Onshore or offshore – that is the question. Shoaib Ahmed, Senior Technical Manager at M&G has the answer, to five of the questions that paraplanners are still being asked.
The decision on whether to use an onshore or offshore investment bond can have a significant impact on a client’s future financial position.
In order to decide between onshore or offshore, paraplanners need to ascertain what the client’s income is likely to be in the year of encashment, along with the client’s time horizon and investment strategy.
Below are five of the most common technical questions that continue to arise regarding the onshore vs offshore debate.
1. How does the investor compensation compare?
With an onshore bond that is invested in an insured fund, policyholders are protected by the Financial Services Compensation Scheme (FSCS). If a provider is unable to meet their obligations, then compensation up to 100% of the value of a policy will be paid, with no upper limit.
As offshore bonds are issued in jurisdictions outside the UK, then they are not protected by the FSCS and instead, the protection will depend on the jurisdiction the bond is issued in.
For bonds issued in Dublin (Ireland), there is no formal compensation scheme, but policyholders do benefit from the robust regulation set out by the Central Bank of Ireland (CBI) and European Union (EU).
For bonds issued in the Isle of Man, there is the Isle of Man Policyholder Compensation Scheme which means a policyholder could be compensated up to 90% of the policy’s value.
However, it is important to understand that any compensation payout would be funded through a levy on other policyholders from other companies, so it does not work in the same way as the FSCS.
Importantly, both Ireland and Isle of Man require offshore bond providers to segregate client assets, which adds a critical layer of protection.
In summary, the lack of FSCS protection might be a concern for some clients, but this should not be a significant reason to avoid using offshore bonds.
When you combine the regulation, segregation of assets and the financial strength of providers who operate in this market, the likelihood of a compensation scheme ever being needed is remote.
2. How important is the client’s expected tax position at encashment?
It is the most important factor when deciding whether to go onshore or offshore.
For clients who are going to be non-taxpayers at the point of encashment, then going offshore is quite frankly a no-brainer.
This is because the chargeable gain can be offset against an individual’s allowances. When you account for the personal allowance (£12,570), starting rate savings band (£5,000) and personal savings allowance (£1,000), then a non-taxpayer can surrender up to £18,570 in chargeable gains per tax year and pay no tax!
If this type of planning is repeated over a number of tax years then the tax saving potential could be huge.
For clients who will be taxpayers, then the decision to go onshore or offshore is more complex as the client’s exact income at encashment, time horizon and dividend component of investment return will impact the break-even point.
And by break-even point, I am talking about at what point in time does an offshore bond become more advantageous than an onshore bond.
For example, an individual investing £250,000 with a gross return of 7.4% (of which 20% was dividend component) would have to invest for at least 9 years before an offshore bond became more advantageous than an onshore bond.
In this same case study, we established that a higher or additional rate taxpayer at encashment would need to wait 18 and 21 years respectively for their break-even point.
3. How does the internal tax work?
Within an onshore bond, any capital gains and interest/rental income will be subject to tax at 20% (rising to 22% from April 2027).
However, any dividends are exempt from tax, and this has the effect of reducing the overall rate of internal tax on the bond.
In very simple terms, if an investment in an onshore bond produced a return which was fully comprised of capital growth and contained no dividend element, then the internal tax would be 20%.
However, if an investment in an onshore bond produced a return which was comprised of a 75% capital growth component and a 25% dividend component, then the internal tax rate reduces from 20% to 15% (75% of 20%).
What this means in practice is that holding dividend producing investments in an onshore bond are highly tax efficient.
But it is important not to let the tax tail wag the investment dog, so the choice of investment should not be driven by tax.
As for offshore bonds, the position is much simpler. There is gross roll-up which means there is no internal tax (some withholding tax may apply but this is minimal).
So if you had the same investment in an onshore bond and offshore bond, the latter would grow faster as there is no tax drag in the investment.
4. Does gross roll-up mean the offshore bond will always be more tax-efficient?
No.
Although an offshore bond should grow faster than an onshore bond, it is important to remember that what matters is the post-tax return, and this is where onshore bonds have a distinct advantage over offshore bonds for clients with higher or additional rate tax exposure.
The table below runs through a scenario where there is a gain of £100,000 for a higher-rate taxpayer. It assumes the £500 personal savings allowance has been used elsewhere.
The above table highlights that the internal tax in an onshore bond creates an effective rate of tax of 36% for a higher-rate taxpayer.
Whereas with an offshore bond, the higher rate taxpayer has an effective rate of tax of 40%.
So, in simple terms, in order for the offshore bond to “win”, the funds would need to remain invested for longer and for the gross roll-up to outweigh the lower effective tax rate on an onshore bond.
5. Does placing a bond in a discretionary trust impact the decision?
No, the same factors determine whether you should go onshore or offshore e.g. expected tax rate of beneficiary (or settlor) on encashment, time horizon and dividend component of return.
For example, if a discretionary trust has beneficiaries who might be non-taxpayers during certain stages in their life, then an offshore bond could work really well.
Real-life examples of this are school fees planning for grandchildren, where the beneficiary is almost certainly going to be a non-taxpayer, meaning a deed of appointment could result in tax being paid at 0% on bond gains.
Another benefit of using an offshore bond in a trust is that you can opt for a capital redemption version of the bond.
This helps ensure the bond will run for a significant period of time (e.g. 99 years), and you do not need to be concerned about a life assured’s death bringing an end to the bond.
In summary, I think offshore bonds are the more common tax wrapper for discretionary trusts, but that’s not to say onshore bonds cannot work for certain families, especially where the beneficiaries are always likely to be higher or additional-rate taxpayers.
Webinar
If you want more detail on the taxation of onshore and offshore insurance bonds then check out this recording of our May 2026 Techy Thursday: Events & CPD | Tech Matters | M&G for Advisers
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