In the late 1990s, the then Government (under Howard-Costello) commissioned the Ralph Review of the business and taxation laws to recommend improving Australia’s business tax system. Many would argue that they didn’t go far enough, or at the very least, it is required again.

Back then Treasury considered scrapping the investment bond “section 26AH/160AAB tax mechanism” (which provides the main tax feature benefits of an investment bond) and replacing this with the imputation system as it currently exists. While that would have leveled the tax playing field, it would have meant losing all the special tax features and advantages of bond taxation, especially where bond investors are individuals or trusts, the ongoing income tax shelter to investors, assignment benefits, etc. So, the life insurance and friendly society industries strongly opposed the idea and were successful. And then it was forgotten, and superannuation with the large contribution caps (in those days) became the main game in town. Until recently, with significantly reduced contribution caps, the concept and use of Investment Bonds have come back into vogue.

This is the second investment concept which I alluded to recently and which I will speak on.

The key advantage is the Bond’s tax effectiveness. The Investment Bond provides a tax-free environment if held for ten years or longer. And unlike superannuation, you can access monies at any time. Moreover, because the Bond pays tax at 30% (company tax rate), should you withdraw before ten years, you will receive a tax credit of 30% to offset your marginal rate of tax. In this regard, it is an excellent vehicle for those income earners who are likely to be on high marginal rates for many years to come. But it doesn’t stop there. The redeeming feature of the Investment bond is that you can add to it. In particular, you can add up to 125% of the previous year’s investment, which also forms part of the original tax-free investment. Please see the diagram below illustrating the impact of $10,000 invested where the 125% rule is utilised each year for a ten year period.

This means that after ten years, you can continue to add to the Bond and what you add can be withdrawn tax-free, even the gains. Importantly, you don’t have to disclose the income or capital gains on your taxation returns as this remains within the Bond. Also, because the investment Bonds are offered by Institutions that hold a Life insurer’s License, they also receive the bankruptcy and litigation protections that superannuation and life insurance policies have i.e. they cannot be touched.

These Bonds also offer unique advantages in Estate Planning which will be covered off next time.