Investment bonds
Updated: 1 day ago
Originally written in 2019. Some rules, rates and figures have changed since, so check the current details before relying on them.
I often hear people asking about investment bonds as a way to save for a future expense like their kid’s education. There are two reasons I generally find people invest in investment bonds: convenience and tax.
Convenience
Investment bonds are convenient. They’re relatively easy to set-up and it’s easy to automate regular savings to be invested. This automation is great as I find it leads to a higher chance of you sticking to your plan. It’s like meal prepping on a Sunday night so you eat healthier and cheaper throughout the week.
Tax benefits
Investment bonds are a confusing product to the point that they’re often misunderstood by many financial experts. Although they do have their tax benefits, they’re not as tax effective as many experts (and providers) lead on.
The common advice is “invest in an investment bond if your marginal tax rate is above 30% as the investment bond only pays tax at 30% and there’s no tax liability to you personally after 10 years”.
This is true, and when this was written anyone earning more than $37,000 had a marginal tax rate above 30%, so many people were attracted to them. Tax brackets have changed since, which changes the comparison.
When you invest in growth assets like shares, often a lot of the return comes from capital gains and these capital gains are taxed at half of your marginal tax rate (if held for more than 12 months) when held in your personal name.
Investment bonds don’t get this benefit and contrary to what many believe, they’re taxed on all income, including gains along the way at 30%.
Because of this, the tax advantage of an investment bond holding growth assets is often smaller than it first looks, and it depends heavily on your marginal tax rate. It tends to be largest for people on the top marginal rate. Your situation, the investment strategy and the specific product all matter.
Their convenience isn’t exclusive to investment bonds either, as regular automated investing is available through other structures too.
PS. Investment bonds are sometimes called insurance bonds, they’re the same thing.
PPS. Investment bonds are different from bonds. Bonds are a defensive asset class (think cash, shares, property) whereas an investment bond is an investment structure (think personal, superannuation, company). As such it’s possible to invest in bonds within an investment bond.
PPPS. Education Savings Plans are similar to investment bonds however they have an additional layer of complexity which can make them more tax advantageous when paying education expenses. These are often more expensive again so make sure you crunch the numbers before committing.
I cover this in more detail in my video, Stop Making These 5 Investing Mistakes (Do This Instead), on the Edvest YouTube channel.
Explore free Australian finance education from Kyle Frost at Edvest.
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About the author: Kyle Frost is the founder of Millennial Independent Advice and Edvest. He previously worked in financial advice and now builds tailored financial models that show the levers, trade-offs and risks in big money decisions. Watch more on Kyle Frost's YouTube channel.
Connect with Kyle Frost: LinkedIn | Instagram (@kylefrostfinance) | YouTube | Edvest
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