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Offshore Investment Bonds

Offshore Investment Bonds get mixed reviews. When implemented correctly, they can be an excellent investment opportunity, but they can be abused and end up costing expats a lot of money

Last updated 7 January 2022 at 16:13

Offshore investment bonds can be a tax efficient investment wrapper often provided by global life insurance firms with the aim to enable investors to grow capital often without attracting any tax.

Offshore bonds are regularly used by wealth managers and financial advisers. For a variety of reasons, many expats and UK non-residents have invested in offshore bonds, details of which are highlighted and explained in this article.

Regarded as complex financial products and many people would not invest in offshore bonds directly without taking appropriate advice first.

The type and range of underlying investments available through offshore bonds will depend on the provider and the jurisdiction to which the bond is located. The jurisdiction of the offshore bond will also define the exact tax rules that may apply to the bond itself and the client.

While offshore bonds can be an excellent option for financial planning if used correctly, there has been a global trend over the past 10-15 years where some offshore financial advisers have taken advantage of the flexibility of these products for their own benefit. Unfortunately, these practices are still relatively frequent and offshore bonds are often used to hide fees and commissions from the investor.

Such practices can significantly reduce the investment, while also making the long-term costs for the investor significantly higher than they believed when they originally made the investment.

This article looks at how offshore investment bonds are used, the benefits on offer, how to spot hidden fees and how to avoid making a bad financial decision.

This article must not be used in isolation to make a decision about your finances and you must always seek professional advice from an independent financial adviser or wealth manager.

How offshore investment bonds work

An offshore investment bond is a tax wrapper that can hold different kinds of financial products including stocks, shares, mutual funds and structured notes. However, the location and type of each specific bond is based will determine the options that are available with the bond.

The bond itself is hosted in offshore, tax friendly jurisdictions such as Guernsey, Isle of Man, Jersey, Gibraltar, Cayman Islands and Malta.

In terms of how it works, it is a standard life insurance product and different financial products can be bought and sold through. Because the bond is an insurance product, it provides both a tax and legal shield to the investments held within.

Often offshore advisers will use offshore bonds within a pension wrapper, such as a QROPS or SIPP.

Underlying investment options

As an offshore investment bond is a tax wrapper holding a variety of financial products, it is important to understand how different offshore bonds can have different underlying investment options.

Highly personalised offshore bonds

Highly personalised offshore bonds enable the holder to invest in most financial products. These offshore bonds are often used within pensions and investments by advisers looking to hide commissions and client fees to make them look more lucrative.

The client will often be tied into the bond for a long period of time and the fees can increase due to the commissions paid to the adviser that are based on the initial investment.

For high net worth investors with significant capital to invest these bonds can be beneficial, provided the advice is offered on a fee-only basis (i.e. no commission is taken by the adviser), and can be a cost-effective way for money to be held inside or outside other structures.

Collective Offshore Bonds

Collective offshore bonds, unlike highly personalised offshore bonds, have restricted investment options, all of which must be approved by the insurance provider. Often collective offshore bonds will be used by advisers for clients with smaller investment capital and used for inheritance tax planning.

Provided the bonds are only provided on a fee-only basis (i.e. no commission paid to the adviser) they can be a good option for investors. For UK residents, collective offshore bonds are not tax free, instead the tax is deferred and may be payable in the future.

INVESTOR WARNING: As an investor you should always be very cautious about an offshore bond that enables you to invest in anything (within reason). These types of offshore bonds will be referred to as “highly personalised offshore bonds” and can have massive tax implications, especially in the UK and many other western countries if the offshore bond is held without a wrapper, such as a pension.

It is also vital that you are aware of the underlying investments and understand why your adviser or wealth manager has recommended them for you. An adviser should always provide a full report detailing all aspects of each investment, including the underlying investments. You should never allow this to be discussed at a later date as you will not have the full story regarding fees and tie-in periods.

If any of the report your adviser produces for you is missing, you should avoid agreeing to anything to ensure you are not exposed to potentially toxic products or hidden fees or charges further down the line.

Tax efficiency of offshore investment bonds

As previously mentioned, offshore investment bonds are naturally tax efficient for non-residents due to the jurisdiction and nature of the investment. As life insurance products, the investments held within are naturally shielded from tax in the traditional means with gains not attracting capital gains tax and any income drawn from the investment taxed only as income tax in the country of residence of the investor.

There are other tax benefits, such as being able to draw 5% of the investment amount per year for up to 20 years (known as a tax deferred income), without attracting any tax. Investors can also opt to not withdraw every year and take a larger sum before being subject to tax.

Due to the nature of the income being charged as income tax, expats or UK non-residents living in tax friendly jurisdictions (such as the UAE) are able to draw an income free of income tax altogether. Therefore, if the investor knows they will be moving to a tax friendly jurisdiction, they may be encouraged to defer any withdrawal until they are a tax resident in that jurisdiction to minimise their tax liability.

For investors relocating back to the UK, providing the offshore bond is correctly set up, any withdrawal would be subject to standard UK tax laws, including the personal allowance and withdrawals subject to UK income tax thresholds and rates of 20%, 40% and 50%.

Offshore investment bond fee structures

There are essentially two types of fee structures for offshore investment bonds available for expats and UK non-residents. The modern UK style, FCA-led approach and the traditional offshore approach which is far less favourable.

As most investors will be aware, in the UK the FCA has set up rules to ensure that financial advisers and wealth managers adopt a fee-based approach to financial advice and wealth management. This will normally manifest as a percentage of the fees under management (for example 0.5% of the total invested amount).

The FCA also require all fees to be clearly explained before any agreement is signed and the investor is fully aware of all fees and charges and how they apply throughout the life of the investment.

Unfortunately, the FCA’s remit is limited to the UK and while there are similar rules applied across the EU, not all jurisdictions are as tight, so the role of the FCA is limited with regards to providing protection and rules for people not living in the UK.

This means that the traditional method of offering offshore investment bonds using a commission-based is still used by a number of offshore advisory firms that use the commissions to hide fees and make investments less lucrative and more expensive than they should be.

Establishment fees

An offshore investment bond will have an establishment fee. This fee is calculated as a percentage of the investment and paid on an annual basis. This fee is applicable in both the modern approach and the traditional approach and is payable to the provider of the offshore bond. While the percentage can vary, it is normally around 0.2% of the investment amount.

Be mindful that with many offshore advisers the establishment fee is based on the initial investment amount or the current value which ever is the greater.  For those who plan to draw from the bond within a short period of time could actually be increasing the costs without knowing it.

Admin fees

An offshore bond will also normally be subject to an admin fee which is payable to the provider, irrespective of which model is in play. This admin fee will vary according to the provider but will typically be a fixed amount per annum.

Adviser fees

Additionally, if the investor is choosing the offshore bond through an adviser or wealth manager, they will normally apply their own fee for managing the product. Like the establishment fee, this will normally be a fixed percentage of the amount under management and will include the management of the underlying investments.

Under the UK model, this is the only way that adviser can be compensated and breaches of this would be in breach of FCA rules.

While the management fee may be between 0.5% and 1.5% of the funds under management, importantly, these fees are declared up front and are paid to the adviser to provide a service.

Commission payments

Commission payments are not permitted under FCA rules in the UK, however offshore advisers can still receive payments from providers as a commission payment. While some advisers may disclose this voluntarily, it is normal for the commission payment to be hidden within the establishment fees of offshore bonds. 

It is important to state not all offshore advisors work on a commission basis and we work with those that are fee based following a UK model for transparency

Below are examples of how the commission route can be taken advantage of.

The commission will normally be based on the initial investment amount and spread over a number of years.

For example, an adviser may request from the offshore investment bond provider that they would like to receive a commission from the provider and the bond provider would then increase the establishment fee to 1% instead of 0.2% of the initial investment over a period of 10 years.

In real terms this would mean that the actual cost of the investment would be an additional 8% of the original investment, irrespective of how much was actually under management.

From this the adviser would receive a payment of a percentage of this, say 7%, by the provider at the start of the investment, while the fee charged to the investor would be spread over the ten years.

Ultimately, as the provider has paid the adviser upfront, the adviser has made their money and therefore has no long-term commitment to the investor or the provider. While the provider needs to recover the payment given to the adviser over that ten-year period.

Under these circumstances, the investor would also be subject to a penalty charge if they were to close the investment and withdraw their money.

The problem for the investor is exacerbated if the fund underperforms or the investor wishes to withdraw money from the investment as the fees would still be based on the original amount, not the actual value of the investment.

How to spot hidden fees common with offshore bonds

“Free investment advice”

It is very rare for anybody to work for free. If a financial adviser or wealth manager is offering their initial (most important) or ongoing financial management services at zero cost, it is essential you ask the question of how they get paid as it is likely they are hiding additional costs from you.

While it is common from advisers and firms to offer initial consultations for free on the basis that this is the start of a relationship, the actual advice and guidance will always be paid for.

If you are unclear about how an adviser is getting paid, you must always ask and seek clarification before signing any agreements or handing over any capital.  We would always recommend obtaining a second, independent opinion when considering paying via commission.

Underlying investments not disclosed

Before making an investment decision it is vital that the investor is fully away of all aspects of the investment being made, including the underlying investments of any wrappers, such as QROPS, SIPPS or offshore bonds.

While this may sound obvious, some advisers will purposefully exclude the underlying investments from reports on the basis that they will be disclosed further down the line. However, as the investor whatever you agree to you are responsible for, especially without the protection of the FCA.

Advisers that do not disclose the underlying investments are likely to be agreeing you to riskier investments that cost more and pay larger commissions – which is ultimately only in their interests and not yours.

Other problems with offshore bonds

Limitations of the adviser

Not all financial advisers or wealth managers are able to offer a full range of investment products to investors and some are limited purely to life insurance products due to the regulations they may hold. As a result, some advisers would only be able to “sell” offshore bonds to expats or non-resident investors.

As an investor, you should always check that the adviser you are dealing with is able to offer a wider ranger of investment products to ensure you are getting independent and whole of market advice.

People returning to the UK

While correctly implemented offshore investment bonds can provide significant tax benefits for people never intending to return to the UK, some such bonds may also attract tax penalties of up to 45% of the investment amount if the investor were to relocate back to the UK.

When discussing your situation with any financial adviser or wealth manager, always ensure that your future plans are also discussed as this may help you avoid significant tax bills and other costs in the future.

Complex products for sophisticated investors

Some investments can be limited to sophisticated investors only, meaning they should only be available to people who have significant capital or are able to self-certify as knowing what they are doing.

Due to these limitations, it is possible for regular investors to invest through offshore bonds/life companies who are classified as sophisticated investors and therefore hold the investments not the investor themselves. However, you should always ensure that as an investor you are fully aware of the risks of the investments recommend to you, and always be fully aware of all the costs and fees associated with the investment before making a decision.

Is an offshore investment bond the right option for you?

Offshore investment bonds are not for everybody and advice should always be sought before making any decision. For the people who meet certain criteria, offshore bonds can provide significant benefits and be a cost effective, tax efficient way of increasing capital.

However, if an offshore bond is incorrectly sold or is not suitable for the investor, they can be incredibly expensive and result in the investment amount reducing over time through fees, charges and tax penalties.

Is it too late to change my mind?

If you have already invested in an offshore bond but are unsure about either the fee structure or the underlying investments, it might not be too late to make changes.  Many organisations provide a cooling if period where changes can be made or cancellations all together.

However, while there might be some charges, it may be possible to change the underlying investments held within the offshore bond, which could help reduce the fees and charges you are subjected to.

Request a free consultation with an independent adviser

Whether you have already invested in offshore bonds, you have been approached by someone recommending them, or you would simply like clarification on whether offshore bonds are for you, we can help.

Enter your details using the form and we will hand pick our most suitable independent financial adviser from our network to set up an initial free consultation with you.

During this consultation the adviser will ask a serious of questions to understand more about you and your situation and be able to answer any questions you have.

Following the consultation, if you decide that you would like to proceed with any advice or like additional services, everything (including fees, costs and charges) will be explained in full and you will be able to decide whether to proceed or not.

At no time will you be pressured into making a decision or obligated to proceed with any services.

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