The Federal Budget's superannuation changes should make investment bonds an even more attractive option for retirement saving, says Greg Bird, national business development manager for Lifeplan Funds Management.
"The budget changes introduce a $1.6 million transfer balance cap on the amount that can be transferred to tax-free retirement phase accounts; a 30% tax on concessional contributions for those earning over $250,000 per annum; a lower annual concessional contributions cap of $25,000; the introduction of a $500,000 lifetime non-concessional cap; and the tightening of the rules around Transition to Retirement.
"The budget changes don't sound the death knell for retirement savings, but they do open up opportunities for investors to look further afield to other tax-advantaged vehicles to save in, that also have the advantage of fewer restrictions on withdrawals.
"The tax effective nature of superannuation, with its tax rate of only 15 per cent on investment earnings for most investors, is well known. Less well known is that investment bonds are also a tax-advantaged option - where earnings are tax paid at a maximum of 30 per cent.
"They also do not carry the restriction on withdrawals prior to preservation age, and they do not have contribution limits.
"As earnings are tax paid at a maximum of 30 per cent, investors do not have a tax liability while the funds remain invested inside the investment bond. This is an attractive option for those with a close eye on their personal tax liability.
"When held for the long term – 10 years or more – withdrawals from the investment bond carry nil personal tax liability, and taxable withdrawals prior to the 10th year receive a 30 per cent tax rebate as earnings are tax paid by the investment bond issuer.
The Federal Budget's subtle tweaking of the middle tax bracket of 32.5% from $80,000 to $87,000 provides another incentive for investors to look to investment bonds, Mr Bird says.
"This means there is ample opportunity for investment bonds, with their capped tax rate of 30%, to offer investors an attractive tax arbitrage.
"It should be noted that like regular managed funds, investments held within an investment bond are also entitled to full franking credits, although such credits are reflected in the effective rate of tax paid by the investment bond, and thus in the unit price rather than being redistributed."
There are also other benefits in using investment bonds as a retirement savings vehicle, Mr Bird says.
"While the trigger event for a super withdrawal to be non-taxable is age based - the investor must attain age 60 years and satisfy a condition of release - the trigger event for an investment bond withdrawal to be non-taxable is much simpler: it is anniversary based. Once the policy has satisfactorily met its 10th anniversary, withdrawals are non-assessable for income tax purposes. What's more, there is no requirement to satisfy a condition of release.
"Investment bonds are an attractive option for those who aim to retire prior to reaching preservation age, or who aim to decrease their working hours while keeping a steady income flow available. In effect, enabling a True Transition to Retirement strategy outside of superannuation."
In this situation an investment bond can be drawn on with a "deductible amount" plus a tax offset in accordance with the individual's marginal tax rate, Mr Bird says.
"This means if an investor chose to work 20 hours less a week, they could substitute the lost income by drawing on an investment bond. Such withdrawals can be as large or small as the investor requires, and the withdrawal comprises of both a capital and earnings component. The capital component is not subject to tax.
"For this reason many investors have been using investment bonds as a means to transition into retirement without increasing the tax burden. Where the bond is held in excess of 10 years, any withdrawal amount will not be subject to further personal tax, a strategy that may allow an investor to retire early and maintain an income without affecting their taxation liability."
Investment bonds can often offer a superior estate planning outcome, than that which would be achieved with superannuation, Mr Bird says.
"Where the investment bond really shines for many investors, is for the purposes of estate planning. An investor can nominate beneficiaries within the investment account – including charities – to receive the proceeds tax free upon the investor's death, irrespective of how long the investment bond has been in place."