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Will insurance bonds become the new superannuation?

Insurance bonds are an almost forgotten investment product which is starting to emerge amongst better planners and wealth management groups. Money is slowly moving back in to this form of saving for higher income earners.

Insurance bonds have some strong features:

  • uncapped contributions
  • flexibility of investment options and more under development
  • access to money regardless of age
  • generally low cost
  • tax at 30% during the taxed period.

What is the 10 year rule for investment bonds?

If the investment bond is held for 10 years or more, no additional tax is payable on investment earnings.

The tax treatment of investment earnings from the bond depends upon the timing of the withdrawal:

  • up to the 8th year all earnings are assessable (less offsets, see below)
  • during the 9th year 2/3rd earnings are assessable (less offsets)
  • during the 10th year 1/3rd earnings are assessable (less offsets)
  • after the 10th year all earnings are not assessable (ie tax is already paid)

Additionally, the tax treatment is not only for the initial amount invested, but each year after the initial year you can contribute up to 125% of the previous year’s amount and still stay within the 10 year rule. However, if you stop contributing for a year, the next time starts a new 10 year period for that new money and the balance that was previously there continues on the pre-existing 10 year period. Following the logic, if contributions for the last year were nil, then 125% of nil is nil.

If the bond is withdrawn before the expiry of the 10 year period, the profit (proceeds less total amounts invested) will be included in the investor’s assessable income and be taxed at their marginal tax rate. However, any profit that is assessable receives a tax offset of 30%.

As superannuation becomes more controlled with more tax applied to it, especially for larger income earners, this vehicle provides a mechanism for people to tax-efficiently invest and still have access.

Who is best suited to insurance bonds?

Insurance bonds are worth considering by anyone who has a marginal tax rate greater than 30% that directly affects their savings.

Insurance bonds are still not as efficient as super, under the current legislation, as a savings vehicle, although insurance bonds may provide greater access, depending on age. However, superannuation tax incentives may change and tilt the scales more towards insurance bonds.

The downside is that the structures are predominantly unchanged from 20 years ago and many only have managed fund options. Change is happening here though.

What about Self Managed Insurance Bonds?

The question I am hearing is when will we see a Self Managed Insurance Bond (SMIB) where investments can be directed more like an SMSF?

Technically that is possible now but expensive because each SMIB must be its own life company and hold a licence. As this develops however we may see the insurance companies offering investment options in directed investments for managed funds, direct shares and cash and even Separately Managed Accounts.

As a SMSF provider we are certainly looking at the merits of building this type of service in the future.

Who knows where the superannuation industry will end up in relation to tax. What we know is that the media is playing a part in focusing on superannuation as a tax issue and unfortunately looking at it in isolation to all retirement assets. The Cooper Review tried to focus attention on retirement rather than superannuation but that seems to have been left to the halls of time. All good advice must have one eye to the future so perhaps the trickle we see may become a trend and SMIB may become a future buzz acronym.

 

Andrew Bloore is Chief Executive of SuperIQ, a leading administrator and provider of integrated services for SMSFs. This article is general information and does not address the personal circumstances of any individual.

4 Comments
Adam
May 06, 2015

I would just be happy with a bond that gives more choice and operates more like a full wrap account. The available investment options on current bonds are completely uninspiring benchmark hugging (mostly) assets. If moving to a Self Managed asset is the way next way forward, well I would support that too. It would also force the current operators to become more competitive and enhance their offering.

Bob
May 05, 2015

You talk of "only managed fund options" as if this is a bad thing. There is nothing intrinsically wrong with a managed fund...only the vehicle within which you own it.

A unit trust structure means that an investor is purchasing other investors embedded gains and/or income. A unit trust must distribute realised capital gains as income; often at an inconvenient time for the investor. Thus converting capital to income for the investor.

A tax paid vehicle, such as an investment bond, makes contingency for income and capital gains tax, as income and growth occurs. This contingent tax is always reflected in the unit price. This means that you are never buying another investor's tax position. In addition, an investment bond converts income into capital; a fundamental (and important) difference between unit trusts and investment bonds.

It amazes me that so many "professional" advisers don't actually understand the workings of the product structure that they are selling to clients.

John
April 14, 2015

"downside is that the structures are predominantly unchanged from 20 years ago and many only have managed fund options."

... this is the issue, of being beholden to the providers, which naturally utilise their own products, and with insufficient transparency/ flexibility

Andrew Bloore
April 14, 2015

Yes, but to my point, that is changing. I can see us generating a vehicle that allows all the same investments that can be held via an SMSF as this develops. Your point is reflective of the past but the view of the future is dynamic and that is as very interesting development.

 

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