If you’re looking for ways to invest for children, or looked into tax efficient ways to structure your income, you may have come across investment bonds.
Here we compare the performance of investment bonds against a low-cost diversified portfolio of ETFs, taking into consideration fees, returns and performance (returns).
In this article we’ll cover:
- What is an investment bond?
- How investment bonds have performed
- Why we recommend ETFs over investment bonds
- Pros and cons of investment bonds
- Providers of investment bonds
- Conclusion: investment bond or ETF portfolio?
- Overview of the investment bond tax rules
What is an investment bond?
An investment bond (also known as an insurance bond) is a combination of an investment portfolio and a life insurance policy. You can access them via life insurers and friendly societies.
Investment bonds let you invest on behalf of a child (or grandchild) and have the ownership automatically transferred to the child at a date you set in the future. It’s for this reason that parents (and grandparents) like investment bonds as a way to help save for big ticket expenses like their education, a car, or house deposit.
You can also use investment bonds as a tax efficient way, especially for high income earners, of investing outside of super (as long as certain conditions are met).
What are the benefits of investment bonds?
An investment bond is a ‘tax paid‘ investment. This means the tax on investment earnings is paid by the bond issuer at the (current) company tax rate of 30%.
After 10 years from the start date of the investment you don’t need to pay personal income tax on the investment. So as long as you definitely won’t touch your investment for at least 10 years, you won’t need to pay additional tax or capital gains tax.
Investment bonds are available across a range of different investment options including shares, bonds, property, infrastructure, and mixed asset portfolios.
How have investment bonds performed?
The average 5 year return for a growth investment bond has been 5.4% per year. A portfolio of ETFs with a similar asset mix (and risk) – like the Stockspot Topaz Portfolio – has returned 9.2% p.a. over 5 years.
This has beaten the average investment bond by almost 4% per year. Note: the Stockspot return is before taxes – below is a worked example to show the impact of tax.
Return are net after fees as of 30 June 2019 using a growth diversified investment option (OnePath – Managed Growth, Australian Unity – Perpetual Balanced Growth, CBA NC – Growth, AMP – Balanced Growth, IOOF WealthBuilder Growth MultiMix, Generation Life MLC Horizon 4 portfolio, Key Invest Russell Growth Fund, Centuria – Growth Bond Fund). Stockspot Topaz Portfolio used not taking into account personal income tax. Total cumulative return computed from 5 year annualised figure. Source: Investment bond Providers, Stockspot. IOOF WealthBuilder was not presented in the 5 year graph due to limited track record.
The returns from investment bonds have been poor compared to alternative options like a mix of low-cost index funds (ETFs), even when you take the tax benefits into consideration.
Higher management fees (ie anything over 1% p.a.) and the tax drag of paying company tax actually harms returns. Over the last 5 years, the 4% p.a. additional returns by investing in a growth Stockspot portfolio would have been enough to cover any tax consequences compared to an investment bond, even if you’re on the highest marginal tax rate.
Post-tax worked example of a Stockspot ETF portfolio vs average investment bond over 10 years
|Stockspot ETF Portfolio |
owned by parent
|Average investment Bond|
|Highest marginal |
|47% (including Medicare levy)|
|Amount after 10 Years|
(assuming past growth)
|Tax on investment income||-$2,163||0|
|CGT (less 50% discount)||-$2,235||0|
|Total value (after tax and CGT)||$19,714||$16,840|
|Post tax Total Return||97%||68%|
|Additional return from|
a Stockspot ETF portfolio after-tax
This is just one example. Past performance isn’t a reliable indicator of future performance and there may be cases where there are other tax or strategic benefits of owning an investment bond that aren’t considered in our examples. You should seek tax advice if you think an investment bond might be right for you. You can also check out the ASIC MoneySmart website.
Why you should consider ETFs over investment bonds
It’s quite simple. Yes, investment bonds do have a tax advantage. However the after-tax returns of investment bonds have been poor in comparison to ETFs.
So poor that – for most people even in higher marginal tax brackets – it makes more sense to invest in a diversified low-cost portfolio of ETFs.
The fees on a diversified portfolio of low-cost index funds, like the ones Stockspot offer, are less than half the cost of many investment bonds.
One of the other reasons we recommend exchange-traded funds (ETFs) for Australian investors is because they are highly tax efficient and have a more consistent performance.
Plus in order to help parents (or grandparents) invest for their children, we don’t charge any fees when investing on behalf of a child – while their portfolio is under $10,000.
Stockspot offers two options to invest for children:
- You can invest as an individual client – the investments are held in your name from a legal and tax perspective, but we can add your child’s name to the account which acts as an identifier.
- You can invest on behalf of a child if you are a trustee of a Family Trust or Discretionary Trust and your child is a beneficiary. From a legal and tax perspective the assets are held by the Trust.
Before investing on behalf of your child, you should speak to a tax adviser or accountant to be aware of the legal and tax consequences.
Pros and cons of investment bonds
|Benefits of investment bonds||Details|
|Tax effective||Income tax and CGT are taxed at a company tax rate of 30%, and there is no need to include it in your personal income tax return provided you hold the investment bond for 10 years.|
|Transfer Ownership||Investment bonds allow you to invest on behalf of a child or grandchild and have the ownership automatically transferred to the child on reaching their nominated vesting age (e.g. 25), without triggering CGT or stamp duty.|
|No caps on contribution amounts||Subject to the 125% rule, investment bonds can be used for people who are unable to contribute further to their superannuation (due to the concessional and non-concessional contribution caps)|
|Disadvantages of investment bonds||Details|
|Liquidity||If you need to withdraw before the 10 year period is reached, some of the tax benefits may be lost.|
|Fees and performance||Investment bonds have high fees relative to other investment options and historically their performance has been poor.|
|Capital gains tax (CGT)||Investment bond providers don’t enjoy the 50% CGT discount that individuals get on assets owned for longer than 12 months. Instead, they are taxed at the company rate of 30%. The loss of any CGT discount is a deterring factor and may result in a lower after-tax return rate when investments are sold.|
Who are the main providers of investment bonds in Australia?
|Provider||Investment bond name||Growth Option Fund||5 Year Return of Fund (p.a.)|
|Generation Life||Generation Life – LifeBuilder, ChildBuilder, and FuneralBond||MLC Horizon 4 Portfolio||4.5%|
|Commonwealth Bank||Investment Growth Bond||NC – Growth||5.8%|
|AMP||AMP Growth Bond||AMP Balanced Growth||5.7%|
|IOOF||IOOF WealthBuilder investment bond||IOOF WealthBuilder Growth – IOOFMultiMix||N/A|
|KeyInvest||KeyInvest Life Events Bond, KeyInvest Funeral Bond||Russell Growth Fund ||5.6%|
|Australian Unity||Lifeplan Investment Bond, Lifeplan Education Bond, Lifeplan Funeral Bond||Perpetual Balanced Growth||4.4%|
|Centuria||Centuria Investment Bond||Growth Bond Fund||7.8%|
|ANZ/OnePath||Investment Savings Bond||OnePath Managed Growth||3.6%|
|Average investment bond||5.4%|
|Stockspot Topaz Portfolio||9.2%|
At first glance, investment bonds may be appealing to some Australians with a high marginal tax rate, or parents/grandparents who want to invest for their children or grandchildren.
However, over the last 5 years you’d be better off simply investing in a diversified portfolio of low cost ETFs.
The technical stuff in case you’re interested.
10 year tax rule
If an investor has held an investment bond for 10 years or more, earnings do not need to be declared as part of their assessable income with no additional personal or capital gains tax applicable – i.e. it becomes tax exempt.
Any withdrawal prior to the 10 year period, will mean the investor needs to declare the earnings in their tax return proportionate to the time of withdrawal (see table below).
|Time of Withdrawal||Tax Payable|
|Within 8 Years||100% of earnings are taxed at your marginal tax rate with a tax offset of 30%|
|During 9th Year||2/3 of earnings are taxed at your marginal tax rate with a tax offset of 30%|
|During 10th Year||1/3 of earnings are taxed at your marginal tax rate with a tax offset of 30%|
|After 10th Year||All earnings are tax free|
125% contribution rule
Each year, investors can make additional contributions of up to 125% of the previous year’s contributions. The benefit of this is each addition is being treated as if it were invested at time of original investment. If the 125% limit is exceeded, the 10 year tax rule will restart.
Investment earnings are taxed at the corporate tax rate of 30% by the issuer, meaning earnings are not required to be included in an investor’s assessable income tax return (unless withdrawn prior to the 10 year period).
There are no CGT consequences for switching between underlying investment strategies within an investment bond. Ownership can be assigned to another person without tax consequences (e.g. transferred to a minor).
Finally, franking credits from life insurance companies can also reduce the overall effective tax rate.
Accessibility and no contribution restrictions
Unlike superannuation where strict conditions of release must be satisfied (e.g. reaching preservation age), investment bond holders have access to their investment at all times.
There are no government imposed contributions limits, as regular contributions are permitted, with the only restriction being the 125% rule.
The bond holder can nominate one (or more) beneficiaries and the benefit is paid directly to them as a tax free investment rather than to the estate.
This is not subject to the terms of an investor’s will and there far fewer restrictions around who may qualify as a beneficiary than life cover through superannuation.
The rise of more specific types of investment bonds such as ‘education bonds’ and ‘funeral bonds’ have appealed to those with particular objectives.
Financial asset definition
An investment bond can be used as security for a loan, which is not possible with superannuation assets. Any associated financing costs are also tax deductible.
The amount invested in an investment bond is not assessed under the normal deeming rules for Centrelink/Age Care purposes. For small businesses, an investment bond can reduce the aggregate annual turnover of a business to meet the ATO ‘small business entity’ test.
Many investment bonds offer a child advancement policy, where parents can have flexibility in nominating when it can be transferred into their name (without any tax consequences). This can be anywhere between the ages of 10 and 25.
Want to know more? Find out how Stockspot can help grow your wealth investing for a child – or for your own tax benefits.