Insurance bonds may be worth another look

The implementation of the Division 296 tax will prompt individuals to consider holding assets outside of the superannuation environment. Natasha Panagis suggests insurance or investment bonds may be worth consideration in this context.

With the introduction of Division 296 tax on superannuation balances exceeding $3 million from 1 July 2026, together with broader tax reform affecting capital gains and discretionary trusts, the wealth accumulation landscape for high net worth individuals is facing significant change.

Collectively, these measures have the potential to reduce the relative tax advantages traditionally associated with personally held investments, discretionary trusts and other non-superannuation structures. As a result, many of the alternatives being considered in response to Division 296 tax may prove less attractive than first assumed.

Consequently, the question for advisers is no longer simply whether clients should move assets out of superannuation, but rather which wealth accumulation structures remain effective in an evolving tax environment.

Against this backdrop, insurance bonds have re-emerged as a potential complementary strategy for clients who have maximised their superannuation opportunities or who are seeking additional tax-effective investment options.

While insurance bonds are unlikely to replicate the breadth of tax concessions available through the superannuation system, they may offer advantages for certain clients, particularly in relation to tax management, estate planning and investment flexibility.

This article examines the key features of insurance bonds, the clients most likely to benefit from them, their tax and estate planning advantages, how they compare with superannuation and their social security treatment.

What are insurance bonds?

Insurance bonds, also known as investment bonds, are life insurance policies with an investment component designed to be held for the long term, such as 10 years or more.

Insurance bonds combine features of a managed investment with a life insurance policy. Policyholders, or the investors, contribute funds to a pooled investment structure and select from a range of investment options offered by the provider. An insurance bond also allows the policyholder to nominate beneficiaries to receive the bond proceeds on the death of the life insured. This can enable the bond value to be paid directly to beneficiaries tax-free, providing both investment and estate planning benefits.

A key feature is investment earnings are taxed within the bond by the life insurance company at a maximum rate of 30 per cent. As a result, policyholders will not include any earnings in their personal tax return unless a withdrawal is made within the 10-year eligible period (discussed later).

Who may benefit from an insurance bond?

Insurance bonds may be suitable for:

high-income earners seeking a tax-effective non-superannuation investment,
clients who have maximised their contribution opportunities or have high total superannuation balances (TSB),
clients wanting access to capital before retirement,
clients who want to invest tax effectively over the long term,
clients seeking to leave tax-free benefits to adult children or other non-tax dependants,
parents and grandparents investing for future education or wealth transfer objectives, and
small business owners concerned about asset protection and bankruptcy risks.

Insurance bonds are generally less attractive for low-income earners whose marginal tax rate is below the effective tax rate applying within the bond.

Tax treatment of insurance bonds

Insurance bonds are taxed differently from both superannuation and personally held investments. The key tax considerations are outlined below.

Factors to consider	Tax treatment
Investment earnings	Investment earnings are taxed within the bond at a maximum rate of 30 per cent, although the effective rate may be lower where the life insurance company benefits from franking credits, deductions or other tax offsets. As tax is paid within the bond, policyholders generally do not include annual earnings in their assessable income, making insurance bonds potentially attractive for higher-income earners.
Capital gains tax (CGT)	Life insurance companies are not entitled to the 50 per cent CGT discount. As a result, realised capital gains are generally taxed within the bond at up to 30 per cent. However, policyholders are not required to track capital gains or report annual investment income in their personal tax returns.
CGT-free transfer of ownership	Transferring ownership of an insurance bond does not trigger a CGT event. This feature is commonly used in child advancement policies where ownership transfers to the child at a nominated vesting age. Similarly, switching investment options or redeeming the bond does not create a CGT liability for the policyholder. However, stamp duty may apply in some jurisdictions.
Death, disability, accident or illness and severe financial hardship	Amounts received following the death of the life insured are generally excluded from the policyholder’s assessable income. Concessional treatment may also apply where a bond is surrendered due to the life insured suffering an accident, illness or disability, or in cases of severe financial hardship, provided the policy was not originally acquired with the intention of being surrendered within 10 years.

In addition to the above tax considerations, advisers should also understand the operation of the 10-year rule, which determines the tax treatment of withdrawals, and the 125 per cent rule, which governs the level of additional contributions that can be made without restarting the 10-year eligible period. These rules are discussed below.

The 10-year and the 125 per cent rules

A key feature of insurance bonds is the 10-year rule, which determines the tax treatment of withdrawals. While policyholders can access their investment at any time, withdrawals made after the bond has been held for at least 10 years are generally tax-free, which means no amount is included in the policyholder’s assessable income.

Where a withdrawal is made within the 10-year eligible period, a proportion of the earnings component, known as the ‘relevant amount’, may be included in the policyholder’s assessable income in the year of withdrawal. A non-refundable 30 per cent tax offset is available to recognise the tax already paid within the bond. The offset can be applied against the tax payable on the withdrawal and against tax arising from other income sources. Consequently, policyholders with little or no tax liability may not receive the full benefit of the offset.

The 10-year eligible period commences on the start date of the policy, but may restart if the 125 per cent rule is breached. Broadly, this rule allows annual contributions of up to 125 per cent of the previous year’s contribution. Exceeding this limit results in a new 10-year eligible period recommencing from the policy anniversary date in the year the 125 per cent rule was breached.

Advisers should also note that reducing or ceasing contributions may limit future contribution capacity under the 125 per cent rule. Any subsequent contribution will therefore restart the 10-year eligible period. Accordingly, clients intending to make ongoing contributions should adopt a disciplined funding strategy to avoid inadvertently resetting the tax-free withdrawal date.

Estate planning opportunities

One of the strongest advantages of insurance bonds is their estate planning flexibility.

Unlike superannuation, there are no restrictions on who may be nominated as a beneficiary. This means adult children, grandchildren or other beneficiaries can receive the proceeds directly and tax-free upon the death of the life insured.

In many cases, proceeds can be paid directly to beneficiaries without passing through the deceased’s estate, potentially simplifying administration and reducing delays.

However, advisers should be aware that notional estate provisions may still apply in certain jurisdictions, such as New South Wales.

Insurance bonds may therefore be particularly attractive where clients wish to transfer wealth efficiently to adult children who would otherwise pay death benefits tax on taxable superannuation components.

How do insurance bonds compare with super?

Insurance bonds and superannuation serve different purposes and should generally be viewed as complementary strategies rather than direct substitutes.

Advantages of insurance bonds

No cap on contributions, age limits or work status – unlike superannuation, insurance bonds are not subject to contribution caps, age restrictions, work tests or TSB limits. However, some clients may elect to restrict any contributions in future years to no more than 125 per cent of the previous year’s contribution for tax purposes on withdrawals to avoid restarting the 10-year rule.
Access to capital – funds can be accessed at any time. While withdrawals within the first 10 years may have tax consequences, there are no preservation rules.
Tax-effective investment – although the tax rate is higher than the 15 per cent generally paid in superannuation, it may still be more attractive than holding investments personally where income and gains may be taxed at marginal rates of up to 47 per cent.
Estate planning flexibility – benefits can be paid tax-free to any nominated beneficiary without the dependency restrictions that apply to superannuation.
Investment choice – most insurance bonds offer a wide range of diversified investment options catering to different risk profiles and investors at all stages of their lifestyle. As such, insurance bonds can be a suitable long-term investment option for certain clients.
Bankruptcy protection – section 116 of the Bankruptcy Act 1966 dictates insurance bonds may be protected from the trustee in bankruptcy if the life insured is the bankrupt individual or their spouse. However, transfers to an insurance bond made to defeat creditors will be clawed back and may be divisible among creditors.

Limitations of insurance bonds

Not always as tax effective as superannuation – depending on a client’s circumstances, the 30 per cent tax rate on insurance bond earnings may be higher or lower than the effective tax rate applying to earnings within super, particularly following the introduction of Division 296 tax for individuals with TSBs exceeding $3 million.
Not ideal for lower-income clients – if the life insurance tax rate of 30 per cent is higher than a client’s marginal tax rate, investing into an insurance bond may result in more tax being paid than if the client had made investments in other assets.
No CGT discount – life insurance companies do not receive the CGT discount available to individuals and superannuation funds.
No tax deduction – unlike personal deductible superannuation contributions, investments into insurance bonds are made from after-tax money.
Fees – investment costs and administration fees vary between providers and should be carefully reviewed.

Social security treatment

For social security purposes, insurance bonds are generally treated as financial investments. The surrender value is assessed under the assets test and deemed under the income test.

Where an insurance bond is owned through a private trust, the private trust attribution rules apply instead. In these cases, deeming does not apply and the actual taxable income of the trust is assessed.

Because insurance bonds do not distribute annual income, this can create planning opportunities for certain clients affected by means-tested arrangements, such as home-care fees or residential aged-care fees.

Final thoughts

Despite the focus on Division 296 tax, superannuation remains the most tax-effective long-term wealth accumulation structure available for most clients.

However, as contribution caps, TSB limits and proposed broader tax reforms increasingly constrain alternative investment structures, advisers may need to look beyond the traditional super-versus-trust debate when assisting high net worth clients.

Insurance bonds are unlikely to replace superannuation, but they may provide a valuable complementary strategy for clients who have exhausted their super opportunities, require greater access to capital or are seeking estate planning advantages. For the right client, they can represent a useful addition to a broader wealth accumulation and intergenerational wealth transfer strategy.