Last year’s Autumn Budget introduced changes to the inheritability of pensions, which are intended to take effect from 2027. This will see more estates fall into the ambit of Inheritance Tax (IHT) and will increase the potential IHT liability for those with pension funds. As a result, offshore investment bonds are coming increasingly into focus as a possible vehicle for tax-efficient wealth transfer to family members.
While both onshore and offshore bonds exist, a key difference is that discretionary portfolio managers are permitted to manage portfolios in the latter – so the focus here will be on offshore bonds. In recent years, the investment scope of offshore bonds has been widened to allow for direct stocks to be held, as well as investment funds.
With the limitations in place on annual ISA allowances and pension contributions, investment bonds have a valid place in the financial planning discussions of a growing number of clients. The ability to hold these policies within trust has broadened the conversation further. These trusts can take a variety of forms to suit differing needs, including gift trusts, discounted gift trusts and loan trusts.
What are the hallmarks of offshore bonds?
Designed to help promote investment growth, an offshore investment bond is a tax-efficient single premium investment policy.
The underlying investments within the offshore bond structure benefit from 'gross roll up'. Set up in low or tax neutral jurisdictions such as the Isle of Man or Dublin, this ensures there is very little, if any tax payable within the fund. Having the investments grow free of tax on income and gains, (subject to the tax rules of the jurisdiction) substantially bolsters the potential for investment growth.
Tax is deferred: no tax on growth is due unless a ‘chargeable event’ such as a withdrawal is made. When tax is payable, it is a charge to income tax, rather than capital gains tax.
A key benefit of the offshore bond structure is that they can be split into a number of ‘segments’ at the outset of investment, giving the holder flexibility to keep some segments, assign away others, or encash a portion of the bond without crystallizing the entire gain. This in turn allows for more precise and careful planning to mitigate a potential tax liability. The greater the number of segments within the bond, the more exacting and meticulous the planning may be. Therefore opting to split the bond into the maximum permitted number of segments is usually advised. The tax-deferred compounding capability of the investment, and flexibility to manage when and how taxes are paid, are key advantages to this form of investment structure, particularly for those who have already exhausted their other investment allowances and exemptions.
Assigning, withdrawing and topping up
The ability to assign bond segments without triggering a tax change could for example be useful for those who wish to pass along some of their wealth to adult children. By assigning some or all of the bond to the children, it becomes theirs to do with as they wish. Only when the children encash their investment is there a reckoning to tax, and this is measured against their own marginal rate of tax. This scenario is therefore particularly attractive when the assignment is made by a higher/ additional rate taxpayer to those who have a lower marginal rate of tax.
The policyholder is permitted to withdraw up to 5% of the initial amount invested each year, without any immediate charge to tax, until 100% of the original amount invested has been drawn back. After this time, any further withdrawals are treated as chargeable gains and are subject to income tax. The income tax deferral can be helpful for those who may be a higher/ additional rate taxpayer now, but are likely to find themselves in a lower tax band later in life once they retire.
If the 5% per annum withdrawal allowance is unused in a year, it accumulates. The availability of this allowance, and the flexibility it affords, enabling the bond holder to stop, start or vary the withdrawals within the permitted withdrawal allowance, can be attractive.
The tax liability can sometimes be limited, through the possible availability of various reliefs. ‘Time apportionment relief’ can reduce the potential tax burden in some situations where an investment bond holder has been non-resident during some of the investment period. A relief known as ‘top slicing’ can help reduce the tax on a chargeable gain. However, this is not available to all, and therefore professional guidance or advice is highly advisable.
A relief known as ‘top slicing’ can help reduce the tax on a chargeable gain. However, this is not available to all, and therefore professional guidance or advice is highly advisable.
So who are offshore bonds likely to be suitable for? They could potentially be relevant for long-term investors, high-net-worth individuals, individuals saving for their children or investors with lump sum capital. Other groups include those with inheritance tax concerns, high-income professionals, trustees, and Court of Protection deputyship cases.
Whilst investment bonds can offer considerable benefits, there are, of course, disadvantages too. Offshore bonds often have higher fees compared to other investment products – and fees are chargeable both at the point of set up, and on an annual basis. Although growth is tax-deferred, tax liabilities arise upon withdrawal or encashment, and gains may be taxed at the bondholder’s marginal income tax rate. Having funds tied up inside an investment structure such as this does add an additional barrier to how accessible the funds are because of the need to go via a third party to access them.
Offshore bonds are also complex products due to their unique taxation and taking financial advice is essential for anyone considering an investment in such a structure. Ongoing servicing and advice is often also required, which can add to costs.
If this is an area which you think may be of relevance to you, please speak to your investment manager to be put in touch with JM Finn’s team of Wealth Planners.
The information provided in this article is of a general nature and is not a substitute for specific advice with regard to your own circumstances. You are recommended to obtain specific advice from a qualified professional before you take any action or refrain from action.
