The top five benefits of offshore bonds

What are offshore bonds?

While you may be aware of the tax benefits offered by an Individual Savings Account (ISA) or pension plan, you may be less familiar with offshore bonds.

Like pensions and ISAs, international bonds are effectively ‘wrappers’ into which you place your money, for example, investment funds or cash.

Some offshore bonds may have a minor element of life cover attaching, however, the life cover provision is not the main attraction of these investments.

Offering the prospect to choose when you pay tax and possibly how much you pay, plus the potential for Inheritance Tax (IHT) mitigation and further planning opportunities for ex-pats, offshore bonds can be an attractive addition to your wider investment portfolio.

The top five benefits of these lesser known investments:

1. Enjoy tax deferred growth*

Whilst your investments remain inside the offshore bond wrapper, they will not be subject to Income Tax or Capital Gains Tax (CGT).

This is referred to as ‘gross roll up’ and provides the potential for an offshore bond to grow faster than an onshore UK bond thanks to the compounding effect of the tax deferment.

There is no UK Corporation Tax on gains, and you can switch between different funds within the offshore bond without giving rise to taxable gains.

(* a small amount of withholding tax may apply)

2. Withdraw up to 5% per year tax free – or let this allowance rollover

You can take up to 5% of the original investment each policy year without attracting an immediate tax liability and, if you choose not to take the 5% allowance in any one year, it can be carried forward on a cumulative basis for future years.

For example, if you made an original investment of £200,000, you could withdraw £10,000 per year for 20 years and would not need to pay tax at the time of taking. If you decided not to take any withdrawals for the first five years, then you would have a cumulative allowance of £60,000 in year six.

The allowance is treated as the return of your original investment and continues until such a time that the original investment has been fully drawn.

Withdrawals over the 5% allowance will be liable to tax, however, there are two different ways you can partially encash your investment and, with the correct advice, legitimately manage the tax you pay.

3. Choose when you pay tax and potentially how much

Gains arising from disposal of the bond are liable to Income tax at your marginal rate. However, if you are currently a higher-rate taxpayer but expect to become a basic-rate taxpayer in the future (for example, when you enter into retirement), you can delay cashing in your bond assets until retirement and possibly pay half the tax due on any gains.

Be sure to ask your financial or tax adviser about how top-slicing relief works to reduce the tax payable on the gain.

Furthermore, you can offset gains against any unused personal allowance, the starting rate of 0% and the personal savings rate, if applicable.

4. Give some or all of it away – but only when you want to!

This might not sound like a benefit, but if you were looking at different options for investing for say, your children or grandchildren, the offshore bond presents an opportunity to meet this objective and unlike a junior ISA, you have control over when your child can have access to the money.

The way this works is that the bond is divided into equal segments. So, for your £200,000 investment, you could have say 20 segments of £10,000 each. If you then chose to gift £100,000 to your child, you could assign 10 segments of the bond to them without having to encash any investments and without incurring a tax charge at that point.

If your child is a non-tax payer, there could be no tax to pay when money is withdrawn. Your child could also benefit from any unused 5% withdrawals carried over on the segments assigned.

5. Keep control - put it into Trust

If you do decide to gift some or all of your offshore bond to your child (or somebody else), you have the option of putting it into Trust. This will enable you to keep control over when the money can be accessed.

Trusts can also be used for other tax planning opportunities such as Inheritance Tax (IHT) Planning. A Discounted Gift Trust or a Loan Trust are both excellent ways of minimising IHT whilst still retaining some access to your investment. Watch out for our upcoming articles which explain how these products work.

Be aware

Generally, offshore bonds are not subject to the Financial Services Compensation Scheme protection and other schemes may not be as developed as in the UK.

You should make sure that you are comfortable with the level of risk the underlying investment is taking and remember that the value of this investment is not guaranteed and on encashment you may not get back the full amount invested.

Offshore bonds are long term investments and cashing in early may incur a penalty.

There are many other benefits associated with offshore bonds, especially if you have been living abroad but the rules are quite complex, and you should consult a specialist tax adviser.

There are also a number of risk considerations that you should be aware of before embarking on any investment. It is therefore very important to always obtain professional advice prior to making any investment to ensure that it is appropriate to your circumstances.