Tax wrappers can be expensive if the benefits are not justifiable for the individual concerned.
Investment bonds often are loaded with high establishment charges and high discontinuance penalties.
Unscrupulous “advisers” (read brokers) may recommend underlying investments that pay them a trail commission, and therefore have high total expense ratios.
This can significantly harm investment returns.
The main charges to be mindful of are establishment charges, administration charges, dealing charges, fund manager charges, and exit charges.
Be clear on each of these.
Offshore bonds provide the investor with the ability to defer and plan taxation.
As financial planners, we use these wrappers to assist clients with their (often) fairly complex tax planning needs.
Being able to hold assets offshore and pay no tax on the capital increases or income distributions until a point in time specified by the client, to fit around other controllable sources of income, is a very valuable tool.
Many expatriates prefer to invest in offshore funds via offshore bonds rather than onshore unit trusts, because when profits are taken from the offshore investment bond, they are taxed as income at whatever tax rate applies to the investor in the country they are residing in.
This can allow the investor to defer tax, to time the surrender of an offshore investment bond, and to control what tax they pay and when they pay it.
Offshore investment bonds offer potential tax advantages if you spend time residing outside the UK.
This is because you can claim tax relief on gains made while you reside offshore.
This is called ‘time apportionment relief’ (see above) and you can reduce the tax paid by the proportion of time you were resident outside the UK.
Conversely, time spent residing overseas reduces the number of years used when calculating “top slicing” relief.
Top slicing can be applied where a chargeable gain (profit made on the crystallisation / sale of an offshore bond) pushes a basic rate taxpayer into the higher rate bracket. If, after adding the (profit) slice to a your other taxable income, you remain within the basic rate tier, then the whole gain would be subject to income tax at 20% (2017/2018 tax year).
If you are already a higher rate taxpayer, then top slicing will have no effect, as the whole gain will be subject to higher rate tax.
Below we have set out an example of how top slicing works:
An individual has £30,000 of taxable income and has made a gain of £15,000 on their offshore bond, which they have held for three complete policy years.
The top sliced gain equals £15,000 divided by 3, resulting in a £5,000 slice.
Their total taxable income is £30,000, and the higher rate threshold for 2017/2018 is £33,500. Effectively, part of the slice is within the basic rate and part is within the higher rate. Top slicing allows tax to be applied proportionately at different rates on each slice.
As a result £3,500 is within the basic rate of tax and £1,500 within the higher rate.
£3,500 x 20% = £700
£1,500 x 40% = £600
The total tax on the slice is £1,300 (£700 + £600), which is effectively a tax rate of 26% ((£1,300/ £5,000) x 100).
The bond has been in force for three policy years, so £1,300 is multiplied by 3 to arrive at the final tax payable on the gain of £3,900.
Onshore bonds also benefit from top slicing where appropriate, however here the rules are slightly different and only available going back to the date of the last chargeable event, not back to the start of the bond.
In the event of a full surrender, top-slicing for a non-UK resident uses all the years the offshore investment bond has been held but any full policy years the holder was a non-UK resident are not included in the top slicing calculation.
However, we find many people hold offshore bonds not because of an underlying tax reason - but because, when used incorrectly, they provide an opportunity to a commission-based IFA to extract a large percentage of your savings (and transfer your wealth to them) through an opaque charging structure.