Benefits of Portfolio Bonds for British Expatriates
Under HMRC tax rules ‘foreign investment bonds have extra tax planning benefits compared
with their domestic counterparts. The purpose of this article is to highlight the most significant.
An offshore portfolio bond adds the legal and tax shield of a life insurance policy to an
investment portfolio. This tax efficient wrapper can hold a wide array of assets such as shares,
mutual funds and exchange traded funds.
Investment bonds have long been used by international investors to legally manage and mitigate
tax liabilities. Tax liability on gains (which would usually be due for the present tax year) can be
deferred to potential liability for tax later (when the individual may be in a lower tax bracket or a
more favourable tax jurisdiction).
Portfolio bonds offer flexibility, choice and are typically located in low-tax jurisdictions that have
robust investor protection legislation. You can retain a bond as long as you wish to do so
because they are not close-ended. As you can hold such a wide variety of assets within a
portfolio bond, you have superior worldwide investment choice and maximum diversification
benefits. An individual’s portfolio bond should be appropriately diversified and personalised in
accordance with their attitude to risk and financial planning goals.
Whilst the policyholder is offshore (non-UK resident), the underlying investments can grow in a
tax efficient environment throughout the holding period. On realising the investment, any
potential tax charge is dependent on your country of residence, For British expatriates, portfolio
bonds have tax planning benefits even when you have repatriated back to the UK. The
information below refers to policyholders who are UK resident at the time of withdrawal.
Gross Roll-Up
Investment in an offshore bond grows free of year-on-year income tax and Capital Gains Tax
charges, unlike equivalent onshore bonds. This means that funds within the bond can be
exchanged without incurring a Capital Gains Tax Charge and without the need for tax reporting.
Moreover, the income that is then reinvested into the bond does not incur an income tax charge.
Minor amounts of irrecoverable holding tax may be owed on certain assets in the country where
the income was produced, but the assets in which a policy invests are not subject to taxes in the
insurer’s jurisdiction.
Control over Tax
Tax deferment is an important feature of offshore bonds. Compared with an onshore bond you
will have greater control over how much, and when, income tax is paid. This enables you to
choose when a tax charge may occur, for example when you cash in some of or your entire
bond. The tax payable at the point of a chargeable event will depend on your highest marginal
rate at that time, giving the opportunity to defer such an event until you are either no longer a
tax payer, or have relocated to country with lower taxes.
Accessing your Money
The ability to take regular withdrawals from their investments is very important for many
investors and this is a feature offered by most portfolio bonds. Most offshore bonds enable you
to have access to some or all your investment should you need to.
British expatriates who return to the UK can take 5% deferred tax withdrawals annually. 5%
withdrawals are treated for tax purposes as return of capital, rather than income. 5% of the
initial premium and any additional premiums for the year in which they are added can be taken
without an immediate tax charge. This lets you turn your existing capital into a tax efficient
income stream. This is an extremely valuable benefit for higher-rate taxpayers.
Taking similar withdrawals from a portfolio of units trusts may result in an annual tax charge.
This 5% amount can be taken every year for 20 years, or it is cumulative if not used. For
example, if no withdrawals are taken for five years, one could then take a 25% withdrawal
without triggering a chargeable event.
Gift Assignment
Where the policyholder is a higher rate taxpayer, assigning individual segments or the whole
policy to a non-tax (or lower rate tax) paying spouse or adult child is a tax effective way of
passing assets on between family members, as all future UK income tax is charged at the new
owner’s tax rate (if any).
Therefore, the overall UK tax payable can be reduced if the bond is assigned as a gift to a nontaxpayer, for example a non-working spouse or a child/grandchild of the assignor.
Bonds can be assigned, unlike pensions or ISA’s. Assigning a policy absolutely to a third party as
a gift is not a chargeable event for tax purposes. There is no UK income or capital gains tax
charge on the assignor at the time of assignment.
Trusts
Bonds can be placed in trust and taken out of a trust without giving rise to income tax or capital
gains tax. Wrapping your offshore portfolio bond in trust means you can offset or wholly
mitigate taxes due when transferring capital. This provides generation planning and asset
protection advantages, as it may be possible to reduce or eliminate UK inheritance tax liabilities
and can remove the requirements of probate.
Time Apportionment Relief
Time apportionment reduction applies on full surrender of the policy (or segments) if you have
been non-UK resident at any time during the term of the policy. Any UK income tax on any gain will
be reduced proportionately for time spent as a non-UK resident. The gain after time
apportionment reduction will be subject to income tax at the beneficiaries’ applicable rate (not
capital gains tax).
Tax calculation is
𝐶ℎ𝑎𝑟𝑔𝑒𝑎𝑏𝑙𝑒 𝑔𝑎𝑖𝑛 𝑓𝑜𝑟 𝑡𝑎𝑥 = 𝑇𝑜𝑡𝑎𝑙 𝑔𝑎𝑖𝑛 𝑥
𝑇𝑜𝑡𝑎𝑙 𝑛𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑑𝑎𝑦𝑠 𝑖𝑛 𝑡ℎ𝑒 𝑈𝐾 𝑑𝑢𝑟𝑖𝑛𝑔 𝑏𝑜𝑛𝑑
𝑇𝑜𝑡𝑎𝑙 𝑛𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑑𝑎𝑦𝑠 𝑏𝑜𝑛𝑑 ℎ𝑎𝑠 𝑒𝑥𝑖𝑠𝑡𝑒𝑑
For example, if you have held a bond for eight years prior to full surrender, and you were UK
resident for 4 of those years, the chargeable gain is reduced by half (4/8).
Time apportionment relief starts from the commencement of the policy, even for premiums paid
into the policy further down the line. For British expatriates likely to return to the UK at some
point, this makes it beneficial to start the bond early.
For example
British expatriate in Switzerland opens the bond and invests £70k. In year 7, he invests a further
£150k into the bond. The following year he returns to the UK. After twelve years of holding the
bond, he withdraws the full amount of £310k.
Using the formula above, the chargeable gain is a third of the total gain (4yrs/12yrs).
Total gain: 310k – 70k – 150k = £90k
Chargeable gain: £30k
Segmentation
Most bond providers permit their policies to be split into several segments. Each segment is a
policy in its’ own right, which has advantages for tax planning purposes. The segmented bonds
provide an alternate way of accessing capital without surrendering the whole bond. When a
segment is surrendered, the chargeable amount of tax is directly related to the performance of the
bond.
This differs from a cash withdrawal across the whole bond, where payments more than the 5%
allowance are immediately taxable.
An important consideration is that surrendering segments reduces the 5% allowance available in
all subsequent years as it will be based on the initial premium left in the remaining segments.
Example
A premium of £120,000 was invested as 12 segments. After four years, it is now valued at
£150,000. A sum of £37,500 is required by the policyholder.
Using the 5% allowance
Using segment surrender
Available allowance: 4 years x 5% =
20%
One segment valued at £12,500
£37,500 requires 3 segments.
20% x £120,000 = £24,000
Excess amount= £37,500 - £24,000 =
£13,500
Chargeable excess: £13,500
Gain on 1 segment is £2500 (£12500 £10000)
£2500 x 3 = £7500 chargeable gain
Top Slicing Relief
Top slicing relief is only pertinent if you are already a non-higher rate taxpayer when the
chargeable event occurs. The relief can’t benefit you if you are already a higher rate taxpayer
before the chargeable event gain is added to your income.
If you are a non-higher rate taxpayer and the gain from the bond results in your total income
falling into the higher rate tax-band, then top slicing relief will apply. Top slicing governs what
proportion of the gain (the ‘slice’) is liable for higher rate tax.
The gain is sliced by the number of complete policy years the bond was in force, reduced by the
number of years of non-UK residency.
In the year of surrender, the reduced gain is added to taxable income, which could mean that the
policyholder will not fall in the higher rate (40%0 and additional rate (45%) rates of UK income tax
on very large taxable gains.
Example
The chargeable gain after time apportionment relief is £70,000 and the bond owner was UK
resident for the past seven years having invested in the bond twelve years ago whilst living in
Switzerland.
The bond owner at the time of surrender is a basic rate taxpayer with taxable income after
allowances of £26,000. The gain is divided into seven slices of £10,000 which is added to the
taxable income of the bond owner making a total of £36,000. The basic tax rate threshold is
£32,000 for UK tax year 2016/2017.
£32,000 - £26,000= £6000
£6000 x 20% = £1200
£36,000 - £32,000 - £4,000 x 40% = £1,600
Tax on one slice= £2800
Total tax payable on the chargeable gain= £2800 x 7 = £196000
Disclaimer
Many offshore portfolio bonds offered are transparent, low cost, efficient tax planning
structures, although care must be taken to avoid misusing such a ‘tax wrapper’. The potential
benefits and disadvantages of these bonds depend on one’s individual situation, and anyone
considering their choices should seek expert advice from a reputable financial adviser.
Contact Us
To discuss your options for your personal situation, please call us on +41415087510 or email us
at [email protected] to arrange an appointment with an adviser.