Cash & Bonds Investment Bonds - 10Invest via Australian Unity

OK, so theoretically if I use Australian Unity's new cheap Vanguard version of investment Bonds (10Invest) and select the option that has the underlying Vanguard Australian shares option with total fees of 0.46% .... then when retired I purposely start drawing down at the 8 year mark (or before), then this would mean that I get a full 30 cents in the dollar tax credit on earnings inside the Bond. The benefit once retired would be greater than waiting the full 10 years.

Thoughts?

 

It would depend
1. Will franking credits be refundable in 8 years ? ...Hmmmm.
2. What is your grossed up income incl of franking in year in years 8 / 9 ? Its possible shortfall tax may be due unless the sum is small...You cant defer to years 10+ as its then tax free. No refund.
Typically to remain under the 30% tax rate the earnings incl of franking must be under $37K. So $20K per year ?
3. The apparent growth after the 10 years (tax free) may outweigh early exit and refunds that limit growth

Its a small window to plan to leap through

 

Yep, interesting observations. So the tax credits are not exactly the same as franking credits refunds so will not be impacted if excess franking credits are hit in the future as they are technically not franking credits.
Yes, to make the 30% tax rebate useful, it would be necessary to only draw down when no (or very low) other taxable income sources where available - e.g. when fully retired.
It is totally possible to reset the 10 years easily by purposely breaking the 125% rule.
To remain under the 30% tax rate you can earn up to approx $134000 (including the 30% rebate) and pay no extra tax. That's roughly $94K tax paid assuming no other taxable income sources.
There are several different ways to slice and dice this product depending on income, total wealth and draw down amounts and dates.

 

After having a read of this article on investment bonds, it seems that while these investment companies tell you that you pay no capital gains tax, the capital gains are still paid, just that it is paid before it gets to you, and on top of this you can not claim the 50% CGT deduction.

Firstly, can anyone confirm this is correct?

Secondly, if this is true, how would investment bonds make sense for anyone besides someone on the highest marginal tax rate, and how many retirees would be on the highest marginal tax rate for this product to be useful?

 

Yes, correct. There is massive misunderstanding of how CG are treated inside investment bonds. The facts are that you personally do not pay the CGT but it is most certainly paid by the company at 30%. Australian Unity and IOOF are very clear bout this in it PDS (other providers are not as clear).

It is important to choose an underlying product inside that the bond that does not rely heavily on CG for its growth (e.g VGS) but to choose income or dividend reliant growth choices so that you can claim back your 30% tax rebate on draw down and minimise your CG. The small amount of pure CG will be internally taxed internally at draw down at 30%. So, VAS or VAP would work better inside a bond than VGS for example.

The confusion is that projected CGT is calculated daily and shown on the holders statements (as a paper calculation only) as being accounted for - this allows holders to see their net benefit if they were to draw down in total. In reality the CGT is not set physically aside, it is fully invested and only actually triggered inside the bond if drawn down in full or part occurs.

Plenty of people are on high marginal tax rates - its not difficult these days. There are also plenty of people who are still much better off capping their earnings tax at 30% and taking the CGT hit on draw down. Its all about doing the math across the long term.

For example if a holder has the VAS equivalent underlying holding inside the bond then not much pure CG occurs across the long term as a goodly percentage of VAS's growth comes from distributions - thus if the 125% rule is purposely broken you get a full 30% tax rebate on all earnings growth component. This would be like getting VAS fully franked which never happens outside of a bond.

Edit - typos

 

Yep understand that CGT is delayed until you sell, but that occurs both in an investment bond and outside. So on the growth side, it's a pretty big downside for anyone not on the highest MTR due to losing the 50% CGT reduction.

While Australian shares such as VAS pay out more as dividends than global shares, there is still a lot of return from growth. Historically I think it's been roughly inline with the US which has had a 10% CAGR return, so if we take off the 4% dividends of Australian shares, that still leaves 6% annual growth of which would be losing a lot due to no CGT discount if you're not retiring in the highest marginal tax rate.

As to your last comment, can you explain that a bit more, I'm not sure if I quite understand it.
Are you saying that if you held it for 9 years and purposely broke the 125% rule, you would then get the growth to be in your own name and could claim the CGT discount on it?

Also in this case are you saying you'd keep the fact that dividends were taxed at 30% until that point?

 

OK,so looking at the Vanguard wholesale managed fund (VAS equivalent) return across the last 10 years you'll see that roughly CG's are roughly 50% of the growth and the rest is realised via distributions Investment Products - the fund has averaged a little over 8% total return across 10 years. OK depending on the start date this will differ admittedly (pick a date, any date).

So take an early retiree's situation using drawn-down from the bond as an only source of income: - Assuming a maximum of $94K draw down annually, tax paid on distributions can be fully recovered by triggering the break of the rules and getting a 30% tax rebate. 30% CGT however is nonredeemable. Effectively then, only 15% tax is getting pre-paid on total return.

Whilst certainly not as good as owning VAS ETF directly with regards to CGT discount during retirement, it is a very reasonable bridge between Superannuation and direct investment into the Vanguard managed fund, but with so much less hassle & paperwork.

The added benefit would have been during the accumulation period where 15% tax on the earnings portion (50% of the total returns) would have been saved through out the entire accumulation period (assuming 45% marginal tax) compared to direct ownership. That 15% tax saving is thus compounded back into the Bond fund, yet another benefit. The longer the accumulation period the more significant this amount becomes when compounded.