Insurance bonds a super complement

For all the bleating about SMSFs and their status as “onshore tax havens,” it’s timely to remember that severely limited contribution caps impose practical limits on the size of super that even wealthy Australians can accumulate.

Tax concessions for super are designed to offset the psychological and practical detriment of not being able to access money in super until retirement. For investors who are making maximum deductible contributions into super, insurance bonds offer another tax-effective way to invest for the future. Modernisation has moved into this once stodgy sector, with new-style products like the Austock Imputation Bond offering a wide range of underlying assets and flexibility: www.austocklife.com.au.

Tax rules for insurance bonds

Insurance bonds can only be issued by registered insurance companies, and this brings prudential oversight by the Australian Prudential Regulation Authority coupled with rules around product features and design. The tax effectiveness of insurance bonds has four main aspects, specifically sanctioned by the Review of Business Taxation in the late 1990s and clearly enshrined in current tax laws:

1. Tax on capital gains and earnings on the underlying investments within insurance bonds is levied at 30% per annum, and imputation credits on shares held within insurance bonds can further reduce that tax rate;
2. All gains from the investments within the insurance bond can be paid out to beneficiaries free of tax after 10 years from the date of original investment;
3. There are no caps on the amounts which can be invested into insurance bonds;
4. Interest is tax deductible on investment loans used to purchase insurance bonds.

Insurance bonds are also effective asset protection vehicles because they are specifically excluded from “divisible property” under section 116 of the Bankruptcy Act (1966) – so insurance bonds owned by a bankrupt or spouse cannot be accessed by a bankruptcy trustee in the event of personal insolvency.

Modern insurance bonds provide flexibility and investor choice regarding what the funds held within the bond are invested in, and so they parallel the innovations within the superannuation industry over the last couple of decades (where investors can access a range of investments from menus available on retail master trusts).

This means that insurance bonds can be used like superannuation as a tax-effective form of investment, (albeit with less tax effectiveness than superannuation) and with various levels of investment control being provided during the investment term, depending on the product design and features.

Insurance bonds are issued by a number of providers including Australian Unity, OnePath, CBA/Colonial, IOOF, NAB, AMP and Austock, each with slightly different features and benefits. The Austock Imputation Bond is available for direct purchase by retail investors and also is available through financial intermediaries, and includes a standalone Term Deposit investment option targeting investors looking for a cash-only investment.

Specific features of the Austock Imputation Bond

The Austock Imputation Bond operates like this:

• The minimum initial investment is $10,000, and during the minimum 10-year term annual ongoing investments of up to 125% of the initial investment can be made;
• A term of between 10 years up to a maximum of 99 years can be selected;
• The policyholder (i.e. the investor) selects from a menu of 28 underlying managed funds or assets in whatever blend suits their needs;
• Most of the funds provide exposure to specific sectors or asset classes;
• All distributions received on the investments are taxed within the insurance bond structure at the 30% tax rate;
• The policyholder can switch between investments without any capital gains tax (CGT) liability – this is an important collateral tax benefit compared to moving between investments held directly by the individual or via their family trust or company;
• At the maturity of the insurance bond the payout is free from any further tax liability;
• Investors can access their money earlier than 10 years, in which case they receive a tax credit for the 30% tax paid within the insurance bond (and hence will only be liable for top up tax to the level of the investor’s marginal tax rate);
• The insurance bond will pay out upon the death of the policyholder;
• The proceeds of the payout of the insurance bond can be targeted to a specific purpose which will be binding in the event of death of the policyholder – e.g. for the specific purpose of making payment to a designated person (e.g. child, grandchild) and for a specific purpose (e.g. to fund school fees).

What does it invest into?

The investment menu for the Austock Imputation Bond allows investors to choose from 28 investment managers, across the major asset classes of cash/fixed interest; Australian and international shares, property securities and passive index funds. Although most of the investment managers available are of the traditional high turnover/benchmark aware style, (pleasingly) more innovative managers offering concentrated/low turnover styles – such as the well performing Magellan –also are available. A limited range of specialist funds also are available, such as the UBS and Schroders “hybrid” securities funds, and the Dimensional index/”quant” fund. The full list is at: http://www.austocklife.com/investment-menu .

Austock sets three key performance benchmarks for funds available on the investment menu, and once selected each fund must continue to meet these KPIs. To gain initial selection the investment must have beaten these benchmarks for the previous three and five years. Because consistent performance persistence for active fund managers is demonstrably low (with typically only 1/3 of industry wide/outperforming managers continuing to outperform after three years), investors should consistently review the performance of the investments they select within the Austock Imputation Bond. Inclusion of a component of funds selected from the passive index funds available on the menu could suit investors wishing to reduce the costs and improve the tax effectiveness of their investment portfolio.

Fees and charges

There are several layers of fees within the Austock Imputation Bond, depending on the investments selected. There are no contribution fees charged for investments.

Austock charges:

• an Administration Fee for its management of the product, and this varies depending on the investments selected, ranging from 0.2% pa for cash funds, with the majority of investments being charged at a rate of 0.6% pa;
• an Expense Recovery fee (typically covering fixed costs such as audit and tax compliance) at the rate of between 0.11% pa to 0.31% pa);
• actual fees for each underlying investment are charged by each investment provider.

Investors should check the detail in the Product Disclosure Statement for fees applicable to specific investments. Total fees are generally higher than would apply to investments made through retail superannuation master trusts or wrap platforms, but the costs and complexity of providing a product regulated under the Life Insurance Act are generally higher than the costs incurred by retail superannuation platforms.

As mentioned above, the Austock Imputation Bond allows investors to select an actively managed term deposit option. The total costs for this option are 0.65% pa (management fees are 0.49% pa and expense recovery fees are 0.16% pa). Assuming an underlying interest rate of 3% pa is received on these term deposits, the tax savings for an investor who would otherwise be taxed at the top marginal rate of 46.5% pa would equate to around 0.495% pa – depending on actual returns, the net benefit of this option may be negligible compared to direct investing in term deposits.

Redemption requests are typically met within 10 days from being lodged with Austock but depend on the continuing liquidity of the underlying investments selected.

For investors looking to complement their superannuation in a tax-effective format, insurance bonds from all the major providers offer some useful attractions. I've used the Austock example because it is available to direct investors, but the asset protection and estate planning benefits mentioned are generally present in most products. Insurance bonds are one of the least known tax-effective products in the market, and investors should spend more time getting to know them.

Dr Tony Rumble provides asset consulting services to financial product providers and educational services to BetaShares Capital Limited, an ETF provider. The author does not receive any pecuniary benefit from the product reviewed. The comments published are not financial product recommendations and may not represent the views of Eureka Report. To the extent that it contains general advice it has been prepared without taking into account your objectives, financial situation or needs. Before acting on it you should consider its appropriateness, having regard to your objectives, financial situation and needs.