Advisers warn investors over offshore bonds

Offshore bonds are growing in popularity as investors try to shield their wealth from the top rate of income tax, set to rise to 50 per cent in April. But advisers have warned that the tax wrappers are not suitable for all.

Offshore bonds are usually recommended to people on higher rates of tax who are set to pay a lower rate of income tax in the future – perhaps after retirement – or who are planning to leave the country. Income tax is only paid on the products when they are encashed, making them a way of deferring income tax bills.

Killik & Co, the advisers, also uses offshore bonds for higher-rate taxpayers with cash on deposit.

Investors with large portfolios are often told to buy bonds in segments – for example, for £10,000 each. When they need to make withdrawals, they can encash one segment at a time, which is more tax efficient. Investors should check that their tax adviser does not instead make withdrawals across all their bond holdings, which can incur higher tax.

Theresa Parker, 29, invested more than £250,000 in offshore bonds five years ago after taking advice from a private bank. But when she wanted to withdraw £70,000 for a deposit on a house this year, she was told the tax bill would be £21,000. “It came as a surprise that I had to pay that much tax,” she says.

Some advisers refuse to recommend offshore bonds, however. Charles MacKinnon, head of Thurleigh Investment Managers, describes the products as “toxic waste”. He argues that the products come with relatively high fees – about 150 basis points a year – and have restricted investment choice.

He also says it is difficult for most clients to predict whether they will be paying a lower rate of tax in 10 years’ time, or whether they will have left the country.

“Trying to make that level of judgment is a leap of faith,” he cautions. “The simple truth is that if an adviser can get a client to go into a bond, the adviser has a revenue stream of 0.75-1.5 per cent a year for a minimum of six years – so the incentives are massive for the sales people.”

Charlie Hoffman, head of HSBC Private Bank, says investors should also check that products taxed as capital gains are not being put into their offshore bonds, as this is likely to be tax inefficient.

Lee Smythe at Killik warns that there is little point investing in an offshore bond if investors pay the same rate of tax when they encash the bond, due to the charges they incur. “You’ll be worse off to the tune of the charges as you haven’t gained anything – you’ve just deferred the tax you would have paid anyway,” he says.

“For UK-resident domiciled people who aren’t planning on leaving, you’re better off with a direct investment subject to capital gains tax than an offshore bond,” says Smythe.