Jeff and Anna are recently retired and fortunately, they have accumulated enough wealth to enjoy a comfortable retirement. They have two children and are keen to ensure they are able to help them in the future. They have available funds of $200,000 set aside which they could simply give this to the children as an early inheritance, but they were concerned that they would be tempted to spend it all at once.
They met with Tribel adviser Wendy Barnham, to devise a plan that suited their needs. The idea was to be able to have this money set aside and invested for the long term without the children knowing about it.
Jeff and Anna wanted this investment to be low maintenance on their part since they prefer to enjoy their retirement and not have to worry about it. Importantly they didn’t want to have to pay tax out of their own pocket.
After consulting with Wendy, it was recommended that they set up an investment bond of $100,000 for each child. The investment will be in their name with each child named as the beneficiary. This way, the children will not know about it but will be in a position to benefit from the investment in the future.
In terms of tax, they don’t have to worry about it since the investment bond pays tax from money held inside it. Furthermore, they didn’t have to include the income generated from the investment in their annual tax returns. Another good thing about this investment is that if it is held for more than 10 years, any capital gain on the investment is tax free.
What are investment bonds?
An investment bond, also known as an insurance bond, is a long-term investment offered by insurance companies and friendly societies where investors’ money is pooled and invested according to the investment option chosen. There are tax advantages for higher income earners if the investment is held for at least 10 years and certain conditions are met.
Insurance bonds are tax paid investments, meaning that when earnings are received the operator of the insurance bond pays the tax rather than the investor. The effective tax rate paid by insurance bonds is up to 30% of the earnings. If your marginal tax rate is higher than 30%, insurance bonds can represent an opportunity to pay lower tax.
If you invest in the bond for at least 10 years, the capital growth on the entire investment will be tax free when you withdraw the money. If you do withdraw part or all of your investment before the 10 years is up, some of the earnings may be taxable in your hands but you will get a tax offset for the tax already paid by the insurance bond.
Unlike superannuation, which locks your money in until you meet certain conditions, particularly around age, you have access to all the money invested in an insurance bond. So if you change your mind or need money to spend, you can access the funds – although the tax benefits will not be as attractive should you withdraw money before the 10 years is up.
Based on the characteristics of insurance bonds, they have become popular for those who want to:
- Build wealth tax effectively, particularly if their marginal tax rate is greater than 30%,
- Give their children financial security, particularly children who may not be good with their money, or
- Pass on their wealth to loved ones without burdening them with additional tax.
Jeff and Anna wanted to have the funds invested conservatively and the let funds grow over time. One year down the track the $200,000 is now worth $206,000. Jeff and Anna are continuing to enjoy their retirement with the added knowledge that the money they’ve set aside for their children is growing in value.
Anna was thinking whether to tell the children but Jeff says “Let’s keep it a secret for now”.