Offshore bonds have often been tarred with the same brush as their onshore counterparts, whose reputation has been sullied by high initial commissions and recommendations to clients who have no need of them.
But offshore bonds have undergone something of a renaissance. Over recent years they have attracted more assets than onshore bonds as many investors have realised tax planning and investment opportunities are generally superior to those available from onshore bonds. With this in mind, when should advisers be looking to offshore bonds for their clients?
Offshore bonds are usually administered in a well-regulated offshore jurisdictions, typically Dublin, the Isle of Man or the Channel Islands. They fall into two main types: The first - single premium - is cheaper, but restricts the underlying investments to the funds of the life company issuing the bond. Portfolio bonds tend to be more expensive but offer a wide range of underlying mutual funds, usually with the option of alternatives and direct equity as well. Often the underlying investments for a portfolio bond will be managed by a discretionary manager.
This investment choice offers a clear advantage over many onshore bonds and has been a precursor to many of the popular wrap products around today. David Ferguson, chief executive of wrap provider Nucleus, calls offshore bonds the "first real wrap", saying they also fit neatly into the new breed of wraps because they have asset pooling, online capabilities and clean charging.
However, the main advantage of offshore bonds is tax planning. The first of these tax planning advantages is that the funds held within an offshore wrapper are not taxed locally or at source. The funds also grow without any liability to UK income tax - "gross roll-up". Income of 5% a year can be taken each year without any immediate liability to tax. Plus, a client can take advantage of top slicing and time apportionment reliefs.
Overall, this means that clients can use offshore bonds to manipulate their tax liability from year to year, ensuring that they derive maximum advantage from all reliefs. Also, for the increasing number of Brits who want to retire abroad, if the holder is no longer UK resident when the bond is encashed, there is no liability to UK income tax (though there may be a liability in the new country of residence).
They can also be used for inheritance tax planning when combined with a trust. Assuming investors do not need access to the assets in the offshore bond held in trust for 7 years, they can mitigate or avoid tax due on transfers of wealth. An offshore bond and trust can also be structured to offer IHT benefits while allowing restricted access to the underlying funds.
Offshore bonds are suitable for anyone with this type of financial planning need. As an increasing number of people fall into the inheritance tax net, there is more demand for the tax planning opportunities afforded by offshore bonds.Adrian Smith, marketing manager for Royal Skandia, says: "It was traditionally seen as a product for high net worth clients, but it has changed a lot. The minimum investment level is now around £20,000, so it is a myth that it is only for the very rich."
He believes that the traditional shady image of offshore bonds is disappearing. He says: "The market has been very good for offshore bonds recently. They have benefited from a general climate of rising stockmarkets and a lot of wealth around.
"Costs have come down and they are becoming a more mainstream product." Business was buoyant in 2006, according to the Association of International Life Offices (AILO). This follows the £3bn that went into offshore bonds in 2004.
Ferguson agrees that costs are coming down, which was one of the biggest criticisms of offshore bonds.
They have tended to be slightly more expensive than onshore bonds, which was offset by the tax situation.
However, investment in technology, economies of scale and increased competition have meant that charges for offshore bonds have now fallen to broadly into line with those of onshore bonds. The charges often reflect the quality of the administration.
This tends to be the main differentiator between offshore bonds, though investment choice and product features will also vary.
Ferguson says: "I have always been confused as to why onshore bonds have been so popular. Offshore bonds offer more tax planning opportunities, including inheritance tax. They have always tended to be sold by better quality IFAs to high net worth investors. I believe this should really be a mass market investment. Minimums are getting lower."
Ferguson says that offshore bonds provide additional pension planning on top of Sipps if investors have already used their lifetime allowance. They can also be useful for the internationally mobile executive who spends long periods of time abroad, making pension planning difficult. Offshore bonds can be company-sponsored.
Far from being the smoke-and-mirrors product of popular myth, offshore bonds now look like an extremely practical solution to a range of tax planning dilemmas.
The investment choice and ability to include alternatives is another bonus for this type of product. As yet, they have worked well alongside the new wrap products, which have not eroded their market share. The same may well not be true for onshore bonds.
01 February 2007