Nick Bruining: For high-income earners, savings bonds are the century-old investment vehicle to dodge CGT

With new tax reform laws already passed, and others on the way, there’s been a significant increase in inquiries about a little-understood investment vehicle that’s been around for more than 100 years.

For high tax-payers, the use of special tax-paid savings bonds could see savings of at least 5 per cent in the effective rate of tax paid.

Savings bonds — offered by registered Australian life insurance companies — operate in a similar way to superannuation funds, but with no access restrictions.

Head of Australian Unity’s life division Adnan Glinac said the capital gains tax changes to be imposed from July next year would not apply to the investments within savings bonds.

“The CGT changes markedly weaken the tax efficiency of alternative structures such as unit trusts, master fund platforms, direct shares and property,” Mr Glinac said.

Citing research conducted by Christian Gillitzer from Sydney University, Mr Glinac said for investors on higher marginal tax rates, the new CGT calculation methods could result in effective CGT rates of 30-38 per cent.

“In contrast, investment bonds offer sub-25 per cent or even lower rates after you apply the allowable tax offsets.,” he said.

“Withdrawals are not subject to CGT, and after 10 years withdrawals are tax-free.”

If the money is accessed within the 10-year time frame, the growth component of the withdrawal is added to your other assessable income. However, a 30 per cent tax offset applies — but in this case it is a use-it-or-lose-it arrangement. Unlike franking credits with Australian share-based investments, any unused or surplus offset available is not refundable.

As a further concession, and as you approach the 10th anniversary, the portion of the withdrawal that is taxable is reduced. In year eight, for example, only two-thirds of the growth component of any withdrawn amount is taxable, and in year nine, that drops to just one third.

Like superannuation, investors using investment bonds can dial up their own mix of investments within the fund including shares, exchange-traded funds, property and fixed interest investments; or use pre-mixed funds like “conservative” or “balanced”.

While there are no contribution caps on the use of investment bonds, there are time-based restrictions which are designed to prevent people rorting the tax-free aspects as the bond approaches the 10-year, tax-free mark.

Investors are restricted to a contribution of 125 per cent of the previous year’s contribution.

For example, a person who starts with a $10,000 payment in year one could make a $12,500 contribution in year two. If they miss year three and then contribute again in year four, the 10-year clock effectively starts again. In most cases, another bond would be started with the new contribution.

Because insurance bonds are effectively held in trust by the issuer, they offer many of the protections available to money held in superannuation — but with much greater flexibility.

Money held in a savings bond, for example, isn’t automatically available to bankruptcy trustees, providing it wasn’t set up to thwart creditors from receiving distributions from a bankrupt person’s estate.

You can direct who is to receive the proceeds from a savings bond when you die. Unlike superannuation which restricts the beneficiaries to your dependants, savings bond beneficiaries can include any person, company or trust.

Cost-wise, most savings bonds are on par with retail superannuation funds, but without the economies of scale now existent in the $4.5 trillion superannuation industry.

There’s typically an administration fee of about 0.4 per cent of the account balance a year, and investment administration fees which are linked to the underlying investments.

A savings bond based around a Betashares exchange-traded fund, for example, would have total annual costs of around 0.7 per cent.

Nick Bruining is an independent financial adviser and a member of the Certified Independent Financial Advisers Association