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Offshore bonds are a tax-efficient way to invest money over the medium to long term (usually five years or more).
Investments can be made as either lump sum or regular payments. You can invest in a wide range of assets such as stocks and shares, mutual funds, fixed interest securities, property, and alternative investments.
Withdrawals of up to 5% of the total payments made into the bond are allowed every year on a tax-deferred basis. This is cumulative so if, for example, you don't take a 5% withdrawal in year one, you can take 10% in year two.
Offshore bonds are not subject to capital gains tax (CGT) so any investment profits can ‘roll up’ over time without an immediate tax charge. Taxation on growth is deferred until withdrawal.
The bonds can be fully or partially surrendered at any time. You won’t normally pay any tax on profits unless you withdraw more than the 5% tax-deferred allowance from the bond.
Withdrawals over this amount are taxed as savings income and the amount of tax you’ll have to pay will be based on your tax status at the time.
To calculate if tax is payable, gains from the bond will be added on top of all other income, apart from dividends and onshore bond gains, and depending on the size of the gain, tax could be payable at any or all of the 0%, 20%, 40% and 45% rates.
It may be possible to strategically time withdrawal until, say, retirement if you are likely to be a lower rate taxpayer at that time. However, income tax may still be due when you withdraw funds from the bond.
When a withdrawal is made from an offshore bond, the gains can be ‘top-sliced’ over the number of years the bond has been held. This means that for tax purposes, only a portion of the gain is considered as income in any one tax year, potentially reducing an investor’s liability for higher rate tax.
Benefits of investing in an offshore bond
Offshore bonds can offer additional tax efficiency for those who regularly use up their pension, ISA, and CGT allowances.
They can be particularly beneficial if:
You are a high earner looking for a tax-efficient way to save for the future. During the investment term, profits are reinvested without having to pay any income tax. This is often referred to as gross roll-up of gains. Tax only becomes payable on withdrawal, which can be beneficial for those who have been higher rate taxpayers during their working life but become basic rate or non-taxpayers in retirement.
You’ve used up your pension allowance, as they provide an alternative tax efficient savings vehicle.
Offshore bonds can also be useful if you are thinking about protecting your estate against inheritance tax (IHT). By placing an offshore bond in trust (in full or in part by segmentation), the bond’s value is removed from your estate, potentially reducing your IHT liability.
Potential disadvantages of investing in an offshore bond include:
Offshore investment bonds tend to have higher fees, premiums, and overall costs than their onshore alternatives, given the additional regulatory burdens and complex administration.
They can hold higher risk investments than most onshore products and therefore are often only suitable for a particular segment of the market.
Fluctuations in exchange rates can impact the ultimate investment value.
Income tax may be payable on surrender, part surrender or death.
An insurance company issuing a bond outside the UK is unlikely to benefit from the UK policyholder protection, though some jurisdictions have their own schemes.
Using an offshore bond to create tax free retirement income
The following example demonstrates, in very general terms, how an offshore bond can help a higher rate taxpayer to generate a tax efficient income in retirement.
Olivia is 45 and earns £400,000 per annum. Her aim is to retire at 65, with a retirement income of £95,000 per annum.
We have discussed her goals and objectives and gained an understanding of the level of risk which she is comfortable with (moderately adventurous). We have also confirmed that this level of risk matches her financial objectives, and capacity for loss.
Due to her level of income, the maximum amount that Olivia can contribute into her pension each year without incurring a tax charge is £10,000. This is due to the tapered annual allowance - for every £2 of adjusted income over £260,000 she receives, her pension annual allowance is reduced by £1, down to the minimum, which is currently £10,000 per annum.
However, with the effective use of tax efficient wrappers such as ISAs and offshore bonds, Olivia can achieve her retirement goal.
She chooses to invest £90,000 per annum:
£10,000 into her pension
£20,000 into an ISA, which fully utilises her annual ISA allowance
£10,000 into a general investment account (GIA)
£40,000 into an offshore bond
Over 20 years, assuming a growth rate of 5% net of charges and fees, Olivia’s savings will have grown, as follows:
Investment | Annual Investment | Annual Growth [1] | Total Invested after 20 years | Total Value after 20 years |
|---|---|---|---|---|
Pension | £10,000 | 5% | £200,000 | £330,659 [2] |
ISA | £20,000 | 5% | £400,000 | £661,319 [2] |
GIA | £10,000 | 5% | £200,000 | £330,659 [2] |
Offshore Bond | £40,000 | 5% | £800,000 | £1,322,638 [2] |
TOTAL | £1,600,000 | £2,645,275 |
[1] This growth rate is purely for illustrative purposes. The actual growth rate could be higher or lower.
[2] smartmoneytools.co.uk/tools/compound-interest-calculator/
This will allow her to generate the following tax-free income:
£10,000 per annum from her pension (this is within the personal allowance – which is currently £12,570 - and so will be tax free)
£30,000 from her ISA pot (ISAs are free of income tax and CGT)
£15,000 from her GIA (although this could cause a taxable event, Olivia can use the annual CGT allowance to crystallise some of her gain – making the withdrawal of her invested capital and profits taken tax free)
£40,000 from her offshore bond (Olivia can access 5% per annum from the £800,000 she has invested in her bond tax free each year, for 20 years).
By the time she is 80, Olivia will have used up the original capital withdrawals from the bond.
At this point, she will be able to create additional tax-free income from the growth made in her investment portfolio, taking additional tax-free income from her ISA and by utilising ‘top-slicing’ within her offshore bond, which has benefited from gross roll up of investment return.
Please note: This example is for illustrative purposes only and should not be relied upon. The value of investment(s) and the income derived from it, can go down as well as up, is not guaranteed and you may not get back the full amount invested.
The need for advice
Offshore bonds can play an important part in an investment portfolio, providing a wide range of tax efficient investment options. However, they can be complex, and you should always seek advice to ensure that an offshore bond is suitable for your specific circumstances, objectives, and risk profile.
If you would like to discuss this, or any aspect of financial advice with one of our Wealth Planners, feel free to email us at hello@successionwealth.co.uk or call us on 0800 051 4659 and we will arrange for someone in your area to contact you.
Please note: The Financial Conduct Authority does not regulate advice on taxation.
This content is for general information only and does not constitute advice. The information is aimed at retail clients only.
The content of this article was accurate at the time of writing. Whilst information is considered to be true and correct at the date of publication, changes in circumstances, regulation, and legislation after the time of publication may impact on the accuracy of the article.
This information is based on our current understanding of taxation legislation and regulations. Any levels and bases of, and reliefs from, taxation are subject to change and tax implications will be based on your individual circumstances.
FP2024-153 - Last updated April 2024