Important Disclaimer: The information provided in this blog is intended for educational purposes only. It is not intended as financial advice. The article is based on objective, factual information. If you want to find out whether investment bonds are right for you, speak to a qualified adviser.
If you’re looking for ways to invest for children, or have looked into tax efficient ways to structure your income, you may have come across investment bonds (also known as insurance bonds). You might also have heard of investment bonds if you’ve read any of the Barefoot Investor books (including Barefoot Kids) by Scott Pape.
Here we compare the historical returns of investment bonds available in Australia in the growth category (61%-80% growth assets) to a diversified portfolio of exchange traded funds (ETFs) with similar risk, taking into consideration fees, tax and performance.
In this article we’ll cover:
- What is an investment bond?
- What are the benefits of investment bonds?
- Investment bond performance
- Pros and cons of investment bonds
- Providers of investment bonds
- Conclusion: when 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.
Investment bonds are considered to be 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 five year return for a growth investment bond of the 8 surveyed has been 2.9% per year at at 31 December 2022. A portfolio of ETFs with a similar asset mix (and risk) – like the Stockspot Topaz Portfolio – has returned 6.8% p.a. over five years.
An important difference is the impact of tax. Investment bonds are ‘tax paid’ investments whereas with a portfolio of ETFs the investors need to pay tax on income and capital gains.
Assuming the portfolio of ETFs was taxed at the highest marginal rate on income and capital gains, the after-tax return would be 4.7% p.a. This is higher than the 8 popular growth investment bond options surveyed and may be because ETFs have low fees and are themselves tax efficient.
At lower marginal tax rates the after-tax ETF portfolio return would be between 4.7% p.a. and 6.8% p.a.
It is important to note that 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 captured in this example.
Below the performance chart below is a worked example to show the impact of tax at the highest marginal rate.
Past performance of financial products is no guarantee of future performance. Return are net after fees as of 31 December 2022 using a growth diversified investment option (OnePath – Managed Growth, Australian Unity – Lifeplan Advance Balanced, CBA – Nil Commission (NC) Growth, AMP – Balanced Growth, IOOF WealthBuilder Growth MultiMix, Generation Life MLC Horizon 4 Portfolio, Key Invest Life Events Diversified Growth, 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: Morningstar, Stockspot.
Over the last 5 years, the returns from investment bonds has been lower compared to a similar risk portfolio of low-cost index funds (ETFs) after accounting for the impact of tax at the highest marginal rate. This may be because ETFs have low fees and are themselves tax efficient.
Post-tax worked example of an ETF portfolio vs average investment bond over 5 years
| Stockspot Topaz (ETF Portfolio) owned by parent and sold | Average Investment Bond | |
| Highest marginal tax rate | 47% (including Medicare levy) | |
| Initial investment | $10,000 | $10,000 |
| Amount after 5 Years (assuming past growth) | $13,895 | $11,537 |
| Tax on investment income | -$808 | 0 |
| CGT (less 50% discount) | -$511 | 0 |
| Total value (after tax and CGT) | $12,576 | $11,537 |
| Post tax Total Return | 25.76% | 15.50% |
| Additional return from an ETF portfolio after-tax | 10.26% |
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 and financial advice if you think an investment bond might be right for you. You can also check out the ASIC MoneySmart website.
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 higher fees relative to other investment options like ETFs. |
| 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%. |
Who are the main providers of investment bonds in Australia?
| Provider | Investment bond name | Growth Option Fund (61% – 80% growth assets) | 5 Year Return of Fund to 31 December 2022 (p.a.) |
| Generation Life | Generation Life – LifeBuilder, ChildBuilder, and FuneralBond | MLC Horizon 4 Portfolio | 2.5% |
| Commonwealth Bank | Investment Growth Bond | NC – Growth | 4.0% |
| AMP | AMP Growth Bond | AMP Balanced Growth | 3.4% |
| IOOF | IOOF WealthBuilder investment bond | IOOF WealthBuilder Growth – IOOFMultiMix | 4.0% |
| KeyInvest | KeyInvest Life Events Bond, KeyInvest Funeral Bond | Diversified Growth | 2.5% |
| Australian Unity | Lifeplan Investment Bond, Lifeplan Education Bond, Lifeplan Funeral Bond | Lifeplan Advance Balanced | 2.9% |
| Centuria | Centuria Investment Bond | Growth Bond Fund | 1.7% |
| ANZ/OnePath | Investment Savings Bond | OnePath Managed Growth | 2.3% |
| Average Investment Bond return | 2.9% p.a. | ||
| Stockspot Topaz ETF Portfolio return after fees (pre tax) | 6.8% p.a. | ||
| Stockspot Topaz ETF Portfolio return after fees (after tax at 47% marginal rate) | 4.7% p.a. |
This is just one ETF portfolio 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 and financial advice if you think an investment bond might be right for you. You can also check out the ASIC MoneySmart website.
Conclusion
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 and who want to avoid the hassle of transferring the assets later.
A diversified portfolio of ETFs may be more attractive for people on lower marginal tax rates or people who want more control over how the money is invested and the flexibility to sell in less than 10 years without penalty.
More info
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.
Tax efficiency
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).
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.
Estate planning
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.
Specificity
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.
Vesting age
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.
