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.
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.
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 as anyone who earns more than $37,000 has a marginal tax rate of more than 30%, many people are attracted to them.
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%.
For this reason, I rarely see tax advantages when investing in an investment bond in growth assets unless the only alternative is to invest in the top marginal tax rate (47%) when income is greater than $180,000. As it’s rare for two members of a couple to have incomes of $180,000+, make sure you understand your situation, investment strategy and the investment bond product to make sure you give yourself the best chance of achieving the best outcome.
Although they are convenient, this convenience isn’t exclusive to investment bonds so there are likely cheaper alternatives if your tax position is such that an investment bond would disadvantage you.
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.