The offshore bond ‘biscuit tin’ solution
15 July 2019
Many advisers find they face the dilemma of what to do with their income and asset-rich clients who are maxed-out on their Lifetime or Annual pension allowances and have all but exhausted all other conventional UK tax-breaks. Do you advise them to simply gift it all away, or are there other tax-efficient options that would still allow them to retain and control their wealth? Prudential’s Technical team looks at the issue and a potential solution.
For just over 30 years, offshore bonds have been a HMRC-compliant solution for a variety of UK client tax planning issues. They are not a solution that’s suitable for everybody, but for those clients maxed out on pension funding and otherwise facing a tax bill they’d like to avoid, offshore bonds do provide some additional scope for financial planning.
In this article, Les Cameron, Head of Technical at Prudential, looks at how offshore bonds can be used as a vehicle to complement existing pension funding and income draw-down, by providing a flexible home for excess income and capital… a supplementary financial ‘biscuit tin’ if you like.
The bald facts
A UK pension scheme is still a highly tax-efficient method of funding retirement income and for those that are eligible or able to fund such arrangements, it remains the main basis by which this objective is achieved. However, over recent years the contribution limits and overall amount allowed to be taken without a tax charge have reduced.
The opportunities for individuals to contribute to pensions have been significantly reduced in recent years. The Annual Allowance, limiting the total contributions for an individual regardless of whether funded by an individual or their employer, is now only £40,000 per annum, and can be further reduced for those earning above £110,000. There is of course the ability to carry forward up to 3 years of unused annual allowance giving scope for larger contributions.
Another sting in the tail is if they access their pension benefits flexibly they could see their ability to make money purchase contributions restricted to £4,000 per annum.
On top of the savings limits there’s an overall limit on benefits that can be taken without tax penalties. The Lifetime Allowance, is £1,055,000 for 2019/2020 tax year, well below the high of £1.8 million and has been increasing by CPI for the last couple of years from its £1million low point.
Penalties for breaching these limits can be penal. If the Lifetime Allowance is exceeded, there’s a tax charge of 55% on the excess if taken as a lump sum and 25% if retained in the pension. Income tax is levied on any income payments as normal. Exceeding the Annual Allowance results in the excess being taxed at the member’s marginal rate.
What can be done?
Depending on the client’s individual circumstances, in any one year there may be a number of ‘tactical’ options open to an adviser to deal with pension funding and draw-down issues. However, there will be client’s where using their investable capital or excess income to fund their pension will no longer make financial planning sense. And if that is the case, there may be some merit to putting in place a flexible alternative solution that can supplement the pension and cope with these issues on an ongoing basis.
An offshore bond represents just such an option and can provide a complementary part of overall retirement planning.
The ‘biscuit tin’ solution
You may think offshore bonds are for “big money” but they’re not, as an example the Prudential International Investment Bond, the initial contribution is as little as £20k and can be topped-up at any time with £15k or more. It’s probably money on which income tax has already been paid, there will be no tax relief on entry like a pension, but the legitimate options to defer, manage or even avoid paying further tax on it are not that obvious these days. While the money is in the bond, it enjoys gross investment roll-up on a potentially diversified portfolio to fit the client’s needs. The bond wrapper makes investment options available that aren’t generally available – smoothed funds and investment guarantees spring to mind (obviously…). These could be useful if the client is looking to see some protection from stockmarket volatility or downturns.
Withdrawing money from the bond is equally flexible. Unlike a pension scheme, benefits can be taken at any age, in the form of either lump sums or regular payments as required. It can also be used to supplement pension income when the pension is in payment.
Similar to onshore bonds, it’s possible to take part surrenders of up to 5% of total investment without any immediate liability to income tax. This makes it possible to defer the tax charge until a time of the client’s choosing, possibly when they’re in a lower tax band.
The 5% allowance doesn’t have to be taken each year and can be accumulated for up to 20 years (5% x 20 years = 100%). Withdrawals within the accumulated allowance can be withdrawn without creating a chargeable tax event.
Client’s with flexible pension arrangements could manage their pension income levels in any given tax year, to ensure their bond withdrawals are taxed at a rate of their choosing. That’s if it’s taxed at all!
Offshore bonds are taxed as savings income. In a tax year where there is no other income, the personal allowance, starting rate for savings and personal savings allowance can see gains up to £17,850 (2018/19) taken with no tax liability.
This provides clients with a great deal of flexibility regarding how and when they can liquidate their investment. Clients making top-up investments also benefit from being able to take annual withdrawals on the larger amount, deferring and managing the tax event in the same way. If the client does not need the full value of the bond, it can be assigned to another family member or put into a trust to assist with inheritance tax planning.
Offshore bonds therefore represent an excellent ‘biscuit tin’for supplementing pension funding. Combining a pension and offshore bond tax wrapper creates a flexible, tax efficient portfolio of options to help client’s make the most of their retirement.