By Jonathon Tainsh and Gary Marsh

Although they pre-date compulsory superannuation, investment bonds (previously known as insurance bonds) are not widely understood. They are a highly versatile financial product with unique features that can be an attractive option for those looking to grow wealth, manage tax, and efficiently tailor their estate arrangements.

Financial advisers Gary Marsh and Jonathon Tainsh provide insights that highlight the practical benefits and strategies associated with modern investment bonds. In particular, they compare investment bonds against superannuation and direct investments for high-income earners and high-net-worth families.

What Are Investment Bonds?

Investment bonds are a hybrid product combining elements of an insurance policy with an investment. They operate under the Life Insurance Act and have been available for many years, predating Australia’s compulsory superannuation system.

At their core, investment bonds are tax-paid investment structures. Earnings within the bond are taxed at a maximum rate of 30%, which may be reduced through franking credits or other tax offsets. After a 10-year holding period, withdrawals are 100% tax-free, providing a compelling option for long-term savings.

Investment bonds are particularly effective for high-income individuals who want to invest tax-efficiently and do not need immediate access to their funds.
They are also versatile, serving as a complementary vehicle to superannuation for those who have reached their contribution limits or who want the flexibility to access funds before retirement.

Key Benefits of Investment Bonds

1. Tax Efficiency

One of the most attractive features of investment bonds is their tax structure. Earnings are taxed internally within the bond at a company rate of up to 30%, although effective tax rates can often be significantly lower—sometimes as low as 12%–15%. This can occur due to tax management strategies, such as offsetting gains with losses and utilising franking credits. However, the actual rate will depend on the underlying investments in the bond.

This internal taxation structure removes the need for personal income tax declarations, making investment bonds ideal for high-income earners. For example, investing in an investment bond instead of directly holding investments or using a family trust can result in substantial tax savings, as any taxable income remains quarantined within the bond.

2. No Distributions

Unlike traditional investments such as managed funds, investment bonds do not distribute income. This feature is particularly beneficial when used within a trust structure, as it eliminates the need for annual taxable distributions to beneficiaries.

3. Estate Planning and Creditor Protection

Investment bonds can bypass a will and the estate administration process, offering a direct method of wealth transfer to beneficiaries. This can safeguard funds from estate disputes or creditors, much like superannuation. Bonds can also be tailored to provide restricted access, for example, releasing funds to children only when they reach a certain age or for a specified purpose.

4. Accessibility and Flexibility

While investment bonds are most tax-effective when held for at least 10 years, they do offer flexibility. Funds can be accessed at any time, but different tax treatments apply if withdrawals occur before the 10-year mark. Partial withdrawals in years 8 and 9 receive concessional treatment, and by year 10, withdrawals are fully tax-free. Additionally, investment bonds allow for tax-free ownership transfers, adding another layer of flexibility for estate planning.

Suitability of Investment Bonds

Investment bonds cater to a wide range of investors:

• High-Income Earners: Ideal for those who have maximised their superannuation contributions and seek additional tax-efficient investment options.
• More Flexibility Than Super: Useful for those who want flexibility without the restrictions of superannuation, particularly those who may need access to funds before retirement.
• Families and Estate Planners: Perfect for parents or grandparents looking to secure funds for future generations, whether for education or other milestones.
• Trust Structures: Particularly effective in discretionary or family trusts, where investment bonds simplify income management and help manage personal tax liabilities.

Strategic Applications of Investment Bonds

1. Superannuation Alternative

For individuals who have reached their superannuation contribution caps, investment bonds provide a comparable tax-efficient option with fewer accessibility restrictions.

2. Wealth Transfer and Intergenerational Planning

Investment bonds can be structured to align with specific estate planning goals, such as funding a child’s education or ensuring wealth is allocated outside the estate to avoid disputes.

3. Laddering for Flexible Access

An effective strategy involves setting up multiple investment bonds over consecutive years, creating a “ladder” of maturity dates. This approach allows staged access to funds over time, which can be ideal for mid-life financial planning.

Key Considerations

1. Contribution Limits and the 125% Rule

Contributions to an investment bond are capped at 125% of the previous year’s contribution. Exceeding this limit or skipping a year resets the 10-year tax-free clock. While this may seem restrictive, it can be managed effectively with proper planning.

2. Early Withdrawals

Withdrawals before the 10-year mark are subject to tax on the earnings portion, with credits for tax already paid. Partial withdrawals made in years 8 and 9 receive concessional treatment, and by year 10, the entire withdrawal is tax-free.

3. Product Selection and Fees

Investment bonds offer a range of investment options, from conservative to high-growth portfolios. While fees are often comparable to superannuation funds, it’s essential to select bonds aligned with your financial goals.

Comparing Investment Options for Mid-Career High-Income Earners

For those in their mid-career stage, typically aged between 35 and 45, investment bonds represent a strategy that many have not considered. Typically, they may be aware of direct investments or superannuation. Investment bonds can be seen as a tax-effective hybrid of these two well-known strategies.

Let’s look at the unique pros and cons of these three approaches—superannuation contributions, investment bonds, and direct investment—particularly as they relate to priorities like tax efficiency, accessibility, and future planning.

Option 1: Additional Superannuation Contributions

Pros:

• Tax Efficiency: Super contributions are taxed at a concessional rate of 15%, significantly lower than most marginal tax rates. Over time, this results in substantial tax savings.
• Compulsory Savings: Super is a dedicated long-term savings vehicle, making it very difficult to access until preservation age (currently 60–65), ensuring disciplined investing.
• Employer Contributions: Your super benefits from mandatory employer contributions, amplifying growth when combined with personal contributions.

Cons:

• Access Restrictions: Funds are locked away until preservation age, making super unsuitable for medium-term goals like funding children’s education.
• Contribution Caps: Concessional contributions are capped, limiting how much you can invest at the favourable tax rate. Non-concessional contributions are also capped.
• Market Dependency: Like any investment, super is exposed to market fluctuations and the chosen fund’s asset allocation.

Option 2: Investment Bonds

Pros:

• Tax-Effective Growth: Earnings are taxed internally at a maximum of 30%, often effectively lower. Withdrawals after 10 years are tax-free.
• Flexibility: Funds are accessible at any time (with tax implications if withdrawn early).
• Estate Planning Benefits: Bonds can bypass wills and estates, and they offer creditor protection and customised wealth transfer options.
• No Personal Tax Reporting: Earnings remain within the bond, so you don’t include them in your personal tax return.

Cons:

• Higher Fees: Investment bonds may have management and administrative fees higher than some direct investment options.
• Contribution Rules: The 125% rule can restrict how much you can add each year without resetting the tax-free clock.
• Market Risk: Performance depends on the underlying portfolio, which can fluctuate.

Option 3: Investing Directly in Managed Funds (either personally or via a family trust)

Pros:

• Flexibility and Access: Managed funds offer the greatest flexibility, with no withdrawal restrictions.
• Wide Investment Choice: Access to a broad range of asset classes and strategies.
• Lower Fees: Managed funds generally have fewer administrative fees than investment bonds.

Cons:

• Tax Inefficiency: All income and capital gains are taxed at your marginal tax rate, which can be as high as 47% for high-income earners.
• Personal Tax Reporting: You must report all income, dividends, and capital gains annually.
• Limited Estate Planning Features: Managed funds do not provide the same estate-planning advantages as investment bonds.

Comparing the Three Options

Which Option is Right for You?

• Consider Superannuation if… you prioritise long-term retirement savings, are comfortable locking funds away, and want maximum tax efficiency. It’s especially effective if you’re already maximising employer contributions.
• Consider Investment Bonds if… you need a tax-efficient vehicle for medium-term goals or value flexibility and estate planning benefits. They are particularly suited to high-income earners who’ve hit super caps.
• Consider Managed Funds if… liquidity is your top priority and you prefer a straightforward investment option without contribution or withdrawal restrictions, even at the cost of higher taxes.

For someone aged 35–45, the right choice may involve a combination of these options. Diversifying across superannuation, investment bonds, and managed funds can strike a balance between tax efficiency, accessibility, and long-term growth.

If You’re Curious …

Investment bonds are a flexible, tax-effective tool that bridges the gap between superannuation and conventional investments. Whether you’re a high-income earner, a retiree, or planning your estate, they offer significant advantages in terms of tax efficiency, accessibility, and wealth transfer.

If you’re curious about how investment bonds could fit into your financial strategy, contact Gary Marsh or Jonathon Tainsh at People + Partners who understand the nuances of these products may be able to unlock a world of possibilities for your financial future.

Disclaimer

People & Partners Wealth Management Pty Ltd ABN 67 127 250 613 is a corporate authorised representative of Fortnum Private Wealth Ltd ABN 54 139 889 535, holder of Australian Financial Services Licence (AFSL) No. 357 306. The content of this article is for general informational purposes only and does not constitute personal financial advice. It does not take into account your individual objectives, financial situation, or needs. Any advice we provide will be detailed in a formal advice document. The opinions expressed in this article are those of the authors at the time of writing and should not be taken as a recommendation to act. To the extent permitted by law, Fortnum Private Wealth Ltd and its associates accept no liability for any loss or damage incurred as a result of reliance on this communication.