Offshore Bonds - Are The Costs Worth it?

08/17/2022

Offshore bonds have been marketed overseas for years. Thousands of expats have been attracted by promises of tax-free investing in offshore locations such as the Isle of Man, Jersey, Guernsey, Bermuda, Cayman Islands etc. often with very mixed results.

With prudent expat financial advice, offshore bonds can offer significant advantages, but with cheaper and more flexible expat investment platforms now available, if an adviser recommends an offshore bond you should be asking, why?

Old Mutual International (Quilter), Friends Provident International, RL 360 and Utmost (Generali), Custodian Life and Investors Trust are familiar names among offshore bond providers, which can provide many tax benefits in the right circumstances. However, some providers still structure charges that facilitate the payment of large upfront commissions to advisers which in turn, reduces 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, with the exception of the quarterly administration charges equating to around $500 pa. Instead, your adviser can agree a flexible structure giving you penalty-free access to capital, leaving only custody and adviser fees to pay which can be revoked if you are dissatisfied with the service you receive.

Taking Benefits

British expats in particular can benefit from bonds when repatriating. Before returning, you'll be 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.

However, in addition to the benefit of gross roll-up on a bond, with strategic planning it may also be possible to assign segments of your bond to others. This allows you to make use of both yours and others individual tax allowances to reduce your liabilities.

Offshore Bond or Investment Platform?

The UK FCA 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 advisers than clients.

The FCA's warning is aimed at offshore bonds being used for pension transfers which, as pensions are already structured within tax wrappers, are rendered unnecessary and with additional costs that could 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, online functionality and ease of administration, platforms can offer a better solution at a lower cost. The likelihood of a regulated expat investment platform allowing purchases of expensive offshore funds is also much lower.

Offshore Bond Commissions

How advisers can be paid to sell bonds is a contentious issue, making it crucial to establish with your adviser how you'll be paying to ensure you get the best results. 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 high 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 adviser payments at the start of the contract can have a detrimental effect on investments longer term. Advisers may take less interest in future results, leaving investors unsure if the product was recommended in their best interests at all. In 2012, this method of adviser remuneration was banned in the UK and later in EUROPE, and while some jurisdictions are implementing commission limits, much of the world is still far behind.

Locally Compliant Bonds

While bonds have often been sold for commission, there are of course exceptions and jurisdictions where bonds are more of a necessity. Countries such as France, Italy, 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 adviser so you can be assured the bond is being used for the right reasons and in your best interests, not theirs.

Request a Free Consultation

To learn more about using offshore bonds effectively, understanding if you actually need one and the other options available to you, contact us today - info@expatwealthatwork.com - and you'll get the expert advice you need.