Investment special focus: Vince Smith Hughes

Retirement Planner talks to Vince Smith-Hughes about the role offshore bonds can play in a retirement planning strategy

How are people using offshore bonds?

So far, people are mainly using them as a complement to their pension planning rather than a replacement for it.

One of the main reasons people pick offshore bonds is for flexibility. For instance, you cannot access your pension whenever you want to, whereas you can with an offshore bond.

This can be very useful, for instance, when someone has had to retire earlier than they planned. If they take their occupational pension early then they may well face a charge.

They could also miss out on years of investment growth and could purchase a lower annuity as a result.

If you have an offshore bond then you can use that to provide a bridging income until the time comes to access your pension that is the real advantage of having an offshore bond as part of your retirement planning.

Tax wise, there is no upfront tax relief on an offshore bond the way you would have with a pension, but what you do get is gross roll up and then you will pay tax on the gain once you access it.

If you were to retire early and need the money then you can cash in part of the bond as they are generally split into segments.

You also only get taxed on the profit and so bearing in mind that individuals have personal allowances of £7,475 then if the profit made on that section of the bond is less than that, it is tax free.

For those who are 65 plus, there is an increased personal allowance so paying little or no tax becomes even more likely.

You are also allowed to take out up to 5% tax deferred every year so the client has a range of options available to them.

Finally, the combination of offshore bonds and income drawdown can be a particularly powerful strategy to minimise personal taxation.

What are the key benefits of using offshore bonds?

Recent pension reform means that pension investors now have a £50,000 contribution limit per year so high net worth investors who wish to invest more than that can use an offshore bond for the excess.

Also, if people are working abroad they may not be able to contribute to a UK scheme and so may choose to invest in an offshore bond.

It is also worth pointing out that offshore bonds are very portable.

All of these reasons tend to stem from tax and accessibility issues but there are also benefits in terms of investment.

For instance, we offer an open architecture bond with over 3,000 options for those high net worth individuals who wish to construct a sophisticated portfolio and need a lot of options.

For those people who don’t need so many options, we have a simpler product available with around 60 investment choices.

There are also no taxes on switching; if your client wanted to go from one unit trust to another and to another then they might have to pay capital gains tax (CGT), but they would not have to do this in an offshore bond.

Also, some offshore bonds might give you up to ten switches per year free of any dealing costs.

Because you only pay tax when you cash in part of the bond this gives the holder real flexibility in terms of when they pay tax, which adds to the flexibility of the product.

For instance, if you were a higher rate taxpayer when you worked but became a basic rate taxpayer in retirement, then you can reduce your tax bill by cashing in the bond after retirement.

Also, if you go to work abroad and are no longer subject to UK taxes, you will only need to pay tax in the country in which you live.

You can also assign the bond to another person if you wish and that means you do not pay tax on it but the person who it has been assigned to will.

So if you are a higher rate tax payer in retirement but your spouse is a basic rate tax payer, then you can assign the bond to your spouse, who will pay less tax. You could also put it into trust for inheritance tax purposes or even give it to a child or grandchild to help pay university fees.

Have you seen a rise in demand for offshore bonds over the past year or so?

We have not seen a massive rise in demand as yet, but the conversations are certainly starting.

Over the past couple of years I have noticed that offshore bonds are becoming increasingly mainstream rather than just for high net worth customers.

Indeed, I believe the split between onshore and offshore bonds is rapidly levelling and I think for all of the reasons above we will see the offshore bond market grow considerably over the next few years.

Vince Smith-Hughes is head of business development - retirement income at Prudential