With A-Day regulations placing onerous restrictions on pensions investment, particularly for the wealthy, international investment bonds could prove to be a ready-made solution
Ask a star footballer or a deep-sea diver what they know about international investment bonds and the chances are you will draw a rather confused blank. However, these are just two categories of individual who could save thousands by ploughing their extra pension cash into such vehicles.
Offshore bonds - which hold money in unit trusts, corporate bond funds and insurance company investment bonds - have become an increasingly attractive proposition during the past 10 years. This is mainly due to their tax efficiency. Most commonly based in the Isle of Man or Dublin, followed by Luxembourg or the Channel Islands, they are not taxed at the outset, but rather when the money is brought back into the UK.
They have gone on the boil over the past two years, in particular, during which time sales have soared by 50% to 60% a year. While this is partly down to an overall increase in high net worth individuals (HNWIs) , generally those with pension savings of more than £200,000, it is also due to the Government's new pension tax simplification laws.
The regime, known as A-Day, which came into effect from 6 April, combined the previous eight tax tiers into one. Although it has introduced greater choice and flexibility for some, for HNWIs especially, it has brought onerous restrictions.
So is there a case for using offshore bonds as a pension savings alternative? The answer is a resounding 'yes' when considering the greatest change to come out of the new regime was the lifetime allowance. This measure hits those whose pension pot exceeds £1.5m in 2006-07 with a 55% tax charge on the excess. The cap will rise each year, reaching £1.8m in 2010. For those likely to exceed this limit, putting their extra savings in an offshore bond is particularly attractive.
Research by Hewitt Associates has found the number of people affected by this change could be as high as 600,000 - far greater than the Government's estimate of 5,000 to 10,000.
Christine Hall, offshore portfolio manager at Axa and chairperson of the marketing committee for the Association of International Life Offices (Ailo), says: "The expectation is investors, particularly HNWIs, will still want to invest considerably more over the longer term and so they will look for alternative ways of doing that. An international bond is an uncapped investment amount that can grow in a tax efficient manner.
"We are not suggesting it should be an alternative, but once they have hit the ceiling on their pension an offshore investment would make sense."
A-Day also restricts the amount someone can contribute to their pension pot with tax advantages to £215,000 a year up to 100% of their earnings. For the wealthy who want to put more in, an offshore bond can provide an appealing solution.
There are now also restrictions on the types of investment funds individuals can attach to their onshore pension. An offshore bond does not have these limitations - any authorised fund is acceptable.
Following A-Day, the amount someone can accrue free of tax is limited to £1.5m and any excess that is accumulated in the pension pot is taxable. Money can only be drawn after the age of 50 - rising to 55 in 2010 - and just 25% can be taken as a tax-free lump sum. The rest can be left invested, used to purchase an annuity or used to buy a drawdown product. Offshore bonds do not impose any of these barriers and allow for the "surrendering" or withdrawal of any amount at any time.
Hall explains: "Surrendering means, for example, if £1m has been invested and a person wants to withdraw £20,000 as income each year, they can do so. It also allows larger lump sums to be withdrawn, for instance £50,000 to buy a yacht. Pension investments are much more restrictive."
Steven Whalley, head of marketing for Scottish Equitable International adds: "People might want to take their money before 50 or 55 - particularly HNWIs. Footballers and deep-sea divers can take it at 35, but are then taxed on the money they withdraw. So they might want to consider taking a look at the offshore option."
Bonds vs Sipps
There is no doubt self-invested personal pensions (Sipps) have come into vogue post A-Day. However, providers are confident offshore bonds will compete well in this space. This is because they offer significant advantages to their UK-based counterparts. For starters, they allow consumers to defer having to pay tax until they claim their benefits.
Paul Sherlin, marketing director of Norwich Union International, explains: "The tax deferral status gives the investor control in deciding when a tax charge may arise. It can prove very beneficial where the investor's tax status has changed, for example, when they are no longer a tax payer, have moved from being a higher rate taxpayer to a lower or basic rate taxpayer, or have moved to a country with lower taxes."
Growth from insurance bonds held offshore rolls up virtually free of taxes, unlike similar investments held onshore, which are taxed at source. Investors can take up to 5% of the initial investment each year, tax free, for up to 20 years. This is because the 5% is treated as a return of capital and not an income withdrawal. Any excess over 5% is taxable.
For expatriates and those planning to retire abroad, offshore bonds can prove particularly useful. For example, someone who works in the UK can decide to retire in another country. They will be subject to the tax rules in that jurisdiction, which more often than not are more lenient than those in the UK.
Another major drawcard of offshore bonds is the sheer range of funds on offer.Rod Macdonald, marketing manager of investment products at Clerical Medical, adds: "Investors are not restricted to just UK collective funds and can access things like hedge funds and deposit accounts."
Whalley adds while the typical onshore bond may have some 50 fund links, the offshore equivalent is likely to be nearer to 150. Better still, an offshore portfolio bond could provide access to up to 23,000 funds.
At the outset, bond management charges can cost between 6% and 8% of the amount invested. This comes on top of fees for the underlying funds, which can total 1.5% per annum. For this reason, it is widely suggested investors should hold the bond for around 10 years.
"Offshore bonds can be more expensive than a mutual fund," Smith warns. "Costs can outweigh the tax savings, so it depends on how different investments are taxed as to whether this is the right thing for someone to do. They are not a universal investment panacea."
Marlene Shalton, certified financial planner at intermediary firm Chambers Morgan James, agrees. "Offshore bonds are an attractive vehicle," she says. "But they are typically more expensive than onshore products, so a reasonable amount needs to be invested. This is why they are more suitable for high earners."
The perception - or misconception - that offshore bonds are dodgy or governed by scanty regulations has also hindered the asset class's popularity in the past. However, with huge financial services firms such as Axa and Canada Life now offering them, this myth is rapidly being dissolved.
Macdonald believes the market will continue to grow by 50%-60% a year, while Hall agrees these are "exciting times" for the class. She adds: "Investors absolutely need to seek financial advice. It is not the sort of thing they can do themselves."
Offshore bonds market has grown by 50% to 60% per year for past two years and this scale of growth is expected to continue
Offshore bonds offer an alternative for retirement saving, following changes to pensions regulations
An advantage of offshore bonds is the sheer range of funds on offer to the investor
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