When Federal Treasurer Jim Chalmers hands down the budget on 14 May, the pressing need for fiscal responsibility is likely to trump spending programs.
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Planning for the future, tax-free, through investment bonds
Investment bonds have an interesting tax twist that should interest middle- and high-income earners, especially when it comes to planning for important life events.
These bonds come with a 125 per cent contribution rule that allows the income component of any withdrawals from the investment fund to be tax-free after 10 years. Investors holding the bond for 10 consecutive years should be able to escape the clutches of the taxman.
The first year’s contribution is uncapped when an investment bond is established; the sky’s the limit. But it’s important to think carefully about this contribution because future annual contributions are capped at 125 per cent of this initial investment, meaning the initial investment sets the benchmark.
There are certain caveats to this tax-free status. If the investment exceeds 125 per cent of the previous year’s contributions, the start date of the 10-year tax rule is reset for tax purposes. Missing a year’s contribution also resets the start date. Money can be withdrawn at any time, but any earnings on withdrawals within the 10 years will be taxed.
This tax incentive makes investment bonds such an efficient way to save for a life event, such as schooling, an inheritance or buying a house. “They can ease much of the financial stress of meeting private school fees in the secondary years when the tax-free income kicks in,” says Foresters Financial CIO Michael McQueen. “If the money is needed before then, it can be redeemed, although any accumulated tax will be payable at the applicable marginal rate”.
Investment bonds – which can be taken out singularly or jointly, including by children aged 10 to 16 (with parental or guardian permission), companies or trusts – are not just a tax play.
They enhance estate planning because they sit outside an estate and thus can’t be contested, are binding by default so can’t lapse, don’t require probate to mature and vest, and are not subject to any inheritance taxes.
These bonds also help protect wealth by allowing people to invest an inheritance, compensation, redundancy payout or windfall gain. And, unlike superannuation, there is no limit on the initial investment.
They also offer flexibility. Ownership can be assigned or transferred at any time with no tax impact. It’s the same with beneficiaries, and there are no restrictions on non-dependents. They also have the capacity to potentially shield assets from creditors and enhance benefits or entitlements from Services Australia.
On the investment front, they offer access to an institutional-grade, diversified investment portfolio that sits outside superannuation.
“In this respect investment bonds are no different to superannuation, as there are no restrictions on asset classes, domestic or international,” McQueen says. “It’s not just asset diversity. Using multiple fund managers is a hallmark of investment bonds, thus minimising key person risk, as well as having a sharp focus on management fees.”
*This article was first published in The Inside Adviser.
