Wednesday 17 February 2021

Investment Bond initial investment and first quarterly contribution

As mentioned in my 2021 goals, I decided to start a 'LifeBuilder' Investment Bond (Insurance Bond) investment with Generation Life, mainly for estate planning purposes (at my marginal tax rate there is negligible tax saving on income compared to investing in my own name, but it does have CGT benefits from year 8 onwards, and is CGT exempt after ten years). I made an initial contribution of $1,000 in January to set up the Investment Bond, with my chosen asset allocation being:

50% Dimensional 70/30 World Allocation Trust

50% Vanguard High Growth Portfolio

Overall, this means that the asset allocation of my IB portfolio will be:

0 - 5.5% cash

0 - 5% property

10.5 - 24.5% fixed interest

24.5 - 36.5% Australian shares

35.5 - 58.5% International shares

A long term average pre-tax ROI of around 8-9% after fees seems a reasonable prospect.

I've also setup up annual rebalancing (that occurs in May each year) back to this asset allocation (if it has deviated by more than 1%), and I've set up an automatic contribution of $500 each quarter to add to this investment bond this year.

The bond is initial setup with myself as the 'life insured' and the beneficiaries to be my two sons. In the longer term I will probably add another life insured - my youngest son (so the IB remains invested after I die) and the beneficiary to be a testamentary trust established via my will that will pay 0.25% of its annual trust income to each of my descendants who are aged over 18. When the testamentary trust eventually gets wound up it would distribute the remaining assets to each surviving descendant who is over 18.

Setting up the testamentary trust correctly will probably require involvement of an estate lawyer, as it seems a bit beyond the scope of a DIY will kit ;)

My total contributions into the IB in the first year will be $3,000, and the maximum contributions that can be added each year without resetting the CGT concessions 'clock' is 125% of the previous year's contributions. So in following years the maximum I can contribute will be:

Year    Max Contribution

2021    $3,000        (whatever amount you contribute in Year 1 forms the basis for the Year 2 limit)

2022    $3,750

2023    $4,687

2024    $5,859

2025    $7,324


While I am still working full-time (and thereafter if I continue working part-time as a financial planner) I'll make these contributions from my after-tax cash flow. Once I retire I will fund that annual contributions from my SMSF pension. From some rough calculations/projections I should have enough 'surplus' retirement income (i.e. above my current 'take home' income level) to continue to make the maximum allowed contributions into the IB each year during my retirement. Of course how things turn out in reality will depend on market performance over the coming decades.

While the value of the IB is initially very modest, the power of compounding (and the increasing annual contributions) will make the IB value 'snowball' quite rapidly over the decades. And although the first distributions from the testamentary trust to my descendants will also be very modest, they will also increase quite rapidly over time, and the final 'lump sum' payment to each descendant might be quite substantial.

One of the benefits of an IB is that it doesn't normally form part of one's estate if there are nominated beneficiaries (such as a testamentary trust), so there is less risk of the beneficiaries of my estate being upset about not having immediate access to the IB. And in any case, the bulk of my 'estate' (home, lake house, residual superannuation balance etc.) will go to DW and my children.

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I'm not sure why I fancy the idea of setting up a long-term legacy for my descendants. It probably has something to do with being an atheist and therefore not believing that there is any sort of 'after life' (any more than there was a 'before life' prior to my conception). When I was younger I fancied the idea of cryonic suspension, but the chances of that being anything more than an expensive method for preserving a corpse (corpsicle) seems extremely remote. So leaving a legacy seems a practical method to ensure I will be fondly remembered by a few of my descendants for a few years after my death ;)

If Elon Musk is correct and AI 'singularity' happens in my lifetime, mind uploading *might* offer some version of personal immortality. - but I doubt it. And in any event, one of the good features of an IB is that while I am still alive I can choose to access the funds if needed.

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mOOm said...

I'm confused by your comments on CGT. I thought an IB was taxed at 30% unless it was reset by adding a new too big contribution or broken early. The long-term capital gains tax rate is less than this, even for the top tax bracket. said...

Yeah, you're correct. It has to do with the total earnings (income and CG) of the IB, not just CG. If you take money out of an IB before year 8 the earnings of the IB you withdraw will be assessable to you, minus a 30% tax offset (for the amount of tax paid by the IB). If you hold it 8 years then 2/3 of the IB earnings are assessable (-30% tax offset), after 9 years 1/3 of the IB earnings are assessable (-30% tax offset), and if you hold the IB 10 years or longer before making a withdrawal then the it is non-assessable. The 125% rule is the amount you can add to an existing IB investment compared to the previous year without this 10-year period being reset.

BTW there is no CGT discount applied to long term CG within the IB, all its earnings (income and capital gains) are taxed at 30%. So it's probably worth looking into the more tax effective IB investment options (presumably they minimize CG by not over-trading) - GenLife flags there investment options within the IB as being more or less tax effective.

Although the notional tax rate of the IB is 30%, due to franking credits etc. the effective tax rate within the IB ends up being around 20%-25% according to some explanations about IB I've watched.