Offshore bonds

What options are available if you consistently max out your pension allowance (£60,000), contribute £20,000 to your ISA each year, and take full advantage of your annual capital gains tax allowance? And what if your income exceeds £260,000 and your annual pension allowance is significantly reduced? Let's talk offshore bonds.

What options are available if you consistently max out your pension allowance (£60,000), contribute £20,000 to your ISA each year, and take full advantage of your annual capital gains tax allowance? And what if your income exceeds £260,000 and your annual pension allowance is significantly reduced? This week, Director of Private Clients Nick Rolf discusses a slightly less than “vanilla” tax wrapper that can sit alongside your existing GIAs, ISAs and pensions: offshore bonds.

What is an offshore bond?

An offshore investment bond is a tax wrapper set up by a life insurance company and domiciled in a jurisdiction with a favourable tax regime, such as the Isle of Man, Luxembourg, or Guernsey. It is used as a means of investment and wealth management, offering potential tax advantages.

The term “offshore” is somewhat negatively connotated and is sometimes associated with intricate, less-than-legitimate mechanisms for evading taxes. But this is unfair. Indeed, they are commonly included as standard in the tax planning strategies for high net-worth individuals. Like a pension, an offshore bond allows you to invest in various assets, including funds, bonds, alternatives and property, in order to achieve long-term growth in your funds.

Tax efficiencies

Contributions made to an offshore bond do not qualify for tax relief in the way pension contributions do. But there are other advantageous features. Offshore bonds are exempt from capital gains and dividend tax, allowing capital gains and income to accumulate over time without incurring any immediate tax liability. Any gains will be subject to income tax at your marginal rate, but only when you trigger a “chargeable event” (see below). Therefore, although there is no incoming relief (when you pay the money in), there is also no tax obligation as your money grows. Paying less tax on investment growth within the bond (giving you more savings for the future) is often referred to as “gross roll-up”. Ultimately, you are able to take control of the timing of any tax liability.

5% annual withdrawals

One significant benefit of an offshore bond is that you can withdraw 5% of the initial capital annually without incurring any tax liability. This is a cumulative allowance, which means that if you do not utilise your yearly 5%, it will accumulate, allowing you to withdraw more than 5% at a later time. The result is that you can preserve a portion of your funds in a tax-deferred state, providing you with the option to access them immediately if necessary, while simultaneously allowing your money to grow in a tax-efficient setting.

What are the advantages of using an offshore bond?

  • In certain cases, tax reporting actually becomes more straightforward. Because offshore bonds are not “income-producing assets”, there is no need for them to be detailed in self-assessment tax returns, unless you trigger a chargeable event.
  • Then there is the “gross roll-up” mentioned above. No tax reporting is required when investments within the bond are switched, and no capital gains tax is payable.
  • Regarding income tax, the income generated from bond investments is received "gross".
  • If an offshore bond is held by a chargeable person who is only a UK resident for part of the period between the policy’s inception and the chargeable event, then “time apportionment relief” can reduce the income tax liability proportionally.
  • Offshore bonds are useful as gifts – although there may be inheritance tax considerations, the gifting of a bond does not give rise to an income tax charge.
  • 5% of the original premium can be withdrawn for 20 years cumulatively without being subject to tax.
  • Bonds can be placed in trust (and withdrawn) without giving rise to an income tax charge or Capital Gains Tax (CGT).

Chargeable events

A number of events can trigger a chargeable event.

Most importantly, the full and final encashment of the investment bond constitutes a chargeable event. But there are a number of others, such as making a withdrawal in excess of the 5% per annum cumulative allowance.

When any of the above happens, a chargeable gain calculation establishes whether any tax must be paid.

Who are they appropriate for?

Offshore bonds should form part of a broader financial strategy and are not something you should normally consider unless you have a cash lump sum of at least £200,000 and an investment time horizon of 10 years or more. If you are a high earner, you have already utilised your other allowances (pension, ISA…) and you intend to withdraw a regular amount within the cumulative 5% allowance, then they are absolutely worth discussing when you next check in with us to discuss your retirement strategies.

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