Are offshore bonds truly worth an expat’s hard-earned money? Read to find out!
Offshore bonds provide a tax efficient investment option for most expats, but not all
An offshore investment bond is essentially a tax efficient investment wrapper that can hold a variety of assets, like stocks, mutual funds or structured notes.
(A ‘wrapper’ is simply means of consolidating and managing an investor's investment portfolio and financial plans - services that are offered for a fee or a series of charges.)
An offshore investment bond is essentially a tax efficient investment wrapper that can hold a variety of assets
They are often provided by global life insurance firms with the aim to enable investors to grow capital often without attracting any tax.
Also referred to as ‘portfolio bonds’ and ‘tax wrappers’, they are domiciled in a jurisdiction with a favourable tax regime, which enable insurers to avail this scheme to their clients.
Others include Gibraltar, Guernsey, The Isle of Man Mauritius, Lichtenstein, Monaco, Panama, St. Kitts, and Nevis.
Also important to note that some of the most popular countries that offer the financial freedom of having no income tax are the United Arab Emirates, Bermuda, Monaco, Bahamas, and Andorra.
Mixed reviews
Offshore investment bonds get mixed reviews.
They are widely regarded as complex financial products and many people would not invest in offshore bonds directly without taking appropriate advice first.
When implemented correctly, they can be a great investment opportunity!
When implemented correctly, however, they can be a great investment opportunity, but on the flip side they can be abused and there have been a number of instances that end up costing expats a lot of money.
Key selling point?
Offshore bonds provide a tax efficient investment option for expats as the bond will not be subject to capital gains tax and income tax deferred.
Offshore bonds provide a tax efficient investment option for expats!
This means that the investment grows free of tax, substantially increasing the value of the investment itself.
Even if the investor returns to his or her home country, the investment will continue to grow free of tax, provided the correct offshore bond is in place.
Even if it means perks may be comparatively limited and moving cash to an offshore bond is largely unnecessary from a taxation point of view.
Difference between onshore and offshore bonds?
While onshore bonds are available to almost every country’s residents, expats and non-residents have access to offshore bonds which are typically based on any of the below tax haven countries.
One of the major differences between onshore and offshore bonds is that taxation is deferred within an offshore bond
One of the major differences between onshore and offshore bonds is that taxation is deferred within an offshore bond due to low (or no) tax on gains and income arising on the underlying investments during the investment term.
Offshore investment bonds should not be confused with traditional bonds.
Traditional bonds are fixed income investments where investors lend money to an entity (typically a company or government) which borrows the funds for a defined period of time at a variable or fixed interest rate.
The tax payable on a ‘chargeable event’ such as this will depend on your highest marginal income tax rate at that time. (A 'chargeable event' happens when a certain event occur and money is taken out of a bond due to personal reasons.)
So, many expats are advised to postpone such an event until they are either no longer a taxpayer (like shifting to a no-tax land like the UAE), or shift from being a higher tax-rate to a lower rate taxpayer, perhaps when they retire.
If you do move to a different jurisdiction or already reside in a low or no tax country, the benefit of tax deferral may be lost to you!
It’s again worth mentioning however, that if you do move to a different jurisdiction or already reside in a low or no tax country, the benefit of tax deferral may be lost to you.
Let’s now look at a series of risks that are associated with such bonds.
The trend being some offshore financial advisers have taken advantage of the flexibility of these products for their own benefit.
Offshore bonds are often used to hide fees and commissions from the investor and unfortunately, these practices are still relatively frequent.
Such practices can significantly reduce the investment, while also making the long-term costs for the investor significantly higher than they believed when they originally made the investment.
Complex products for sophisticated investors
Some investments can be limited to sophisticated investors only, meaning they should only be available to people who have significant capital or are able to self-certify as knowing what they are doing.
Some investments can be limited to just sophisticated investors!
Due to these limitations, it is possible for regular investors to invest through offshore bonds who are classified as sophisticated investors.
The type and range of underlying investments available through offshore bonds will depend on the provider and the jurisdiction to which the bond is located.
The jurisdiction of the offshore bond will also define the exact tax rules that may apply to the bond itself and the client.
#BEWARE: There are also some increasingly complex offshore bonds that incur income tax as high as 45 per cent on drawdown (or accessing the funds) when the investor returns to the home country, which is very high!
Therefore, the answer to this question is – yes, offshore bonds work well for many investors for whom they are suitable, but only when they are not subject to commission charges and high ongoing costs.
For this reason it is vital to seek independent advice from someone who can analyse your full situation, including where you are likely to live in the future.
Know the charges, fees, commissions
While investment bonds can offer some excellent advantages, it is important to understand the charges, fees and, potentially, commissions which will be charged.
The minimum investment for an offshore bond will depend greatly on the providers.
The provider’s recommendation will depend on a number of factors, including the level of control and diversification required, as well as the level of acceptable risk against an investment.
It is important to seek independent advice before making any decision on provider and investment amount.
The costs associated with investment bonds are likely to occur when the investment is originally made, while there is also likely to be an ongoing annual fee.
The costs associated with investment bonds are likely to occur when the investment is originally made
You may also be charged a management fee by the adviser, which may be fixed or a percentage of the investment amount under management.
Also, long-term savings plans are often sold without disclosing key details such as what is being invested in or the penalties for breaking a contract early.
What many financial advisers particularly take advantage of is the ability, for as long as it lasts, to charge commissions and then they put icing on that by not disclosing the commissions and upfront charges.
There’s also little recourse to right wrongs when disputes with the sellers of these products (such as complex insurance-linked offshore investments) arise.
The reason being because the regulation in most countries are is still nascent, especially in the Middle East.
Constant reminder for expats
A tip that is repeatedly offered by veteran expat investors is ignore the cold callers that many are much too familiar with.
While there might sometimes be a reason to shift pensions from, let’s say the UK, to offshore equivalents, expats must carefully analyse whether it’s worth the fees and potential pitfalls of doing so.
In a lot of cases that experts say they have seen, investments were best left as they were.
This is mainly because some of the major players such as Vanguard and Fidelity don’t allow you to invest unless you are a resident in the US or UK, or a small number of other countries.
However, there are a number of reputable brokerages that experts recommend including TD Direct Investing in Luxembourg and Saxo Bank that expats in Dubai can easily open accounts with.
Key takeaways?
• Beware of dodgy purveyors!
Beware of dodgy purveyors of insurance-linked financial products that look to bilk the unsuspecting. Spend time researching options before plunging in, and if you feel remotely suspicious – pull out!
Beware of dodgy purveyors of insurance-linked financial products that look to bilk the unsuspecting.
Many of the offshore bonds available are transparent, low cost, efficient tax planning structures - although great care must be taken considering such a tax wrapper.
Unfortunately, overseas use of offshore bonds has become associated with high-charging, opaque, commission-based salespeople - who sell risky investments to the unsuspecting expatriates.
Using a fee-based adviser means they're not incentivised to sell you a product because of the commission they will receive. Instead you pay for agreed deliverables and the ongoing service.
In the UAE, a number of advisers have long shifted from commission-based structures to fee-based, such as AES International and Killik Offshore.
Fees will vary between companies so again, make sure you do your research and get all the charges disclosed upfront.
• Be aware of your country’s tax regime
Investors must be aware of the tax regime in which they are resident when they encash their bond.
Choosing the provider and location of your offshore bond is therefore important, as this will dictate many of the rules surrounding taxation and access.
Provided you have knowledge of the underlying investment options, tax jurisdiction and fee structures of the bond and where advisers are willing to work on a commission-free basis, offshore bonds can provide significant benefits and be a cost effective, tax efficient way of increasing capital.
However, if an offshore bond is incorrectly sold or is not suitable for the investor, they can be incredibly expensive and result in the investment amount reducing over time through fees, charges and tax penalties.