Could offshore bonds help you with your tax planning?

An offshore bond, also called an international bond, is a type of investment bond issued by a company based outside the UK that offers various tax advantages.

Through an offshore bond, you can invest in assets such as stocks and funds and potentially defer or reduce tax liabilities to some point in the future.

Are offshore bonds solely a tool for the super-rich – or are they a suitable investment for a more typical over-50 investor planning for retirement or inheritance tax?

What’s on this page?

1. What is an offshore bond?
2. How does offshore bond tax work?
3. Who offers offshore bonds?
4. Onshore vs offshore bonds
5. Who should consider offshore bonds?
6. Offshore bonds and IHT planning
7. Disadvantages of offshore bonds

What is an offshore bond?

An offshore bond is a tax-efficient investment wrapper held outside the UK. It’s a legal, regulated investment product. When you invest in an offshore bond, your money is pooled with other investors’ and placed in a selection of underlying investments, such as funds, shares or property. You can typically choose which funds to invest in and switch between different funds within the offshore bond.

Rosie Hooper, a chartered financial planner at Quilter Cheviot, says offshore bonds can be a valuable tax planning tool, but they’re not for everyone. “They tend to suit investors who have already built up a decent amount of wealth and are looking for tax-efficient ways to manage it over the long term – particularly if they’re higher or additional rate taxpayers today but expect to be basic rate taxpayers in retirement.”

This is because offshore bonds offer tax deferral, meaning you don’t pay income or capital gains tax on the bond’s growth until you take money out or fully cash in the bond. This is taxed as income, so the amount and rate of tax depends on the other taxable income.

Each year you can typically take out up to 5% of the initial investment amount into an offshore bond each year and defer any tax owed. This withdrawal allowance is limited to 100% of the initial investment – so you could take out 5% a year for 20 years, or 4% for 25 years.

It means you won’t pay income tax at the time, but can defer the tax charge until the time you choose to cash in the bond completely or take out more than accumulated allowances (if you don’t use 5% in one year, it rolls over to the next year so you could take out 10%).

Joshua Gerstler, chartered financial planner at Orchard Practice, says tax deferral can be useful if your income is currently high, but you expect it to drop in the future – for example, when you retire fully and move into a lower tax bracket. “It’s about timing your tax, which is a subtle but powerful bit of planning.”

It’s important to understand that, like other investments, offshore bonds are not covered by the Financial Services Compensation Scheme (FSCS) and the value of your investment can go down as well as up. It’s also always possible that tax rules could change in future.

What is an offshore bond?

When you withdraw money from an offshore bond, the profit is added to your income and taxed at your marginal rate. For example, let’s say you invest £100,000 in an offshore bond. Each year you can withdraw £5,000 tax-deferred.

• Year 1 - You withdraw £3,000 tax-deferred, with £2,000 allowance rolling over 
• Year 2 - You withdraw £7,000 
• Year 3 - You withdraw £5,000 

Surrendering the bond:

If the bond has grown to a value of £105,000, you will have received £15,000 income from the bond plus an extra £5,000 in growth from your initial investment. This £20,000 is a “chargeable gain” and may be subject to income tax depending on your earnings in that tax year.

However, financial planners can use strategies such as top slicing relief – which averages the gain over the number of years you held the bond – to potentially reduce your tax bill.

For example, say you invest £100,000 in an offshore bond for 10 years and don’t withdraw anything from it. The value has now grown to £150,000, giving you a profit of £50,000. If you’re a higher-rate taxpayer, this would be subject to 40% income tax. But with top slicing, you may be able to spread the gain across the 10 previous tax years.

For over-50s this means that if you plan to retire soon and your income will drop, you might delay encashment until you're in a lower tax bracket. This can make offshore bonds more tax-efficient than other investments taxed annually.

Who offers offshore bonds?

Offshore bonds are typically issued by life insurance companies based in offshore financial centres such as the Isle of Man, Jersey or Dublin. They’re usually classed as single-premium life insurance policies and will make a small payout when you die, although that isn’t really the reason for investing in them. It’s important to note that offshore bonds are still subject to UK tax laws when used by UK residents – which is why it’s vital to take professional advice before investing in an offshore bond.

Onshore vs offshore bonds

An onshore bond is a type of investment bond issued by a UK-based life insurance company and is subject to UK tax rules. 

Onshore bonds offer potential for capital growth and flexibility in withdrawals. When it comes to tax, UK insurance companies pay tax on income and gains inside the bond, typically at 20%.

When you cash in an onshore bond, you may pay more tax, but you receive a credit for the tax already paid within the bond. Unlike offshore bonds, onshore bonds don’t have tax deferral benefits, meaning you can’t do gross roll-up.

Who should consider offshore bonds?

In most cases, offshore bonds are best suited to those with medium to large portfolios upwards of about £100,000, although minimums vary.

That’s because they tend to come with higher charges than other types of investments, and the tax benefits only really become valuable when you’re dealing with larger sums or more complex financial planning needs.

Hooper says: “For someone with a smaller portfolio, an ISA or a pension is usually a more efficient place to start. That said, if you’ve already made good use of your pension and ISA allowances, and are looking for another tax-efficient wrapper, offshore bonds can be worth exploring, even for more modest sums. It depends on your situation and your future income plans.”

Some examples when offshore bonds might be useful include:

1. If you’ve come into an inheritance, especially if you’re already a higher-rate taxpayer.  

2. For some people planning to move at a later date to another country where they will be domiciled for tax purposes, particularly if tax rates are lower there. 

3. To gift to family members – which may be tax-efficient if the recipient is in a lower tax bracket.

When it comes to giving away a bond, this can be done without triggering a tax charge, as long as no cash changes hands.

You can give away all or part of a bond. Usually the bond is divided into equal segments. So if you invest £100,000, you could have 10 segments of £10,000. If you choose to gift £50,000 to a child or grandchild, you could assign five segments of the bond to them without incurring a tax charge at that point. If they are a non-taxpayer, there may be no tax to pay when money is withdrawn. Your child or grandchild could also benefit from any unused 5% withdrawals carried over on the segments assigned.

Offshore bonds and IHT planning

Offshore bonds can be a good option for inheritance tax planning for parents or grandparents who want to pass on wealth while controlling access. They can be placed in trust relatively easily, which means the value of the bond sits outside your estate for IHT purposes if you live a further seven years.

Hooper says the combination of tax deferral during your lifetime and smoother estate planning on death can make offshore bonds a useful tool for passing on wealth. “For example, if you’re over 50 and starting to think about how to pass money to your children or grandchildren, putting a bond in trust allows you to make a gift while still keeping some control over how and when it’s accessed. It can also help your family avoid delays during probate, depending on the structure.”

• Read more about setting up a trust for your children or grandchildren. 

Disadvantages of offshore bonds

While offshore bonds offer flexibility and tax planning benefits, they also come with high setup and annual fees. ISAs have a more generous tax treatment, so it’s usually best to make the most of your ISA allowance before you invest in offshore bonds.

The tax treatment can be complex, especially when it comes to top-slicing or assigning the bond to others. If not managed properly, withdrawals can push you into a higher tax bracket or affect entitlements like the personal allowance or child benefit. As with any investment, the suitability of an offshore bond comes down to your goals, your tax position, and how you plan to use your money.

As with any investments, they can fall in value as well as rise, and you may not get back the value you put in. Given the potential benefits and complexity of offshore bonds, it’s recommended to seek professional advice. In fact some providers will only allow you to invest in an offshore bond if you speak to an independent financial adviser first.

Gerstler warns: “These are not ‘ready-made’ investments. The tax rules around them are more complex than for pensions or ISAs, and the wrong use can cause more harm than good. For instance, taking large withdrawals at the wrong time can trigger unexpected tax bills.”

An independent financial adviser can assess whether offshore bonds fit into your wider retirement, tax and estate planning goals.