Are Offshore Bonds a Good Alternative to Annuities?

In the absence of economic stability and steady interest rates, offshore bonds are back in the spotlight.

According to the UK arm of insurer Canada Life International, investments in offshore bonds were up by 60 per cent in the first half of this year, and a number of British insurers and building societies have been quick to capitalise on the trend by offering their own competitively-priced offshore products.

Meanwhile, annuity rates have been consistently poor for more than a decade, reaching an all-time low last summer in the wake of the Brexit vote.

Add in rising inflation and dwindling savings rates, and the average pensioner would be forgiven for wanting to ditch their annuity plan and start investigating offshore options which can offer a regular, tax-free income.  

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What are Offshore Bonds?

Offshore bonds have had some bad press in recent years. The Panama Papers revealed how the rich and famous have been able to avoid tax over the years, while a number of household names were exposed for their barely-legal offshore dealings on the Cayman Islands back in 2012.

But for the average saver, offshore bonds are a completely legal, ethical and low-risk form of investing. And you don’t have to send your money across the Atlantic to benefit from the tax-free returns offered by these investment vehicles. Some of the best rates for over-60s are available in UK-based offshore jurisdictions such as the Isle of Man, Gibraltar, and the Channel Islands.

Offshore bonds work in a similar way to annuities, but with more flexibility and some unique tax benefits. As long as your money is being held in an offshore vehicle, it is exempt from the usual UK tax laws. For instance, under ‘onshore’ rules, a £100,000 one-time investment would be subject to either capital gains tax or the higher rate of income tax, depending on the origin of the cash.

Under ‘offshore’ rules, this money is essentially shielded from UK tax law until such time as you choose to withdraw it. For anyone over the age of 60, this can be a great way to defer taxation until after your retirement, when your tax liability will be much lower.

Unlike most onshore bonds, offshore bonds can be purchased either as a whole, or in a number of segments. This means that you could either lock away your £100,000 for a fixed period of time, or use it to buy 100 £1000 ‘segments’ of the same bond.

Investors can withdraw up to five per cent of each segment each year, without any immediate charges for taxation. If no withdrawals are made, the five per cent allowance is carried over to the next year and so on, so by year four, you could withdraw up to 20 per cent of each bond segment, tax free.

If you wish to use your bond as an alternative to an annuity, you can use the five per cent allowance to pay yourself an income, while also benefitting from tax-free returns.

Should You Invest in Offshore Bonds?

As with any investment, there are limitations and risks associated with offshore bonds. First and foremost, before you invest in any bond you should ask to speak to the portfolio manager or request a copy of the most recent portfolio report.

There is a big difference between secured bonds and unsecured bonds, and this is usually reflected in the returns being offered. As a general rule, the higher the returns, the higher the risk.

Unsecured bonds offer some of the best rates on the market, but the risk cannot be ignored. If the borrowing party defaults on their repayments, the investor could be left with nothing. By comparison, secured bonds involve some form of collateral, which can be used to make up any shortfall in their repayments.

There are also some financial limitations for investors. Most offshore bonds require a minimum investment of at least £5,000, and then there are joining fees, administrative fees, and commission charges to consider.

If an offshore bond is offering you three per cent in annual returns, you will have to adjust that figure to cover your costs. It is also worth noting that you are still liable to pay UK taxation on any interest payments received from your offshore bond.

However, you can avoid this by automatically reinvesting the interest into the bond before it reaches your onshore account.

For many investors, the ability to lock this money away for a fixed period is one of the main advantages of the offshore bond. If you received a substantial windfall during your last few years of employment, you may have to pay the higher rate of tax on the total amount.

However, if you place that windfall into a fixed-term offshore account, you can preserve your capital (while receiving interest payments) until you have retired, when you are likely to be on a lower tax band.

Having said this, potential investors should always be aware of the changing tax laws and HMRC rules regarding offshore bonds. These laws are always changing, and the penalties can be steep if you do not comply.

As long as you are fully informed of the benefits and risks of offshore investing, you can use these bonds to maximise your savings and manage your money post-retirement.

Choose the right product, and in the current economic environment, you could even end up with a much better alternative to a standard annuity.

Kathryn Gaw

Kathryn Gaw is a financial journalist based in Belfast, Northern Ireland. She has been writing about personal finance and investment trends for more than a decade, and her work has been featured in the Financial Times, City A.M., the Press Association, and The Irish Independent, among many other publications.