Insurance and friendly society bonds
Insurance bonds and friendly society bonds are investments made with a single (or regular premium) payment and have a nominal 10-year term. Tax is paid by the insurance company or friendly society at the applicable company tax rate and earnings regularly accumulate within the bond. Bonds are most suitable for accumulating money, but not for providing regular income payments.
These bonds are provided by Life Insurance companies or Friendly Societies, both of which are regulated by the Australian Prudential Regulation Authority (APRA) and by the Australian Securities & Investments Commission (ASIC).
How do insurance and friendly society bonds work?
Duration: Medium to long-term investments.
Returns: Accumulated earnings are received, tax paid, after at least 10 years. Earnings accumulate in the bond and are not paid until you withdraw the bond, in full or in part.
Adding to your investment: Each year, extra deposits of up to 125 per cent of the previous year’s deposit may be made. These count as having the same starting date as the original investment for taxation purposes. This option must be started by the end of the second year. Additional deposits can be made after ten years although the 125 per cent rule still applies and the ten year cycle starts again.
Switching between different investment options (such as market-linked to capital guaranteed) is usually possible for a fee.
Access to your funds: While money in bonds is accessible, they are not designed for regular withdrawals.
Fees: Entry fees vary from nil to 5 per cent. Additional deposits may attract fees. Withdrawal fees may apply. Management fees are payable each year on the full balance of your account. They are deducted before earnings are added to the bonds. In times of low returns, management fees may considerably reduce your earnings. Fees and commissions may be significant, particularly in the early years of the investment.
Security and risks
The security of your money depends on the type of bond and the strength of the institution you invest in. If you have only small amounts to invest or cannot replace lost capital, you should favour capital guaranteed bonds.
Capital guaranteed bonds provide a guaranteed return of your money and may guarantee earnings once credited to your account. There is usually no guarantee of the earnings rate. Capital guaranteed investments are becoming rare.
Managed or growth bonds are market-linked bonds and their value will rise and fall with market changes. They usually invest in higher risk assets, such as shares, which have a greater potential for gain as well as loss.
Capital secure and capital stable bonds are also market-linked, but mainly invest in lower-risk assets such as government bonds. They are not guaranteed, and the value of these bonds can fall as well as rise.
Social security treatment
The capital value of the bond including accumulated earnings will be taken into account for your social security or Veterans’ Affairs income test assessment under the deeming rules.
Taxation
Insurance and friendly society bonds are often sold as tax-free investments. Tax is actually paid on the bonds before earnings are added to your account.
A tax offset is available for withdrawals made before 10 years. If withdrawals take place before the 10 years is up a percentage of the earnings will be assessable for tax. Tax benefits may not be helpful for pensioners and others on low tax rates.
You only pay personal income tax when you withdraw your money. The amount due depends on your tax rate, the tax offset available from tax already paid by the life insurance company or friendly society and the timing of the withdrawal. If you want to withdraw early from a bond, you should contact the friendly society or insurance company concerned. They can advise you about the tax that would apply in your situation.
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Insurance products
Life insurance policies provide death cover—that is, the insurance company pays an agreed amount of money on the death of the insured person. Some policies also include an investment component.
What types of insurance policies are there?
Whole of life policies usually have fixed premiums payable each year and provide death cover for as long as you pay the premiums. There is usually no time or age limit. There may be a cash (or surrender) value if the policy is stopped.
Term insurance policies provide death cover only for a nominated number of years, or until a certain age. No payment is made if you live past the agreed time. There is no surrender value if the policy stops.
Endowment policies provide death cover for a certain number of years and pay a sum of money at the end of that time. They also have a surrender value if stopped early.
Taxation on life insurance products
Bonuses received from life insurance policies may be taxable. It is a complex area and you should get advice from a taxation adviser or the Australian Taxation Office.
If you receive social security or Veterans’ Affairs payments
Assets test—the surrender value of a policy is assessed as an asset for the policy owner. If the policy is taken out on your own life but is stated to be for the benefit of another person, for example your partner or children, it is assessed as an asset of the person who has access to the surrender value.
Income test—bonuses paid on these policies are not assessed as income during the life of the policy provided no withdrawals are made. If the policy is terminated, sold, matures or a withdrawal is made from it, the difference between the sum received and the relevant amount of the premiums paid will be assessed as income for the 12 months following the receipt of these monies. A Centrelink FIS Officer can provide more details on assessment policy regarding these products.
Funeral bonds
These are policies, usually offered by friendly societies or life insurance companies, that allow you to set aside money to cover your funeral costs. They provide a benefit only upon the death of the nominated person and normally cannot be accessed earlier. They work in a similar way to friendly society bonds.
What are the fees?
Entry fees vary from nil to five per cent. Management and trustee fees are payable each year on the full balance of your account. They are deducted before income is paid. In times of low returns, management fees may considerably reduce your income.
Taxation on funeral bonds
The interest accruing in the bond is not assessed as taxable income of the bondholder in the year of accrual.
If bonuses are paid to the trustee of the bondholder’s estate on the death of the bondholder, generally these bonuses will not be assessed as income of the trustee.
For policies purchased after 31 December 2002 the earnings are taxable in the hands of the product provider with effect from 1 January 2003. The provider will be entitled to a deduction for the net investment income when it is distributed to the estate of the deceased or the funeral director. The trustee of the estate will be assessable for tax on this income when received. If paid to a funeral director the proceeds of the policy are assessable to the funeral director at the time of receipt (that is, principle and earnings).
Prepaid funerals
Prepaid funerals are another option available to people. With a prepaid funeral all the arrangements are made and the funeral paid for at ‘today’s prices’. Legislation in the various states is different, so funeral directors may be able to invest the payments received differently. A common practice is for the money to be invested by the funeral director in funeral bonds. It is important that you establish where the money is invested and that you are comfortable with this.
It is important to find out what your situation would be if the funeral director sells the business or has to go into liquidation. Additional security may be gained in confirming the funeral director is a member of an industry association.
If you receive social security or Veterans’ Affairs payments
A funeral bond may be an exempt asset, subject to certain conditions:
- from 1 January 2008 the purchase price of the bond must not exceed $10 000 (however, if the bond increases in value to over $10 000 as a result of investment earnings, the exemption is not affected)
- a second funeral bond can also be exempt, provided the total value of the bonds you hold does not exceed $10 000
- the person cannot have a prepaid funeral plan or cemetery plot as well as a funeral bond.
If you invest more than $10 000, the whole amount is assessed under the deeming rules and also as an asset. Exempt funeral bonds cannot be cashed in before maturity and only mature on the death of the investor.
Important: You may wish to buy a cemetery plot for yourself without prepaying the funeral expenses. The value of the cemetery plot, regardless of its value, is not assessed as an asset.
As with funeral bonds, the money spent prepaying funerals is exempt from the means tests. The limit of $10 000 for each funeral does not apply. If you prepay a funeral and have a funeral bond as well, the funeral bond is assessable for the means tests.