An insurance bond is an insurance-related investment instrument that insurance companies offer as a whole life/term life insurance policy. An Insurance bond, also called an investment bond, is predominantly used in the UK and Australia. These bonds attract investors who prefer long-term investing or use insurance bonds for estate planning. Additionally, insurance bonds come with some tax advantages. Fidelity bonds and Surety bonds are two primary types of insurance bonds, each having subtypes and protecting against different situations.
In this article, we will explore what is an insurance bond and how it works. So, let's delve right into the details!
Understanding Insurance Bonds
An insurance bond is a simple investment option that enables investors to save money for the long term. These bonds allow you to invest on behalf of children, grandchildren or for particular purposes such as weddings or education and have ownership transferred automatically at a future date you set.
The insurance company may offer funds comparable to mutual funds for an investor to choose from. The investment can be made as a one-time payment or regular remitted payments, just like a life insurance policy. So, the structure of an insurance bond can be set either as a term life policy or a whole life policy.
How do Insurance Bonds work?
Insurance bonds sold to investors are made using a pooled premium fund. The insurance company will invest those funds into stocks and other securities to generate a high ROI (Return on Investment). And the insurance bond holders regularly receive dividend or bonus payments. In addition, if the bonds are cashed in early, a portion of the money may be paid out. Also, bonds may be paid out if the insured person dies, who may or may not be the insurance bond's buyer.
Initially, a company would issue these bonds to distribute surplus funds. Today, insurance bonds serve as a collective fund and long-term investment vehicle, intending to provide financial growth. Bond creation was most prevalent in fraternal life insurance companies, which are quite similar to fraternal organizations or mutual benefit societies. Moreover, insurance bonds have started to be referred to as investment bonds or unit-linked bonds after the advent of unitized insurance funds, another type of collective investment.
Payable Fees
The costs applicable to insurance bonds will vary depending on the bond issuer and investment options you have picked. However, standard fees that you might pay include withdrawal fees, switching fees, contribution fees, establishment fees, management fees, and adviser service fees.
Pros and Cons of Insurance Bonds
Let's look at the pros and cons of this insurance-related investment instrument!
Pros:
Tax Effective
If you hold the insurance bond for more than ten years, income tax and capital gains tax (CGT) are taxed at the firm tax rate of 30%, and you do not need to include this income in your personal income tax return.
Transfer Ownership
An insurance bond allows you to make an investment on behalf of your kid or grandchild and transfer the ownership to the child after they reach their designated vesting age, often 25. It avoids CGT and stamp tax.
No caps on the size of contributions
Insurance bonds may also be best for individuals who can not contribute more to their superannuation because of concessional or non-concessional contribution caps, subject to the 125 percent rule.
Cons:
Liquidity
Some of the tax advantages can be lost if you have to withdraw funds before the 10-year mark.
Capital Gains Tax (CGT)
The 50 percent CGT discount that people receive on assets they have owned for more than a year is not available to insurance bond providers. Instead, they pay taxes at a 30% company rate.
Fees and Performance
Insurance bonds usually have higher fees than other investment options such as Exchange Traded funds (ETFs).
Tax Benefits of Insurance Bonds
Insurance bonds are excellent investments for investors who like long-term investments. These bonds are tax-paid investments. One of the tax benefits of insurance bonds is that the taxes paid on these bonds typically decrease with prolonged holdings. In addition, investors who hold their insurance or investment bonds for over a decade without making any withdrawals can actually receive their returns tax-free. However, different formulas determine it in different regions.
Before deciding to invest, it is recommended to thoroughly read the PDS (Product Disclosure Statement) and also get financial advice for more clarification. This ability to lower taxes by holding the insurance bond for over ten years is the most significant benefit of this specific investment vehicle.
Another benefit of these bonds is that they can be bought to give the policyholder either long-term growth or a consistent income. However, this income may vary along with the market, or the policyholder can purchase a bond that guarantees an income for the bond's life. Also, Insurance bonds are available through a wide range of investment options such as bonds, property infrastructure, shares, and mixed-asset portfolios.
The Bottom Line
As you have learned, an insurance bond might be a crucial consideration in circumstances where it is beneficial for you to hold and grow your wealth outside of superannuation in a tax-effective manner. Yet, the use of an insurance bond will depend on your financial goals, situation, and objectives. In addition, managed funds, direct shares, mortgage reduction, or online savings accounts are alternatives to insurance bonds that you may also consider depending on your personal situation and reason for growing wealth.
Last but not least, it is best to consult with your financial advisor to learn more about the suitability of using insurance bonds in your particular case.
