5 min read 21 Jun 21
Insurance bonds have been used by advisers for more than 40 years to allow clients to combine investment growth potential, tax-efficient withdrawals and life insurance. But is an onshore or an offshore bond right for a client? We take a look.
Onshore and offshore bonds are similar in many ways (see panel overleaf). Most importantly, both allow up to 5% of the accumulated premiums to be taken each year without any immediate liability to tax, which can provide a valuable source of tax-efficient withdrawals for many clients.
This allowance is cumulative so any unused part of the 5% limit can be carried forward to future years, provided the total withdrawn is never greater than 100% of the amount paid in.
Because offshore bonds may be located in jurisdictions such as Dublin, the Channel Islands or the Isle of Man, there are important differences in how they are taxed compared to onshore bonds – see panel below. Offshore bonds may also offer a wider choice of investments.
1. Internal tax treatment
Onshore bonds are subject to UK corporation tax on interest, rental income and gains (but not on dividends). Offshore bonds are issued outside the UK so returns can roll up gross of tax within the fund (except any withholding tax at source, which is unreclaimable), and so could grow faster.
2. Basic-rate tax
Gains on onshore bonds are not liable to basic-rate tax as underlying funds are subject to UK life fund taxation. Tax is then charged at 20% higher-rate and 25% additional rate. On an offshore bond, income tax is charged at 20% basic rate; 40% higher rate; and 45% additional rate. On both types of bond, top-slicing (see overleaf) can be used to reduce the rate of tax charged
3. Income treatment
Gains on both onshore and offshore bonds are treated as savings income. Onshore bond gains are treated as the highest part of a client’s total income whereas offshore bond gains come in the first slice of savings income. Therefore, if any personal or savings allowances are available, offshore bonds can offer scope for some or all tax to be charged at a nil rate.
Because of their differing tax treatment, there may be circumstances when an onshore or offshore bond may be more suitable. As always, however, tax should only be one of a range of considerations.
|Onshore Insurance Bonds||Offshore Insurance Bonds|
|Investment : Gives exposure to a pooled, professionally-managed investment portfolio||Investment : Gives exposure to a pooled, professionally-managed investment portfolio; offshore bonds may offer a wider choice of investments|
|Insurance: Includes a life insurance element||Insurance: Includes a life insurance element|
|Tax-efficient withdrawals: Part surrenders of up to 5% of accumulated premiums can be taken without any immediate tax charge. Withdrawals are tax deferred and not tax free.||Tax-efficient withdrawals: Part surrenders of up to 5% of accumulated premiums can be taken without any immediate tax charge. Withdrawals are tax deferred and not tax free.|
|Internal taxation: 20% corporation tax payable on interest, rental income and capital gains (but dividends are exempt)||Internal taxation: Usually registered in a tax-favoured jurisdiction, enabling ‘gross roll-up’ of gains and income1|
Broadly, gains on bonds are only subject to personal tax on the following
|Onshore Insurance Bonds||Offshore Insurance Bonds|
|Taxation of gains: Gains treated as savings income and the highest part of income and taxed as follows: basic-rate client - no further tax on the gain; higher-rate client - subject to 20% tax on the gain; additional-rate client - subject to 25% tax on the gain. If a gain pushes client into a higher tax bracket, top-slicing relief (see below) may help to mitigate this.||Taxation of gains: Gains treated as savings income (before dividend income) and can be set against the personal allowance, starting rate for savings, and/or personal savings allowance where available. Then taxed at basic (20%), higher (40%) or additional rate (45%). If a gain pushes client into a higher tax bracket, top-slicing relief (see below) may help mitigate this.|
Capital gains: All realised returns taxed as income not gains, and so cannot be set against the holder’s annual exempt amount for capital gains.
Top-slicing relief: Can be used where a client would be liable to tax at a lower rate were it not for the inclusion of a chargeable event gain in their income for that year. On full surrender, top-slicing divides the gain by the number of complete years the bond has been held to determine the “annual equivalent” gain, which is then included in the holder’s top slicing relief calculation.
Impact on allowances: Realised gains may affect the holder’s eligibility for certain tax credits and they could lose some or all of their entitlement to the Personal Allowance.
1Withholding tax may be deducted at source and cannot be reclaimed
Issues to consider
Tax rates and thresholds are for the 2021/22 tax year unless otherwise stated.
The information contained in this page is for professional Financial Adviser use only. If you are a private investor, please visit the Private Investor section or contact your Financial Adviser for more information.