02 9683 5999– BY RAY BOSTELMAN
It is only natural for parents or grandparents to want to help their children or grand-children get a head start in life. The most common milestones are being able to pay for your child’s education, first car, or deposit on their first home.
The question is how to structure the investment so that 1) the parent does not have to pay tax at their marginal rate on any income earned along the way; and 2) the child does not have to pay capital gains tax when the investment is liquidated.
I have looked at a number of investment options for children over the years and, for the purposes of planning for one of those big milestones in your child’s life, I believe that you can’t go past a 10-year insurance bond.
WHAT IS AN INSURANCE BOND?
An insurance bond, or investment bond, is a long-term tax paid investment that has a minimum term of 10 years.
There are two types of bonds available, Capital Guaranteed and Market Linked.
Capital Guaranteed bonds are designed for the more conservative investor and the insurance company guarantees the initial capital investment plus declared interest credited to the account.
Market linked products are designed to produce better long-term returns and by their very nature, have a more aggressive asset allocation. The asset allocation for market linked products can have a larger proportion in shares with fewer cash investments. Because of this the capital is not guaranteed, therefore investors’ funds may increase or decrease in line with market conditions.
HOW DO INSURANCE BONDS WORK?
Insurance Bonds are effectively a managed fund that have special tax treatment. A range of investment options are generally available via the Bond Provider. Investors can make a once-off investment, or can choose to make regular investments each year into the bond.
The minimum term is 10 years, but this can be extended at any time up to a maximum of 40 years, without forfeiting the right to withdraw the investment at any time.
Earnings are taxed at a fund manager level at a maximum rate of 30%, and provided that the investment is held for at least 10 years, they do not have to be reported on an investor’s tax return, and no additional tax is payable by the investor.
There is a ‘125% rule’ that make insurance bonds an even more tax-effective investment strategy. Each year, additional investments of up to 125% of the previous year can be made to an insurance bond, and provided the investor does not make any withdrawals, the additional contributions to an insurance bond do not need to be invested for a full 10 years before acquiring a tax paid status.
WHY ARE INSURANCE BONDS GOOD FOR CHILDREN?
In order to discourage adults from transferring assets into their child’s name to avoid tax, the government has applied a very low tax-free threshold to children, and beyond that children are levied with a very high marginal tax rate.
By investing in an insurance bond, the special tax scale applied to a child’s investment income can be avoided. This is due to the fact that investment earnings on insurance bonds are taxed at the fund manager level and are not passed on to the investor. In addition, at the end of the term all proceeds would be tax free provided that at least 10 years have expired.
Parents often prefer that the investment is held in the child’s name for the sake of certainty, and so that the child can watch as their investment grows. Insurance bonds allow direct ownership by the child, without any of the adverse tax implications of other investment options.
