit risk and investment horizons, so long as they are held for 10 years, they’ll be taxed at a maximum rate of 30%.