For many, offshore bonds prove a suitable alternative to pensions, with their inherent flexibility and tax efficient features. Christine Hall reviews this growing market
If you believed the Government's initial estimates that around 5,000 people would be affected by the pension standard lifetime allowance, or that this figure will increase by 1,000 each year, then stop reading now. The chance of your having a large number of these clients will be slim.
If, however, you accept that these figures massively understated the position, or you have clients who:
- want to contribute more than their salary and/or annual limit,
- are close to breaching the lifetime allowance,
- adopt aggressive investment strategies and don't want the upside 'capped' and/ or
- have chosen, or are considering, primary or enhanced protection
then they are likely to be seeking tax efficient alternatives to pension arrangements.
There is without doubt a number of significant advantages for investing in a pension arrangement. These are specifically, tax relief on the contributions, near gross roll up of the fund, the fact that the fund is in an inheritance tax advantageous position if the death of the member occurs before retirement and the potential to take a pension commencement lump sum at retirement.
As an alternative to investing into a pension arrangement for retirement, a number of clients may favour the additional flexibility that investing in an offshore bond will give them. An offshore bond can also complement existing pension arrangements in a number of ways, particularly as investments held in an offshore bond wrapper are taxed similarly to a UK pension fund.
Tax relief is not available on contributions paid into an offshore bond and proceeds from the bond are taxable when redeemed. However, there is no further penalty applied to the amount taken from an offshore bond - unlike the 55% tax charge applied to any vested pension funds over the standard lifetime allowance where the client hasn't elected for protection from the lifetime allowance charge. This tax charge potentially becomes even greater if an individual lives until age 75 and at that time they purchase an alternatively secured pension (ASP).
If it is assumed that the member of the ASP plan is single at their date of death, and that their nil rate band is used up by non-pension assets, then the ASP will effectively be reduced by an 82% tax charge if the fund was distributed to, for example, a family relation on the death of the member. Of course, the proceeds from an offshore bond will form part of the investor's estate for inheritance tax purposes unless written in an appropriate trust.
An offshore bond might be an appropriate solution in the four client scenarios described previously, since it can provide a number of advantages.
An offshore bond provides investors with the ability to invest as much as they wish, when they wish - whatever their current salary.
Contrast this with the pension contribution limits. An individual's personal contribution to a pension arrangement is eligible for tax relief on the higher of £3,600 gross, or 100% of their earnings chargeable to UK tax in the current tax year. While there is no limit on the amount of contribution that an employer can pay in respect of an individual, it is important to remember that to achieve full tax relief contributions payable for connected party individuals must be accepted by the local inspector as satisfying the 'wholly and exclusively' rule. In essence, this means that the contributions must have been made for genuine business reasons and be part of a reasonable overall benefits package for the individual concerned.
For those who would prefer a more disciplined or structured approach to saving, a number of offshore companies offer regular premium offshore bonds which can also accept single premiums.
No lifetime allowance. For those investors worried about the possibility of exceeding the standard lifetime allowance, it may be prudent to redirect some or all of the future pension contributions to an offshore bond. The decision as to whether to redirect pension contributions will depend upon a number of factors, see box for details.
Offshore bonds have no contribution limits placed upon them and typically offer a choice of charging structures, which can be especially useful where large investments are concerned. It should be remembered that a chargeable event will occur when the offshore bond is ultimately surrendered, resulting in a potential tax charge on the investor.
No performance 'cap'. For adventurous customers who may still be some way off the standard lifetime allowance, the thought of strong investment performance causing a lifetime allowance charge to occur could be a concern. Primary protection will not be an option for these clients as this form of protection is only available to individuals where their total eligible fund at A-Day was in excess of £1.5 million.
Enhanced protection is also unlikely to be of interest, as this form of protection is only available to individuals who ceased active membership of all pension schemes at A-Day. So for those individuals who may be some way off the standard lifetime allowance the ability to pay additional contributions might outweigh the benefit offered by enhanced protection.
Furthermore, some pension contracts may not be able to offer access to the investment choice required for these customers. They may be invested in an older style contract with a limited fund choice and could be faced with high penalties if they elect to transfer their pension benefits to one offering a greater investment choice.
An offshore bond provides an extremely wide choice of investments and has no penalties on the returns obtained.
Clients who have elected for primary or enhanced protection are likely to need an alternative tax efficient savings vehicle to support any further retirement planning. Primary protection will, at best, only allow a minimal contribution to be made by an individual without incurring a lifetime allowance charge at retirement and enhanced protection does not allow any contributions to be made to any pension arrangements after A-Day. A regular premium offshore plan might prove to be a suitable investment vehicle for those contributions that would previously have been invested in a pension arrangement.
For those clients who have elected for primary protection an offshore bond could be used to support the more adventurous portion of their investment strategy. Meanwhile the pension could take a more cautious approach to reduce the chances of fund performance taking them above the protected level and incurring a lifetime allowance charge.
As the client approaches retirement it will become clearer as to whether or not their fund is likely to exceed the then standard lifetime allowance. Subject to salary and contribution limits, further pension contributions could be made nearer retirement to make up for any shortfall between the pension fund value and the lifetime allowance at that time.
These contributions could be taken from the offshore bond which, until then, would have benefited from virtually tax free growth. It should be remembered that any chargeable gains made when the bond is surrendered will be liable to income tax. As an alternative, consideration could be given to taking a withdrawal of 5% of the original investment, tax deferred, from the offshore bond. In addition any unused 5% withdrawals from previous years could also be taken. These withdrawals, subject to salary and the annual limits, receive tax relief if they were used to fund a pension contribution - helping a client to get the best of both worlds!
Factors affecting the redirection of pension contributions
- the current pension fund value,
- the level and timing of future pension contributions,
- the assumed growth rate of the pension fund until retirement, and
- the assumed standard lifetime allowance as at the selected retirement date.
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