How attractive are friendly society and life insurance bond investments for investors unable or not wanting to add to their super balances? As with all such questions, the answer will depend on personal situations and the available alternative investment options.
The renewed interest in both friendly society and life insurance bonds stems from the long established 30 per cent income tax rate and the ability to withdraw the accumulated balance tax-free after 10 years. This 30 per cent income tax rate is attractive for taxpayers with annual incomes above $37,000 who face marginal income tax marginal rates of 34.5, 38.5 or 48.5 per cent.
Historically low interest rates have reduced the appeal of the traditional fixed interest friendly society and insurance bonds, with investor attention now focusing on bonds investing in equities paying fully franked dividends. Held in personal names, dividend paying shares will trigger additional personal income tax liabilities when personal marginal tax rates exceed the 30 per cent imputation credit rate.
By owning these shares in a bond fund, the refund of franking credits results in no or very little ongoing annual income tax payable on the dividends received. This is the main appeal of investing in domestic equities via an insurance bond.
Unfortunately, there is another issue that investors in bonds need to consider. This is the capital gains tax treatment of shares owned by friendly societies and life insurance companies. Whereas only 50 per cent of the capital gains on shares owned in personal names for longer than 12 months is subject to income tax, all gains realised by life companies and friendly societies are subject to the flat 30 per cent rate.
By owning shares for longer than 12 months, personal investors can ensure that any realised gains are taxed at marginal rates ranging between 17 and 24 per cent. Even better long-term investors can avoid or postpone paying capital gains tax by not selling or delaying the sale of assets many years.
Friendly society and life insurance bond investors cannot escape paying capital gains tax at the 30 per cent rate because investments must be sold when the bonds are redeemed. Over a 10-year or longer period, the capital gains payable is likely to be substantial because capital gains are a large component of the total return from owning equities.
For this reason, several other options may achieve more tax-effective outcomes. These include income splitting with a spouse or family via a trust or joint ownership of investments. Building up assets in a spouse's super account also provides access to a maximum 15 per cent tax rate on investment income and 10 per cent capital gains tax on assets owned for longer than 12 months.
Daryl Dixon is the executive chairman of Dixon Advisory