Offshore Bonds and their use in Financial Planning

There are a number of tax wrappers available when building an investment portfolio, and this article explores what offshore bonds are, their tax treatment and how they can be effectively used in certain circumstances to invest tax-efficiently.

The advantages can be summarized as follows:

Managing Investment without Tax

An offshore bond is an investment wrapper offered by a life insurance company, held in a jurisdiction with a favourable tax regime, like the Isle of Man.  The funds grow in a virtually tax-free environment, in what is referred to as “gross roll-up”.  The gain on the bond is ultimately subject to income tax when a “chargeable event” occurs but in the meantime, you can buy and sell funds within the bond without paying tax.

Annual Tax Deferred Income

Investors can withdraw up to 5% of their original investment each year for 20 years, without incurring tax and unused allowances can be carried forward.  For example, someone investing £200,000 into an offshore bond could withdraw £10,000 per annum without any immediate tax liability.

Chargeable events include surrendering the bond, withdrawals in excess of the 5% tax-deferred allowance or the death of the life assured.  When such an event occurs, a calculation takes place to assess the tax liability and the gain is subject to income tax at one’s marginal rate.

Bonds are split into “segments”, and withdrawals can be taken by either encashing whole segments or across the whole policy, providing further flexibility depending on one’s circumstances.

Going Abroad

Offshore bonds can be effectively used when an individual retires abroad.  For example, someone who emigrates from the UK can potentially encash the offshore bond and avoid tax altogether!

IHT and Other Tax Planning

Parents may use offshore bonds to save for children, as they retain control of the investments until they feel it appropriate to gift them where importantly such gifts do NOT give rise to income tax.   Therefore, the option to gift part or all of a policy to a lower rate taxpayer can reduce tax on gains.  They can also be used effectively through the tax deferred withdrawals to fund school fees.

Investment Management

Many providers offer access to a wide range of investments within offshore bonds, including Discretionary Fund Managers, enabling diversified portfolios to be implemented to suit different risk profiles and objectives.  Bonds can sit alongside ISAs and Unit Trust portfolios as part of a broad investment strategy.  With a Unit Trust portfolio, gains above one’s annual exemption of £12,300 are subject to Capital Gains Tax, and whilst CGT rates have historically been lower than income tax, this may change in the next Budget, making offshore bonds an attractive alternative in certain cases.

In summary, offshore bonds provide tax-efficiency, access to the funds, broad investment opportunities and flexibility.  However, they can be complex and are not suitable for all investors, so it is essential to seek financial advice.

Elliot Gothold is a Chartered Financial Planner with NLP Financial Management Limited and can be contacted on 020 7472 5555 or at [email protected].