Page 1 Are Offshore Bonds still an attractive investment for UK individuals? Colin Thores –...

Are Offshore Bonds still an attractive investment for UK individuals?

Colin Thores – European Product Development ManagerSeptember 2009

This presentation is intended for qualified financial advisers only and must not be relied upon by anyone else.

© 2009 Standard Life International

A number of factors have changed in the UK investment landscape over the last couple of years

•Changes to HMRC rules on pensions

•Income tax changes. For example, from 6 April 2010

Introduction of 50% higher rate income tax Increase of dividend taxation to 42% Gradual withdrawal of personal allowance for whose earning over £100,000

•Changes in taxation for other investment types From 6 April 2008, CGT moved to a flat rate of 18%

Is an offshore bond still an attractive investment option for your clients?

Recap of the main features of an Offshore Bond

Basic Product FeaturesNon qualifying whole of life insurance product

Issued by non-UK domiciled insurance company (e.g. Irish or IOM)

Contract is written in segments usually 100 – 1,000.

Suitable for Individuals (single / joint), trustees or companies – but not charities

Usually written as life contract with death benefit of 100.1% - 101% of fund value paid on death.

Bond can be wrapped in Trust

The Offshore Bond is an extremely flexible product.

Summary of the main features of Offshore Portfolio Bonds

Individual TaxationNo tax relief on payments on the way in, gains taxed as income on the way out. Growth within the bond is on a ‘gross roll up’ basisBondholder taxed as income at highest marginal rateBondholder does not need to fill in a self-assessment tax form until a chargeable gain is realised from the bond5% tax deferred income allowance Assignment Time apportionment relief

Top slicing

InvestmentsHMRC Personal Portfolio Bond rules govern the assets allowed within the offshore bond for UK residents Main investments allowed within offshore bond are

•Deposit Accounts•Mutual Funds•Insured Funds•Whole of Market funds•DFM

Ongoing AdminClient can top up over the life of the product, with no legislative upper limitIndividual has access to money throughout the life of the policy Bondholder does not need to keep records of dividend and interest distributions

Offshore Bonds and Pensions

Issues for clients placing money into a Pension

Is an offshore bond a suitable investment to sit along side a Pension?

•Pension arrangements provide tax advantaged saving framework for individual but:

Increasing limitations on ability for HNW clients to put money into a DC arrangement Limitations on timing, form and amount of money that can be taken out Limitations for estate planning on crystallised pension funds

• There are particular issues around:

• Inability to access cash if clients circumstances change

• Requirement for vehicle to provide regular income (e.g. annuity)

• Limitations on passing money onto other generations

• Pension may not be best for funding for expenditure – e.g. university fees for child

Increasing limitations on Pensions post budget

Payments for “High Income individuals”

Tax relief on pension payments will be restricted for those who have an annual income in excess of £150,000 from tax year 2011/12.

Relief will be tapered away, so that relief for those with an annual income of £180,000 will be tapered to 20%. (subject to confirmation in final legislation).

There are interim rules in place now, limiting tax relief on payments for many high income individuals to a maximum of up to £20,000 per annum (£30,000 in some cases), for the 2009/10 and 2010/11 tax years.

Freezing of Pension Allowances

• Frozen for 5 years from 2010/11

• Annual allowance £255,000

• Lifetime allowance £1,800,000

How different are offshore bonds and pensions?

Investment growth Virtually tax-free** Virtually tax-free**

PaymentsTax-relief at highest marginal rate* on £3,600 or 100% of relevant UK earnings (possible penalty if annual allowance exceeded)

No tax reliefNo maximums (only product limitations)

Tax-free lump sum Normally 25% of fund from age 55 (50 until 6 April 2010) 100% of original investment

Income All income taxed at marginal rate Only gains are taxed (at marginal rate)

Reliefs available Personal allowances

Personal AllowanceTop Slicing reliefTax-free assignmentTime apportionment

Pension Offshore Bonds

* Tax relief limited to basic rate for payments above the anti-forestalling limits for many individuals with relevant income of £150,000 & above.

** Except for irrecoverable withholding tax.

What potential opportunities exist?

There are potentially a number of situations where an offshore bond can sit comfortably beside a Pension as a means of long term retirement planning?

•If client will breach either the lifetime or annual limits then an offshore bond offers a tax advantaged vehicle for the client

•If client requires cash then offshore bond can potentially allow access

•Offshore bond allows greater flexibility for ownership and access to ‘income’.

•If the rules change in the future then client can surrender their bond and do something else with it. E.g. invest it in a pension and get tax relief on contribution.

•Offshore bond could be used for funding specific known requirements – e.g. university funding

•Offshore bond is a non income producing asset, client can use 5% withdrawals without impacting relevant income, which is particular useful if client is near £150k limit.

•Offshore bonds is a useful investment option for estate planning purposes

Summary of Opportunities

• A pension provides a beneficial framework for providing for a client’s income and capital requirements in later life.

• However it does have a number of limitations. People are not growing old like they used to and their needs are changing.

• An offshore bond, whilst not appropriate for everyone or in every situation, offers a client considerable benefits particularly around:

• Control – of when tax is paid and who pays it

• Access – if required

• A tax advantaged framework

The offshore bond is potentially a very attractive option to sit alongside a Pension

Changes to Income taxation

Change in Taxation for Higher Income Individuals

Does this make it less attractive to hold an Offshore Bond?

• For the 2010/11 tax year individuals will pay the following rates of taxation on taxable income of £150,000 and above:

50% income tax rate

Dividend tax rate 42.5%

• 50% income tax rate potentially bad news for offshore bonds, but investors in mutual funds producing income also adversely impacted.

• This will also be the rate applicable to trusts (RAT)

Higher rate tax is irrelevant, where gains on bonds are not going to be realised by a higher or additional higher rate taxpayer.

• Many bonds will have been sold on the basis that:

• The client will be a basic rate taxpayer when the bond is cashed in.

• The client plans to gift the bond or segments of the bond to another individual for their use. That individual is not a higher rate or additional higher rate taxpayer, for example, a spouse or other adult family member.

• The client plans to move abroad and cash the bond in at a lower rate of tax.

• Top slicing will still apply for basic rate tax payers

• HMRC to confirm whether top slicing exists for clients brought into 50% tax bracket due to bond gains.

What impact does the 50% tax charge have on Offshore bonds?

The introduction of the 50% tax rate has no impact on these situations

Personal Allowance from 2010/11

• Subject to a single income limit of £100,000

• Adjusted net income

• Below limit entitled to full amount

• Above limit reduced by £1 for every £2 income

• This means that the personal allowance is lost for individuals with taxable income over £112,950*

*2009/10 rates applied

For income between £100,000 and £112,950 the effective tax rate is 60%

Personal Allowance – 60% “tax”

• Every £2 income above £1 allowance lost

• Effectively paying tax on £3 at 40% = £1.20

• £1.20 tax on £2 income = 60%

• See worked example in Appendix 2

A potential solution is to shelter income within an Offshore Bond

Review meeting needed

There need to review clients who have total income over £100,000

Individuals and advisers must consider impact for

Assets producing unearned income

Pension planning

Therefore need to reconsider

Investment strategy

Pension strategy

Retirement strategy

There is a potential opportunity for Offshore Bond investors around 5% wdls

Summary

• The new 50% tax rate is irrelevant of holders of an offshore bond, where gains on bonds are not going to be realised by a higher or additional higher rate taxpayer.

• Important to consider the potential for the client to have a lower tax rate (e.g. HRT to BRT)

• Or the ability of the client to assign some or all of the bond to an individual with a lower tax rate.

• Advisers with clients that have income of £100,000 or more need to carefully consider a range of issues.

An Offshore bond could provide a valuable tool for your clients

Offshore bonds v’s Mutual Funds

Changes to Mutual Fund Taxation

• Finance Act 2008 – swept away indexation and taper relief for disposals made by individuals after 5 April 2008

• Individuals have an annual exemption - £10,100 in 2009/10 (£5,050 for trusts)

• Individuals and trustees have a flat rate of 18% on any gains realised above the annual exemption.

• Simple!

Are mutual funds a better investment for clients?

Comparison of Offshore Bond and Mutual Funds

Feature Offshore Bonds UK Mutual Funds Summary

Ta

xatio

n

During Non Income producing asset

Offshore – No tax other than irrecoverable withholding tax

Investors liable for ongoing income tax on dividend and interest payments-HRT – total liability of 32.5% (42.5%) on div income-HRT total liability of 40% (50%) on interest from fixed interest income

•MF income taxed as it arises, whether you take it or not.

•MF gains in excess of annual allowance taxed at CGT rate

•Bond only taxed as income on chargeable eventOn exit Gains taxed as income

-HRT 40% on gain

-BRT 20% on gain

Capital gains in excess of annual allowance (on exit or switch)taxed at 18% CGT rate

Tax reliefs & mitigants

• 5% pa capital withdrawals tax-deferred

• Top-slicing• Tax-free assignment• Pay pension contribution• Offshore - time apportionment

relief

• ISA wrapper permits max £7,200 (£10,200) pa tax-free

• Annual CGT allowance

Switching Switching between funds does not create a taxable event.

Fund switching treated as taxdisposal for CGT purposes

Comparison of offshore bond and mutual funds

Tax status at encashment

Offshore bond Mutual fund - using CGT annual exemption

Mutual fund – without using CGT annual exemption

UK Equity Fund – assumes a total gross return of 7%

Non-taxpayer

Basic rate

Higher rate

£382,538

£346,030

£309,523

£365,249

£365,249

£342,340

£362,922

£362,922

£340,013

Fixed Interest Fund – assumes total gross return of 5.5%

Non-taxpayer

Basic rate

Higher rate

£341,629

£313,303

£284,977

£341,629

£307,634

£276,715

£341,629

£307,634

£276,715

Mixed Fund (50% Fixed Interest, 50% UK equities) – assumes total gross return of 6.3%

Non-taxpayer

Basic rate

Higher rate

£361,563

£329,250

£296,938

£354,355

£336,287

£308,870

£352,028

£333,959

£306,543

Projection amounts for £200,000 invested for 20 years in an Offshore bond and a mutual fund

Source: SL Bond v’s OEIC calculator – SL Adviserzone. Figures are for illustrative purposes only.

For assumptions, please see the following slide.

Modelling Assumptions – Offshore bonds v Mutual funds projections

Economic Assumptions

• Fixed Interest Income: 5.5 % Capital: 0.0 % • UK Equities: Income: 3.0 % Capital: 4.0 % • CGT exemption is assumed to increase each year at RPI of 2.5%,

Tax Rates

• Current years tax rates are used: 10% & 32.5% for dividends 20% & 40% for other income CGT 18% It does not take into account the additional higher rate of 50% from next tax year.

Product Assumptions

- 100% allocation for both mutual fund and offshore bond- Annual product charges of 0.2% p.a. - for both MF and offshore bond- £200,000 single premium investment- Projection term was 20 years

Comparison - Summary

• Raw arithmetic would suggest that investors who are basic or higher rate taxpayers at encashment are potentially better off holding a:

Mutual Fund where they invest primarily in equities

Offshore bond where they invest primarily in fixed interest

There is not much difference where the client is investing equally in equities and fixed interest.

• The relative situation improves even more for mutual fund holders if they can utilise their annual CGT allowance.

Is the answer as simple as this?

Numbers are helpful in making comparisons but they can only take you so far.

• Is it best for the clients to pay tax as they go along, or when money realised? The answer is it will depend on what your client is invested in and what taxpayer status

• Flexibility - Offshore Bonds give you flexibility on not just when, but also who pays the tax. Many end owners of a bond will not be higher rate taxpayers –

E.g. if bond owner assigns bond to spouse or adult children on lower tax rate. There is normally no tax liability on assigning an investment bond.

E.g. bond owner retires to a country where tax is lower

• Relieving past losses – You can use losses on mutual funds to offset future profits. In some circumstances, corresponding deficiency relief may be used to reduce the gain on a bond.

• Bed and Breakfasting - no longer effective for mutual funds

• Time apportionment relief – offshore bond have this benefit on gains if client is temporarily ‘non-resident’ then returns to the UK.

Its not just tax though…….

• Investment Choice - Offshore bonds offer a wide range of investments Life companies own funds Mutual fund platforms Investment trusts Non UK funds Structured deposits Fixed term deposits Discretionary Fund Managers

• Hidden Costs - Care is needed if client is using their annual exemption for mutual funds. Are there any additional costs which could potentially outweigh the benefits. E.g. Dealing costs, bid / offer / client being out of the market etc.

• Charges – Offshore bonds will often offer enhanced terms for larger investments (e.g. large fund discount to ongoing charge). Mutual fund platforms may offer improved terms on the way in but large investments may incur the same ongoing amc as for smaller investments.

• Simplicity – Requirement to keep annual statements and dividend statements for mutual funds, but not for Offshore Bonds unless there is a chargeable event.

• Trusts – Offshore Bond providers offer a number of attractive trust options

Overall Conclusion

• People are not growing old like they used to and their needs are changing. An offshore bond can usefully sit along side a pensions for many higher new worth clients. In particular it offers:

Control – of when tax is paid and who pays it Access – if required A tax advantaged framework

• Offshore Bonds continue to offer a number of valuable features relative to mutual funds, but you need to consider the circumstances of the individual

Offshore bonds wont always be the answer but a number of features of the product continue to make it attractive for clients.

Important information

This presentation is for professional advisers only and should not be distributed to third parties.

The value of investments and any income from them may fall as well as rise and investors may not get back the amount originally invested. In addition, the value of investments may increase or decrease as a result of changes in exchange rates between currencies. Past performance is not a reliable guide to future performance.

Any reference to legislation and tax is based on Standard Life International’s understanding of law and tax practice in Ireland and the UK at September 2009. Tax reliefs mentioned are those currently available and may be subject to change.

No guarantees are given regarding the effectiveness of any arrangements entered into on the basis of this presentation. The value of tax reliefs to the investor depends on their financial circumstances and may vary.

Standard Life International

Standard Life International Limited is a company registered in Ireland (number 408507) with its Registered Office at 90 St Stephen's Green, Dublin 2. Telephone number 00353 16397766. Calls may be recorded/monitored.

Authorised and regulated by the Irish Financial Regulator for the conduct of Linked Long Term Insurance Business and subject to limited regulation by the Financial Services Authority. Details about the extent of our regulation by the Financial Services Authority are available from us on request.

Issued by: Standard Life International Limited© 2009 Standard Life

Appendices

Appendix 1 : Modelling Assumptions

Modelling Assumptions – Offshore bonds v Mutual funds projections

Economic Assumptions

• Fixed Interest Income: 5.5 % Capital: 0.0 % • UK Equities: Income: 3.0 % Capital: 4.0 % • CGT exemption is assumed to increase each year at RPI of 2.5%,

Tax Rates

• Current years tax rates are used: 10% & 32.5% for dividends 20% & 40% for other income CGT 18% It does not take into account the additional higher rate of 50% from next tax year.

Product Assumptions

- 100% allocation for both mutual fund and offshore bond- Annual product charges of 0.2% p.a. - for both MF and offshore bond- £200,000 single premium investment- Projection term was 20 years

Appendix 2 : 60% tax trap example

Avoiding 60% “tax” – John Stevens

Case study• John earns £95,000 p.a.

• Receives income from savings and shares

£12,500 gross interest

Deposit account & Interest bearing OEICs

Does not realise he pays 60% tax

For illustrative purposes only

How does 60% “tax” work – John Stevens

2009/10 tax calculations

Earned income £95,000

Savings income £12,500

Total income £107,500

Less Personal Allowance (£6,475)

Taxable income £101,025

BRT liability £7,480 (£37,400 x 20%)

HRT liability £25,450 ((£51,125 + £12,500) x 40%))

Total tax paid £32,930


How does 60% “tax” work – John Stevens

However, 2010/11 tax calculations

Additional £1,500 (now 60% tax on £7,500)

Earned income £95,000

Savings income £12,500

Total income £107,500

Excess over £100,000 (£7,500 restrict 1/2 = £3,750)

Less Personal Allowance* (£2,725)

Taxable income £104,775

BRT liability £7,480 (£37,400 x 20%)

HRT liability £26,950 ((£54,875 + £12,500) x 40%))

Total tax paid £34,430

For illustrative purposes only *2009/10 rates applied

Avoiding 60% “tax” – John Stevens

Offshore Bond alternativeIf £12,500 income from savings and shares resulted from3.5% yield then investment fund would be £357,142

5% yield then investment fund would be £250,000

John reinvests assets into offshore bonduses 5% withdrawals to replace investment income

• £14,285 (£285,714) or £10,000 (£200,000) • or £7,500 for same net amount (2.6% or 3%)controls encashment timing for minimum tax liability

Ensuring he doesn’t pay 60% tax


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