Offshore Bonds - Are The Costs Worth it?
Offshore bonds have been sold for years to thousands of expats, attracted by promises of tax-free investing in offshore locations such as the Isle of Man, Jersey and Guernsey, often with mixed results. With prudent expat financial advice, offshore bonds offer many advantages but with cheaper, more flexible expat investment platforms now available, if an advisor recommends an offshore bond you should be asking, why?
Utmost, Quilter, Friends Provident International, RL 360 and Generali are familiar names among offshore bonds, which can provide tax benefits in the right circumstances. However, providers can still structure charges that facilitate the payment of large upfront commissions to advisors which in turn, reduces motivation to manage portfolios prudently, lock you into the investment and erode returns.
Remember, the fixed charges of offshore bonds can be removed completely, except the administration charges equating to around £500 pa. Instead, advisors can agree flexible structures giving you penalty-free access, with only custody and advisor fees to pay which can be revoked if you're dissatisfied.
Taking Benefits and Income
Bonds can be of particular benefit to repatriating British expats, as 'endorsing' the bond beforehand will entitle policy holders to lump sum equal to 5% for every year the bond has been open. Thereafter, a tax-deferred income equal to 5% of the initial invested capital can be taken.
The 5% income is taken from the initial invested funds until it is exhausted over 20 years - ie. 5% x 20 years = 100%. Thereafter you'll be deemed to be taking gains and taxed at your marginal rate. Withdrawals greater than 5% of the initial investment will also be taxed.
In addition to the benefits of gross roll-up in a bond, strategic planning also may also permit assigning bond 'segments' to others. This helps you make use of both yours and others' individual tax allowances to reduce your own liabilities. See more on bond segmentation here.
Offshore Bond or Investment Platform?
The FCA recently issued warnings to expat investors regarding the high costs of offshore bonds. The enquiries we receive suggests these warnings are justified as historically, thousands of bonds have been sold more for the benefit of advisors than clients. The FCA's warning relates to bonds being used for pension transfers which, as pensions are already structured as tax wrappers, are rendered unnecessary and with additional costs that can be avoided.
If you plan to repatriate to the UK and can tolerate limits on access, bond can be worthwhile as a tax-deferred income is possible with careful planning. However, with lower custody and trading costs, zero quarterly admin fees, online functionality and ease of administration, platforms can offer a better solution at a much lower cost. Further protection is also provided as UK regulated investment platforms ond't allow purchases of expensive offshore funds.
Offshore Bond Commissions
How advisors are paid to sell bonds is a contentious issue, making it crucial to establish with your advisor how you'll be paying to ensure you get the best results. if the commission structures aren't removed, 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:
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5 years - 1.9% per annum (total 9.5%) plus quarterly administration charges
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8 years - 1.25% per annum (total 10%) plus quarterly administration charges
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10 years - 1% per annum (total 10%) plus quarterly administration charges
The total charges range between 9.5% and 10%. 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 tied into paying up to $8,000 to your advisor on day one.
These high commissions are made possible as investors pay the charges of the 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 commissions at the start of the contract have a detrimental effect on investments as advisors may take less 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
Of course, there advisors that use bonds on a 'fee-basis' without taking commission, and it's in countries such as France, Italy, Spain and Portugal, where bonds can be more of a necessity and locally compliant products are available that you'll need to aware. These bonds offer a tax-deferred income and can protect your beneficiaries from taxation on death, but always check how you pay for the bond however, to be sure you are not paying hidden fees.