Reader feedback on the article about the capital gains tax drawbacks of life insurance and friendly society bonds highlights the continuing need to understand all the details of investments. Despite the requirement for fund managers to issue a product disclosure statement (PDS) about their offerings, advisers and salespeople focus on the attractive features of their products.
In the case of life insurance and friendly society bonds, these include income tax payable at a flat 30 per cent rate, which is below that payable by many taxpayers. No further personal income or capital gains tax is payable on redemption after 10 years.
One reader interpreted the information that no personal tax is payable after a 10-year holding period as providing a capital gains tax benefit as well as lower income tax bills. Unfortunately, this is not the case.
The capital gains tax payable by insurance companies and friendly societies on assets owned for longer than 12 months is higher than personal capital gains tax liabilities. The taxation benefits of owning life insurance and friendly society bonds are reduced when capital gains, for example, from investing in shares, make up a substantial part of the income.
Fees and charges also need to be considered when assessing the value of the taxation benefits. Even a competitive annual management fee of, say, 1 per cent a year reduces an annual return of 7 per cent to a net (after tax and fees) return of 4.2 per cent. In this case, fees and tax total 40 per cent of the annual income.
Apart from not involving ongoing management fees, ownership of assets in personal names allows access to more favourable capital gains tax rates and any requirement to retain investments for an extended period. Where there is an owner-occupied mortgage, even if there is a specific purpose, such as building up assets to pay future education or similar expenses, paying off the mortgage can offer more certain and better returns than buying investment products.
Paying off a home mortgage involves no fees and charges and provides a certain annual return equal to the mortgage interest rate. The quicker the mortgage is paid off, the larger will be the annual cash flow available later in life to meet future commitments.
There is a huge industry encouraging people to invest in managed products that may or may not be best suited to ensuring their financial future. Especially when taxation benefits are highlighted as a reason for making an investment, the clear message is that all the alternatives need to be closely considered. Product disclosure statements are not required to provide information about alternative investments that may better suit the investor.
Daryl Dixon is the executive chairman of Dixon Advisory. firstname.lastname@example.org