InvestmentsDec 4 2013

Offshore strategies

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One that is not often used, yet has major benefits for savers, is the offshore investment bond. The term is often used to describe single premium with profits life assurance policies.

Policyholders will pay a premium to an insurance company, and the amount payable on the death of the life (or lives) assured is linked to the return generated from the investment of that premium.

Investment bonds are available from both UK-based and offshore insurance companies. This article is focused on offshore bonds – those held with offshore insurance companies. However, the position with regards to bonds held with UK insurance companies is broadly similar, apart from the tax treatment of investment returns in the hands of the insurance company.

In basic terms, investors pay a premium to the insurance company, which invests it. When the bond is encashed, either on voluntary redemption, at the end of the term, or on the death of the life or all of the lives assured, the policy holder will get the initial premium back, plus (or minus) the investment return on the funds invested over the life of the investment bond, less fees and previous partial withdrawals. Policyholders can choose how their premiums are invested. Generally, as long as the asset invested in is available to all policyholders, or all of a class of policyholders, and it falls into one of the very broad categories of permissible investments, the investment bond should not become subject to the punitive personal portfolio bond tax rules.

It is possible for policyholders to change investments within their investment bonds during the life of the bond, subject to the specific terms of the insurance company they have invested with, and there being sufficient liquidity within the property they are invested in.

Taxation

The benefits to investors of using offshore bonds are, in general, tax-related. First, as the insurance company is offshore, it will generally not be subject to tax on the investment returns arising to it from the invested premium. All of the returns generated can, therefore, be reinvested, compared with 80 per cent of those arising through an onshore bond, or between 60 per cent and 75 per cent where the investment assets are held directly by a UK resident individual. Often referred to as gross roll up, this will have a significant positive impact on the overall return within the bond over a short period.

Gross roll up is also available when investing through a pension, which has the additional advantage that contributions are made from pre-tax rather than post-tax income. Investors choose an offshore bond over a pension plan simply due to the availability of funds pre-retirement.

Investors in offshore bonds can withdraw up to 5 per cent of their initial premium every year without tax implications, until they have withdrawn their initial premium. So an investor could invest in a product that generates a 5 per cent annual income through an offshore bond. The insurance company would not be taxable on the income, and the investor could withdraw the 5 per cent each year and not be taxed on it.

After 20 years, the investor’s capital would be fully intact within the offshore bond. This compares favourably to holding the same investment personally, as the investor would have saved up to 40 per cent tax a year on that income over the 20 years.

In this case, when the investor withdraws further funds from the bond, the withdrawal will be taxable income in the hands of the investor, as the initial premium has been fully withdrawn. Top slicing relief should be available to, in effect, spread that taxable income over the life of the bond to utilise any unused basic rate band over the period.

Generally investors in these products would be higher rate tax payers for most of the term of the bond, and if that is the case, the majority of any additional funds withdrawn from the bond will be subject to higher rate or additional rate income tax at the prevailing rates (currently 40 per cent or 45 per cent).

However, there are various planning opportunities that can be considered after 20 years of 5 per cent withdrawals. First, it is often the case that investors’ taxable income will have reduced after a 20-year period – especially if the investor has retired during that time. Income arising during the life of the bond, which would have been taxed at 40 per cent or 45 per cent if the relevant asset was held personally when the income arose, can then be withdrawn from the bond at a time when the investor pays only basic rate tax (currently 20 per cent).

The most popular jurisdiction for the issue of offshore bonds is the Isle of Man. All issuers in such a case will be Isle of Man authorised insurers and are, therefore, regulated by the Isle of Man Government Insurance and Pensions Authority, which regularly audits the management and financial stability of all its authorised insurers.

Charges

Charging structures are often complex, usually including a set-up fee, ongoing annual management fee and a dealing charge. These can be structured as a percentage of the investment amount or a fixed amount. Some providers also include an exit charge. If the bond is investing in a fund or other investment product, the fund is likely to have its own charges built in.

The advantage of operating in a post-retail distribution review environment is that these costs are far more visible than before and the most sensible way to deal with them is for an adviser to review at least two options and work out the most cost-effective for each client based on the amount to be invested and the proposed investment strategy of the offshore bond.

Steve Hanlon is head of tax advisory of Mariana Capital Markets

PPB rules

A key tax risk to avoid when using any investment bond is the procurement policy board rules. These rules apply where the investment bond allows selection by the policyholder and is invested in assets that are either not on the approved list or are not available to an acceptable range of policy holders. If the bond does become a PPB, the tax implications are very unattractive for UK resident investors. The ability to withdraw 5 per cent of the premium paid a year without tax implications is withdrawn. Instead, 15 per cent of the premium paid is treated as taxable income in the first year, whether any actual cash withdrawals are made or not. That 15 per cent rises by 15 per cent a year when calculating the amount of deemed taxable income. Provided the PPB rules are avoided, the investor is able to invest his bond into appropriate assets that generate attractive returns, and the fees within the bond and its underlying assets are carefully managed, an offshore bond can be a very attractive investment vehicle for UK-resident clients.