Offshore Bonds - Do I Need One?
Offshore bonds have been marketed overseas for years. Thousands of expats have been lured by promises of tax-free investing in offshore locations such as the Isle of Man, Jersey and Guernsey, often with very mixed results. With cheaper and more flexible expat investment platforms now available, if an advisor recommends you an offshore bond, the question should should ask is why?
Old Mutual International (Quilter), Friends Provident International, RL 360 and Utmost (Generali) are popular names among offshore bond providers which, when used correctly, can be effective tax wrappers. However, the charging structures can facilitate the payment of large upfront commissions to advisors which in turn, reduce motivation to manage portfolios prudently, lock you into the investment and erode returns as a result.
Crucially, the fixed charges of offshore bonds can be removed completely. Instead, your advisor can agree a flexible structure giving you penalty-free access to capital only custody and advisor fees to pay, which can be revoked if you are not satisfied with the service you receive.
British expats in particular can benefit from bonds when repatriating. Before returning, you are required to 'endorse' your bond with the provider and thereafter, you'll be entitled to an annual 5% tax-deferred income in addition to a lump sum equal to 5% for every year the bond has been open.
The 5% income is taken from the 'initial invested capital' until it is exhausted over 20 years - ie. 5% x 20 years = 100%. Thereafter you'll be deemed to withdrawing gains and taxed at your marginal rate. Withdrawals greater than 5% of the initial investment will also be taxed.
Offshore Bond or Platform?
The FCA recently issued a warning to expat investors regarding the high costs of offshore bonds, and feedback from the enquiries we receive suggests that historically, thousands of offshore bonds have been sold more for the benefit of advisors than clients.
The FCA's warning is aimed at those being recommended offshore bonds for pension transfers which, as pensions are already structured within a tax wrapper, are rendered useless and an additional expense that could and should be avoided.
If you plan to repatriate to the UK and can tolerate limits on access, a bond may be worthwhile as a tax-deferred income is possible with careful planning. If not, with lower custody and trading costs, zero quarterly admin fees, improved functionality and ease of administration, platforms can offer a far better solution at a much lower cost. Furthermore, the likelihood of a UK regulated expat investment platform allowing purchases of expensive offshore funds is much lower.
Offshore Bond Commissions
How advisors are paid to sell bonds is a contentious issue. The following three charging options are typical of offshore bonds, ranging from 5 to 10 years and in addition to administration charges of over £100 per quarter:
5 years - 1.9% per annum (total 9.5%) plus quarterly administration charges
8 years - 1.25% per annum (total 10%) plus quarterly administration charges
10 years - 1% per annum (total 10%) plus quarterly administration charges
The total charges range between 9.5% and 10%. However, the actual cost of bonds can be as low as 0.25% per annum equating to between just 1.25% and 2.5% over the same term. The remaining 7% to 8% is paid upfront to the advisory firm, so for each $100,000 invested, you could be paying up to $8,000 to your advisor on day one.
These commissions are made possible as investors are obliged to pay the charges of the complete term, regardless of how long they remain invested. Not completing the term means unpaid charges become payable as an exit fee, so closure after 5 years of the 10 year option results in a 5% penalty (5 years x 1%).
Large advisor payments at the start of the contract can have a detrimental effect on investments longer term. Advisors often take little interest in future results, leaving investors unsure if the product was recommended in their best interests. In 2012, this method of advisor remuneration was banned in the UK, and while some jurisdictions are implementing commission limits, much of the world is still far behind.
Locally Compliant Bonds
While bonds are often sold for commission, there are exceptions where offshore bonds are more of a necessity. Countries such as France, Spain and Portugal offer tax breaks for locally compliant products which can provide a tax-deferred income and protect your beneficiaries from taxation on death. It is still vital to clarify how you pay for the bond however, as you could be paying hidden commissions, so always check with your advisor.
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To understand more about offshore bonds, how to use them effectively and if you actually need one, contact us today and you'll get the expert advice you need.