It seems as if hardly a week goes by without HMRC announcing a crackdown on one exotic tax planning scheme or another. However, don’t overlook the well-established benefits offered by offshore investment bonds. These combine gross roll-up of investment returns, with planning opportunities provided by the chargeable event gains regime.
Deferring income tax on investment returns
A key advantage of offshore investment bonds is that investors can use the chargeable event gains regime to control when they pay income tax on their investment returns. They only incur an income tax liability if they incur a chargeable event. These include surrender of the whole bond, or bond segments, withdrawals exceeding their cumulative 5% a year allowance or if there’s a death claim.
Maximising spendable income
An investor can withdraw 5% a year from a bond for twenty years, without incurring any immediate liability to income tax. What does this mean? This provides the equivalent spendable income for a 50% taxpayer as earning 10% gross interest. The investor also doesn’t have to use all of the 5% allowance each year as restricting the level of regular withdrawals also provides greater potential for investment growth and reduces the risk of eroding capital.
If the investor doesn’t need regular income, the withdrawal allowance still offers benefits. For example if the investor’s made no withdrawals from the first day of the seventh policy year they could withdraw 35% of their original investment amount without incurring an immediate tax liability on any investment growth.
Switching and gifting without making CGT disposals
Investing in an open architecture offshore bond also offers CGT benefits. Investors can switch between different collective investments or move into cash without making CGT disposals. This offers the opportunity to review and rebalance the investor’s portfolio, leaving the CGT annual exemption available for use against other investments.
An easily overlooked benefit of bonds is the chance to make gifts without making GCT disposals. Investor’s often don’t realise until after the event that gifting an OEIC holding to a child is a CGT disposal. Unless any gain is covered by their annual exemption, the gifting investor is liable to pay the tax, without having realised the cash to cover the liability.
It is also possible for an offshore bond investor to assign a bond to an adult child. Provided the assignment is an outright gift from one individual to another, there is no chargeable event. The assignment is normally a potentially exempt transfer for IHT purposes, however, payments from a parent to maintain their child aged over 18 who is still in full-time education are exempt dispositions for IHT.
Offshore investment bonds also offer planning opportunities for trustee of discretionary trusts, who are not disturbing income. An open architecture offshore bond provides the trustees with access to a wide range of deposits and collectives, enabling them to diversify the trust fund. It is also possible for the trustees to avoid a liability to income tax at 50% on any chargeable event gains.
The trustees can assign an investment bond or segments to adult beneficiaries – the assignment is not a chargeable event.
The trustees can use the 5% tax deferred withdrawal allowances to make appointments of trust capital to trust beneficiaries.
Offshore bonds also offer benefits to non-UK domiciles because bond gains aren’t ‘relevant foreign income’ for the remittance basis of taxation. A non-domicile can hold collective investments and deposits within an offshore bond wrapper and benefit from gross roll up until they incur a chargeable event gain. Provided that any other unremitted income and/or capital gains total less than £20,000 in a tax year, they don’t pay the remittance basis charge.
There are complex rules on remittances from mixed funds so to avoid these, non-domiciles either need to invest only funds on which all UK taxes have been paid, or avoid taking any withdrawals while UK resident.
Chartered Financial Adviser
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Census Financial Planning is an independent financial planning practice providing a professional and comprehensive financial planning service, located on the Lisburn Road in Belfast, Northern Ireland.