Investment bonds are a practical investment option for those who earn a high income and seek long term tax efficiencies.
Investment bonds, also known as tax-paid, insurance or growth bonds, work similarly to a managed fund, except they are combined with an insurance policy. There is a ten year rule which allows tax free earnings on the bond if no withdrawals are made in the first ten years and contributions do not exceed 125% of the previous year’s contribution. Most investment bonds offer a range of investment options to cater for differing risk levels such as cash, fixed interest, shares, property or a range of diversified investment options.
Investment bonds are particularly suitable for high income earners with a marginal tax rate higher than 30% who want to build wealth without increasing their personal tax liability. They are also useful for estate planning purposes as beneficiaries other than dependants can be nominated and will not incur tax upon receiving proceeds.
An investment bond can be used as an investment structure for future financial needs of children such as education expenses. Alternatively, investment bonds can be used for supplementary retirement planning as investment bonds are not subject to preservation age, unlike superannuation investments, which may be more viable for those planning an early retirement.
Investments held in an investment bond are generally not subject to capital gains tax (CGT). Where an investment does not qualify for a CGT discount, the maximum tax rate of 49% may apply on earnings whereas an investment bond generates a maximum rate of 30%.
However, investment bonds do carry some risk that individuals should consider before making a decision. Common fees such as establishment, contribution, withdrawal, management, switching and adviser service fees may be applicable depending on your provider and the investment options you choose.
If you do choose to invest in an investment bond ensure you will be able to make regular contributions over the lifetime of the investment and can comply with the 125%. It is important to align your financial and estate planning goals with an appropriate investment structure suitable to your risk profile.
If you have a self-managed super fund (SMSF), then you need to meet the sole purpose test to be eligible for the tax concessions that are normally available to super funds. The sole purpose test aims to ensure that SMSFs are maintained for the purpose of providing benefits to members upon retirement or for beneficiaries if a member dies before retirement.
The sole purpose test is not a formal process that trustees have to go through, but more of a standard rule of thumb they should follow when making decisions relating to their fund and investments. If the sole purpose test is contravened, the fund will lose its concessional tax treatment and be subject to the highest tax rate. Members could also be disqualified as a trustee and face civil and criminal penalties such as fines or imprisonment.
If you or anyone else get some sort of financial, pre-retirement benefit when making investment decisions and arrangements other than increasing the return of your fund, then it is likely that your fund does not meet the sole purpose test. The test is divided into core and ancillary purposes, where regulated funds must be maintained for at least one core purpose and can add one or more ancillary purposes but cannot be run only for ancillary purposes.
The core purposes are paying benefits to:
- Members on or after retirement from gainful employment.
- Members when they have reached a prescribed age.
- Dependents if the member dies.
The ancillary purposes are:
- Termination of a member’s employment where the employee made contributions to the fund on behalf of the member.
- Cessation of employment due to physical or mental health reasons.
- Death of the member after retirement where the benefits are paid to the member’s dependants or legal representative.
- Death of the member after attaining a prescribed age where the benefits are paid to the member’s dependants or legal representative.
- Other ancillary purposes approved in writing by the regulator (ATO or the Australian Prudential Regulation Authority).
The national rental affordability scheme (NRAS) started on 1 July 2008, encouraging large-scale investment in affordable housing. It offers tax and cash incentives to providers of new dwellings for 10 years, granted they are rented to low and moderate income households at 20% below market rates.
Though the NRAS is no longer taking new investments, property owners within the scheme will soon be receiving letters from the ATO to remind them of their claim requirements.
The two key elements of the NRAS are;
- An Australian Government contribution in the form of a refundable tax offset or direct payment to the value of $8,394.10 per dwelling per year in 2018-19. The Australian Government contribution is 75% of the total annual incentive.
- A state or territory contribution in the form of direct financial support or an in-kind contribution to the value of at least $2,798.03 per dwelling per year in 2018-19. The state or territory contribution is 25% of the total annual incentive.
Owners of NRAS rental property are eligible to claim a refundable tax offset if:
- The Approved Participant has provided them with advice of their entitlement based on the certificate received from the Housing Secretary, and;
- The claim is made in the year to which the certificate relates.
Deductions can be claimed for expenses incurred with a NRAS rental property, excluding the contribution amount received from the state or territory. The contribution amount is non-assessable, non-exempt (NANE) income for tax purposes.