Offshore Investment Bonds: Tax Efficiency and Considerations for Investors — Disclosing the Fees and Commissions on the Accounts

18 min readJun 4, 2023

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https://investmentsforexpats.com/offshore-investment-bonds-tax-efficiency-and-considerations-for-investors-disclosing-the-fees-and-commissions/

Introduction:

I have been encouraged to write this article on the basis that Offshore bonds have long been favoured by salespeople as a means to earn undisclosed commissions, often at the expense of investors. Popular platforms such as RL360, Investor Trust, FPI, and Utmost, all have commissions that can be added on giving advisors up to 7% upfront commission.

However, these investment vehicles often fall short of meeting investors’ needs and aspirations, while alternative low-cost platforms have emerged as attractive alternatives. With the widespread availability of financial information on the internet, it is crucial to shed light on the hidden costs associated with offshore bonds. This article aims to inform both current investors about alternative options and prospective investors about the limitations of these products.

Unveiling Hidden Costs:

Commission-Driven Sales: Offshore bonds have traditionally been used to generate undisclosed commissions for salespeople, prioritizing their financial gain over the interests of investors. The lack of transparency regarding these commissions can significantly impact an investor’s returns.
High Fees and Expenses: Offshore bonds often come with a plethora of fees and expenses that eat into investors’ returns. These costs may include establishment fees, administration fees, and adviser fees, among others. Investors need to carefully examine these charges to assess the true cost of their investment.
Limited Investment Options: Offshore bonds may offer limited investment options compared to alternative low-cost platforms. Investors looking for a broader range of investment choices may find themselves constrained by the limited selection within offshore bonds, hindering their ability to tailor their portfolio to their specific needs and risk tolerance.

The Rise of Low-Cost Platforms:

Increased Accessibility: Thanks to advancements in technology and the widespread availability of financial information online, investors now have access to low-cost platforms that offer a wider range of investment options. These platforms empower investors to take control of their investments, make informed decisions, and reduce unnecessary expenses.
Transparent Fee Structures: Unlike offshore bonds, low-cost platforms often adopt transparent fee structures that clearly outline the costs involved. Investors can easily understand and compare fees, ensuring they are getting the best value for their money.
Customization and Flexibility: Low-cost platforms allow investors to tailor their investment portfolios to their specific needs and aspirations. They offer a diverse range of investment options, including index funds, exchange-traded funds (ETFs), and robo-advisors, giving investors the freedom to create a well-diversified and cost-effective portfolio.

As the internet continues to provide access to financial information, investors now have the opportunity to make more informed decisions regarding their investments. Uncovering the hidden costs associated with offshore bonds is a crucial step towards empowering investors and encouraging them to explore alternative low-cost platforms. By understanding the true costs and considering the benefits of transparency, customization, and accessibility, investors can make choices that align with their financial goals and secure a brighter financial future.

Offshore bonds explained

Offshore investment bonds are investment wrappers offered by global life insurance firms, designed to facilitate tax-efficient capital growth for investors. These bonds are commonly utilized by wealth managers and financial advisers, particularly by expats and UK non-residents. This article provides an overview of offshore bonds, highlighting their complexities, underlying investments, tax implications, and potential pitfalls, emphasizing the importance of seeking professional advice.

Understanding Offshore Investment Bonds: Offshore investment bonds are considered complex financial products, making it essential for investors to seek appropriate advice before investing directly. These bonds are structured by providers in various jurisdictions, impacting the range of underlying investments available and the specific tax rules governing the bond and the investor.

Benefits of Offshore Bonds: When used correctly, offshore bonds can offer several benefits for financial planning. Key advantages include tax efficiency, as the growth within the bond is often shielded from immediate taxation. This allows investors to accumulate capital without attracting taxes, potentially resulting in higher net returns over time.

Hidden Fees and Unscrupulous Practices: While offshore bonds can be valuable tools, it is crucial to be aware of potential abuses. Over the past decade or so, some offshore financial advisers have exploited the flexibility of these products for their own gain. Unfortunately, such practices still occur, with offshore bonds being used to conceal fees and commissions from investors. These practices can erode the investment’s value and result in significantly higher costs for the investor than anticipated at the time of investment.

Spotting Hidden Fees and Making Informed Decisions: To make informed financial decisions, it is essential to understand the fee structure associated with offshore bonds. Investors should carefully review and comprehend the charges and commissions levied by the provider. Transparency is crucial, and any discrepancies or unclear information should be thoroughly investigated before committing to an offshore bond. Seeking professional advice from an independent financial adviser or wealth manager is paramount in ensuring a comprehensive understanding of the potential costs and benefits.

Offshore investment bonds can provide tax efficiency and opportunities for capital growth, making them attractive options for investors. However, due to their complexities and the potential for unscrupulous practices, it is crucial to approach offshore bonds with caution. Seeking advice from independent financial advisers or wealth managers is crucial to navigate the intricacies of these products, understanding the underlying investments and tax implications, and identifying any hidden fees. This article serves as a starting point to raise awareness of offshore investment bonds but should not be solely relied upon for financial decision-making.

How do offshore bonds work?

Offshore investment bonds are tax wrappers hosted in offshore jurisdictions, designed to hold various financial products like stocks, shares, mutual funds, and structured notes. Understanding how these bonds work, their underlying investment options, and potential risks is crucial for investors. This article provides an overview of offshore investment bonds, highlighting their features, different types, and important considerations for investors.

Features and Operation: An offshore investment bond functions as a standard life insurance product, providing a tax and legal shield for the investments held within. These bonds are typically hosted in tax-friendly jurisdictions such as Guernsey, Isle of Man, Jersey, Gibraltar, Cayman Islands, and Malta. Financial products can be bought and sold through the bond, making it a versatile tool for investors. Many offshore advisers use offshore bonds within pension wrappers, such as QROPS (Qualifying Recognized Overseas Pension Scheme) or SIPPs (Self-Invested Personal Pensions).

Types of Offshore Investment Bonds:

Highly Personalized Offshore Bonds: Highly personalized offshore bonds offer extensive investment options and are commonly used within pensions and investments. However, caution is advised as some advisers may utilize these bonds to hide commissions and fees, potentially leading to increased costs for the investor. High net-worth investors may find value in these bonds if advice is provided on a fee-only basis, making them cost-effective for holding capital.
Collective Offshore Bonds: Collective offshore bonds have restricted investment options, requiring approval from the insurance provider. They are often used by advisers for clients with smaller investment capital and serve as a tool for inheritance tax planning. It is important to note that for UK residents, collective offshore bonds are not tax-free, but rather provide deferred tax payments that may be due in the future.

Investor Considerations and Warnings: Investors should exercise caution when considering offshore bonds that offer broad investment options, referred to as highly personalized offshore bonds. These bonds can have significant tax implications, particularly in the UK and other Western countries if held without a wrapper, such as a pension. It is crucial for investors to fully understand the underlying investments and why their adviser or wealth manager has recommended them. Advisers should provide comprehensive reports detailing all aspects of each investment, including the underlying investments, fees, and tie-in periods. If any information is missing or incomplete, investors should avoid making any agreements to mitigate the risk of exposure to potentially harmful products or hidden fees.

Offshore investment bonds offer investors tax-efficient solutions, but understanding their features and associated risks is essential. Different types of offshore bonds provide varying investment options, and investors must carefully consider the advice they receive, ensuring transparency in fees and a comprehensive understanding of the underlying investments. Seeking professional advice from independent financial advisers or wealth managers is vital to make informed decisions and mitigate potential risks. This article serves as a starting point for investors, emphasizing the need for due diligence and caution in offshore investment bond transactions.

Tax Efficiency of Offshore Investment Bonds

Offshore investment bonds offer inherent tax advantages, particularly for non-residents, owing to their jurisdiction and structure. As life insurance products, these bonds provide a tax-efficient environment for investments, shielding them from certain taxes. Here’s an overview of the tax benefits associated with offshore investment bonds:

Capital Gains Tax (CGT) Advantage: Gains generated within offshore investment bonds are generally exempt from capital gains tax. This means that any profits made from the investments held within the bond are not subject to CGT, providing a tax-efficient approach to wealth accumulation.
Income Tax Flexibility: Income drawn from offshore investment bonds is typically taxed as income tax in the investor’s country of residence. However, there are tax benefits associated with this arrangement. Investors can opt to withdraw up to 5% of the original investment amount per year, known as a tax-deferred income, without incurring immediate tax liabilities. This provides flexibility in managing tax obligations and allows for tax-efficient income withdrawals.
Tax Optimization for Non-Residents: For expats or UK non-residents residing in tax-friendly jurisdictions, such as the UAE, offshore investment bonds offer additional tax advantages. Income drawn from these bonds can be received free of income tax, as long as the investor is considered a tax resident in the jurisdiction that does not impose income tax. This provides an opportunity for tax optimization, especially for those planning to relocate to a tax-friendly jurisdiction in the future.
Tax Implications for UK Residents: In the case of UK residents returning from abroad, the tax treatment of offshore investment bond withdrawals follows standard UK tax laws. Withdrawals are subject to UK income tax rules, including personal allowances and income tax thresholds and rates of 20%, 40%, and 45% depending on the individual’s income level.

It is important to note that tax laws and regulations are subject to change, and individual circumstances can vary. Seeking advice from a professional tax adviser or financial planner is crucial to ensure proper tax planning and compliance with applicable tax laws.

Examples of how the tax efficiency can be used

Note: only a few places such as the U.K and Australia can the tax efficiency be used effectively here are some examples:

Example 1: U.K residence in the UAE returning to the U.K

Offshore bonds can be particularly advantageous for non-UK residents, especially those living in tax-friendly jurisdictions like the UAE, in conjunction with the UK’s 5% tax-deferred withdrawal rule. Here’s an example to demonstrate their potential benefits:

Let’s say an individual, a UK non-resident, invests £200,000 in an offshore bond. They are living in the UAE, where there is no tax on gains or income. They plan to return to the UK in the future.

Tax-efficient growth: Within the offshore bond, the investments can grow without attracting immediate tax. There is no capital gains tax or income tax on gains or income generated within the bond, making it a tax-efficient vehicle for wealth accumulation.
Tax-deferred withdrawals: Under the UK’s 5% tax-deferred withdrawal rule, the investor can withdraw up to 5% of the original investment amount each year for up to 20 years without triggering an immediate tax liability. In this case, 5% of £200,000 is £10,000.

In the UAE: Since there is no tax on gains or income, the investor can withdraw the £10,000 annually without incurring any tax in the UAE.
Upon returning to the UK: If the investor returns to the UK within the 20-year period, the withdrawals would be subject to UK tax laws.

Top slicing relief: Top slicing is a mechanism used to calculate the taxable amount when a gain from an investment bond is realized. In the case of offshore bonds, it can be used to reduce the tax liability when returning to the UK.

Assuming the investor returns to the UK after ten years and decides to withdraw the remaining balance of £100,000.
The gain is calculated by subtracting the original investment (£200,000) from the withdrawal amount (£100,000), resulting in a gain of £100,000.
To calculate the taxable amount, the gain is divided by the number of years the bond has been held. In this case, it would be £100,000 divided by 10, equaling £10,000.
The taxable amount (£10,000) would then be added to the investor’s other taxable income for that tax year to determine the applicable tax rate.

By utilizing the 5% tax-deferred withdrawals and potential top-slicing relief, offshore bonds can provide flexibility and tax efficiency for non-UK residents living in tax-friendly jurisdictions like the UAE, while also offering benefits upon their return to the UK

Offshore investment bonds can if used properly provide tax-efficient investment opportunities for non-residents and UK residents alike. With advantages such as exemption from capital gains tax, tax-deferred income options, and potential tax optimization for non-residents, these bonds offer flexibility and potential tax savings for investors seeking to maximize their wealth while managing tax liabilities effectively.

Example 2: Australian living in UAE returning to Australia under the ATO example in 10 years-

Suppose an individual, a non-Australian resident, invests AUD 200,000 in an offshore bond. They are living in the UAE, where there is no tax on gains or income. They plan to return to Australia in 10 years.

Tax-efficient growth: Within the offshore bond, the investments can grow without attracting immediate tax. There would be no Australian tax on gains or income generated within the bond, making it a tax-efficient vehicle for wealth accumulation.
Tax-free gains after 10 years: The ATO’s 10-year rule allows non-residents to enjoy tax-free gains on investments held in offshore bonds if they return to Australia within 10 years.

In the UAE: Since there is no tax on gains or income, any growth within the offshore bond would be tax-free while living in the UAE.

Top slicing relief: Top slicing can also be utilized to calculate the taxable amount when returning to Australia and realizing gains from the offshore bond.

Assuming the individual returns to Australia after 10 years and decides to withdraw the entire remaining balance of AUD 300,000.
The gain is calculated by subtracting the original investment (AUD 200,000) from the withdrawal amount (AUD 300,000), resulting in a gain of AUD 100,000.
The taxable amount can be determined by dividing the gain by the number of years the bond has been held. In this case, it would be AUD 100,000 divided by 10, equaling AUD 10,000.
The taxable amount (AUD 10,000) would then be added to the individual’s other taxable income for that tax year to determine the applicable tax rate.

Fee Structures of Offshore Investment Bonds

There are two primary fee structures associated with offshore investment bonds available to expats and UK non-residents: the modern UK-style fee-based approach and the traditional commission-based approach, which is less favorable.

In the UK, the Financial Conduct Authority (FCA) has established rules requiring financial advisers and wealth managers to adopt a fee-based approach, typically charging a percentage of the assets under management (e.g., 0.5% of the total investment amount). The FCA also mandates clear disclosure of all fees and charges before any agreement is signed, ensuring investors are fully informed about the costs throughout the investment’s lifespan.

However, it’s important to note that the FCA’s jurisdiction is limited to the UK, and not all jurisdictions have the same level of regulation. Consequently, some offshore advisory firms still use a commission-based model, which can conceal fees and make investments more costly and less lucrative than they should be.

Let’s examine the different fees associated with offshore investment bonds:

Establishment Fees: Offshore investment bonds typically incur an establishment fee, which is calculated as a percentage of the investment amount and paid annually to the bond provider. This fee applies to both the modern and traditional fee structures and is usually around 0.2% of the investment value. It’s worth noting that in some cases, the establishment fee may be based on the initial investment amount or the current value, whichever is higher. Investors planning to make early withdrawals may unknowingly increase their costs.
Administrative Fees: An admin fee, payable to the provider, is typically charged for maintaining the offshore bond, regardless of the fee structure employed. The specific amount varies among providers but is typically a fixed annual fee.
Adviser Fees: If investors choose to work with an adviser or wealth manager, they will likely incur additional fees for managing the offshore bond. Similar to the establishment fee, these adviser fees are often a fixed percentage of the assets under management and include overseeing the underlying investments. Under the UK model, this is the only permissible way for advisers to be compensated, as deviating from this approach would breach FCA rules. Management fees generally range from 0.5% to 1.5% of the funds under management and are upfront and transparent payments for the service provided.
Commission Payments: While commission payments are prohibited under FCA rules in the UK, offshore advisers can still receive commissions from providers. Although some advisers may voluntarily disclose these commissions, they are often hidden within the establishment fees of offshore bonds. It is important to note that not all offshore advisers operate on a commission basis, and there are fee-based advisers who follow the UK model, prioritizing transparency.

Here are examples illustrating how the commission-based approach can be exploited:

Commission payments are typically based on the initial investment amount and spread over several years. For instance, an adviser may request a commission from the offshore investment bond provider, leading the provider to increase the establishment fee from 0.2% to 1% of the initial investment over a ten-year period.

In practical terms, this would mean an additional 8% of the original investment as the true cost of the investment, regardless of the actual amount under management. The adviser would receive a percentage of this upfront, let’s say 7%, from the provider at the start of the investment, while the fee charged to the investor would be spread over the ten-year period.

Once the provider has paid the adviser upfront, the adviser has received their compensation and no longer has a long-term commitment to the investor or the provider. Meanwhile, the provider must recover the payment given to the adviser over the ten-year period. If the investor decides to close the investment and withdraw their money, they may be subject to penalty charges.

This situation becomes more problematic for investors if the fund underperforms or if they wish to make partial withdrawals, as the fees would still be based on the original investment amount rather than the actual value of the investment.

It is crucial for investors to thoroughly understand the fee structure, including all associated charges and their impact on returns. Seeking advice from a professional financial adviser or planner who operates on a transparent fee-based model can help ensure a clear understanding of fees and charges, enabling informed investment decisions.

Identifying Hidden Fees in Offshore Bonds

Here is a link to a popular sales lead offshore bond and hidden fees-

The commission vs full charges

The base charge for the 10-year period is 0.067% (seen below) and has a surrender charge of 0.670% compared to the full commission. This makes it at least from a financial perspective much more competitive than the full 1% a year cost with less flexibility if the full commission. Where the advisor will get up to 7% upfront.

RL360 PIMs have an upfront model where no exit charges exist, which provides some flexibility

“Free investment advice”: Beware of financial advisers or wealth managers offering their services at no cost. It is important to question how they are compensated, as they are likely hiding additional fees. While initial consultations may be offered for free as the start of a relationship, actual advice and ongoing financial management should always be paid for. If you are unsure about an adviser’s payment structure, seek clarification before signing any agreements or providing capital. Consider obtaining a second opinion from an independent source when commission-based payments are involved.
Non-disclosure of underlying investments: Before making an investment decision, ensure you have a clear understanding of all aspects of the investment, including the underlying investments within wrappers like QROPS, SIPPS, or offshore bonds. Some advisers may intentionally exclude this information, promising disclosure at a later stage. As an investor, you are ultimately responsible for the agreements you enter into, especially without the protection of regulatory bodies like the FCA. Advisers who withhold information about underlying investments may steer you towards riskier options that incur higher costs and pay larger commissions, primarily benefiting them rather than you.

Other Concerns with Offshore Bonds

Adviser limitations: Not all financial advisers or wealth managers have the ability to offer a wide range of investment products. Some may be restricted to selling only life insurance products due to their regulatory status. To ensure you receive independent and comprehensive advice, verify that the adviser you are dealing with can offer a broader selection of investment products.
Investors returning to the UK: While properly structured offshore investment bonds can provide significant tax benefits for individuals not intending to return to the UK, certain bonds may attract tax penalties of up to 45% of the investment amount if the investor relocates back to the UK. When discussing your situation with a financial adviser or wealth manager, ensure that your future plans are thoroughly considered. This can help you avoid substantial tax liabilities and other costs in the future.
Complex products for sophisticated investors: Some investments are limited to sophisticated investors, typically individuals with significant capital or the ability to self-certify their investment knowledge. As a regular investor, you may be able to invest through offshore bonds or life companies that are classified as sophisticated investors, holding the investments on your behalf. However, it is essential to fully understand the risks associated with recommended investments and be aware of all costs and fees before making a decision.

What are the costs of Offshore bonds on the market and do they cost more than platforms?

This is by no means a fully comprehensive review but this gives an idea of some of the offshore bonds on the market and base and full commission costs

How does the cost compare to other options?

In regards to platforms in the offshore or local market space, it doesn’t compare for cost and flexibility. The flexibility on RL360 is much less and the costs are much higher.

Take for example you were to put 500,000 GBP in a platform or RL360 at the base and full commission cost.

One point to note is that the advisor can charge up to the full amount or take less commission upfront I.E 2%

As can see from the table above that if completed on the base cost and compared over a 10-year time frame it is pretty reasonable if you don’t move your investments over 10 times in that period.

If the base cost is compared to other bond platforms it does get a bit more complicated to analyse the charges as platforms have different establishment periods (please see my blog on offshore bond costs for a full review). But, some of the more flexible bond options such as ITA, Movmentum, and Hansard have been compared below.

Here is the cost structure that is compared over 20-year term factoring in 1 trade a year on some of the popular offshore bond products:

Conclusion:

This has gone into a bit of detail about the logicists of offshore bonds.

However, the point is clear for most expats especially those with under $500,000 and not planning on returning back to locations where these products have tax efficiency (U.K and Australia) and can’t afford to lock your money up for 5–10 years these are NOT for you. These have been heavily mis-sold by sales personnel claiming they are free or tax efficient and unless you have:

Over $500,000
Relocating back to the U.K/Australia (or other location where the bond works)
Do not need instantly liquidly and can lock up 5–10 years (as shown in my study ideally 20 to make the fee structure work).
Are using the bond at the base cost where the advisor is explaining the fees and how they are paid using no structured notes and clean-based funds.

NOTE THESE SHOULD NOT BE USED IN 99% OF U.K PENSION TRANSFERS AS THE TAX EFFICIENCY IS IN MOST CASES ARE NOT RELEVANT AND THE ADVISOR WOULD HAVE PUT YOU IN THIS OVER A FCA PLATFORM (Prameium and Novia that cost 0.35%/0.34% respectively on amounts under $500,000) FOR COMMISSION.

They can be useful for a very small minority if used the right way.

Although anyone aiming to sell you these as an investment option (especially without detailed calculation on how they will work better for you) when you have cheaper platforms that cost as low as 0.05% such as IBKR, I would question where the motives are coming from.

I have written this with the aid of getting more people aware of these as seeing beyond the sales personnel as get messages daily from expats in these products of where they have been mis-sold these as an inadequate investment option.

Hopefully, it has put some light on the topic and for any questions feel free to message me or my team using the contact page or the button below.