Explaining tax in an investment bond structure

Some providers quote tax in different ways

Investment bonds pay tax at 30% less allowable deductions. Like superannuation, there are a range of investment bond providers. All superannuation funds are subject to the same tax rules. All Investment bond providers are likewise subject to the same tax rules; therefore, no provider has a unique tax advantage.

Tax paid is not the effective tax rate

Each year, investment bonds pay tax on realised gains and income. These “tax paid” amounts vary greatly from year to year ranging typically from 5 -15%. Whilst these rates are low, they do not reflect the movements in the unit price and ignore provisioning for unrealised capital gains. Some providers of investment bonds quote these tax rates rather than the true tax effective rates. Whilst these rates are lower, your clients will not see these tax rates in their after-tax performance.

Read the fine print – are you being told the tax paid amount?

Effective tax rates include the provision for unrealised CGT

Investment bond unit prices are calculated after tax and include a provision for unrealised capital gains or losses. These are not paid to the ATO but remain in the fund fully invested thereby compounding returns.

The correct way to calculate effective tax rates is to compare the pre-tax headline fund return with the after-tax return of the investment bond. This will give an effective tax rate typically between 20 – 30%. See the example below;

 This applies to all investment bond providers.

Tax optimising your returns

Investment bonds are always a pooled investment whether the provider invests into an underlying managed fund, an ETF or replicates the portfolio. Underlying fund managers will always act to minimise tax payable for investors by managing trading parcels. There is no evidence that replicating a portfolio will minimise tax in an investment bond.

Optimised tax rates that are often quoted as low as 6% are quoting the tax paid amount not the tax effective rate. The table below offers an example of tax paid rates versus tax effective rates over 10 years for three of Centuria’s investment bond funds as at 30 June 2024.

Franking credits are the greatest driver of tax effectiveness.

It’s not all about tax

It is a fact that the more you make, the more tax you pay. If your returns are low or negative, your tax rate will be low or even zero. Instead, focus on total after tax returns which will be driven by your asset allocation and manager selection. The chart below shows net returns (after tax and fees) in the Vanguard Diversified Growth Index Fund from the major investment bond providers in Australia.

The chart clearly demonstrates that after tax performance is not a differentiator between investment bonds. Small differences in performance in the short term can be explained by cashflows and timing differences to tax treatments.

Tax Alpha strategies are not providing any individual investment bond provider a unique tax benefit.

To solve your clients’ needs, Investment Bonds have several unique non-financial benefits these include;

• You do not need to submit an annual tax return on earnings.
• No personal Capital Gains Tax (CGT) issues when switching.
• Estate planning benefits with tax paid payments to beneficiaries outside probate.
• If an investment bond is held for 10 years investors can access the funds tax paid^*.
• Unlike super you can access your funds within 10 years and receive a 30% tax offset.
• You may transfer the ownership of the investment bond with no tax consequences
• Investment bonds automatically reinvest earnings thereby compounding your returns.
• Creditor protection
• All investment bonds have a unique capability to write off capital losses against income. This improves after tax performance when compared to other structures.

*Subject to the 10% year rule.