Will offshore investment be relevant after the introduction of the Retail Distribution Review (RDR)? As we move closer to the long-awaited implementation of the legislation there are a number of ‘naysayers’ claiming this will be the demise of offshore investments.
I would like to address some of the key perceptions, or should I say misconceptions.
Investors and advisers will be seeking choice, flexibility, efficiency and transparency. Offshore investments offer a flexible platform to cater for a client’s changing needs and the potential for advisers adapting their business as the full implications of the RDR unfold.
Offshore control
Offshore investments still offer UK resident clients tax control and flexibility, and the options listed below are based on tried and tested legislation.
- Non-income-producing assets: simplified tax administration, no standard entry on a tax return.
- Tax-free switching.
- Tax-efficient appointment of capital: tax-deferred withdrawals of up to 5% of the original investment are available each year until an amount equal to the original capital has been returned, for example 5% each year for 20 years. Any unused withdrawal allowance accumulates each year, so if no withdrawal is used in year one, 10% is available in years two and so on. Can gift/pass on withdrawals and assign segments, meaning any income tax liability passes to the assignee, who may pay income tax at a lower rate.
- Top-slicing relief: allows gains to be spread over the investment term.
- Tax deferral: can be beneficial to a client who is expected to pay a lower rate of tax in future years when gains may be realised. When a chargeable gain arises, the tax position of the client in the tax year the gain is made is deemed to have applied throughout the life of the investment.
- Time apportionment relief: for those individuals who spend long periods abroad. HMRC has recently issued a consultation paper on this aspect. This proposes several changes, including extending time apportionment relief to onshore policies as well as offshore; basing the relief on the residence history of the beneficial owner, rather than the legal owner; changing the way in which the relief works where the policy has previously been assigned or a top-up has been paid; and determining how the relief should interact with the proposals on the statutory residence test. Any changes as a result of the consultation will be included in the Finance Bill 2013. Although many of the proposals will allow more clients to benefit from the relief and make it more logical, this could be at the cost of greater complexity.
Coping with change
So will offshore investments be able to cope with advisers’ changing business models?
After the RDR has been implemented, the model for an independent adviser may include the use of multiple platforms, a selection of discretionary fund managers, a wide range of funds and portfolios to match a client’s risk profile and a cash administration service. This should all be administered by a core back-office system providing effective customer relationship management and consolidated business data.
Strategic benefits
The offshore bond has a place in the post-RDR world, as it can be utilised to create appropriate strategies for clients:
- Estate planning: offshore propositions offer a wide range of robust tax and estate planning solutions, from the ability to use a simple gift trust to wrap around an offshore investment bond, to the sophistication and innovation of a flexible reversionary interest trust. With the predicted growth in the estate planning market, offshore providers who can offer a wide range of product options and the technical expertise to back them up are well placed to support different adviser models. In addition, as an offshore bond is a non-income producing asset, it is a lot easier for trustees because it helps to reduce the administrative burden.
- Enhancing portfolio return: as a tax wrapper the offshore bond provides a very positive environment where growth is generated by dividends. If you consider the FTSE All Share Index from 31 Dec, 1999, to 29 June, 2012, the All Share Index net of dividends would have achieved a -10.81%. When dividends are included, the return over the same period is a positive 34.45%. By sheltering the dividend income in an offshore bond, you maximise the impact on the overall performance of the fund.
- Discretionary fund management: this service is likely to increase in popularity after the RDR and can be fully facilitated through an offshore investment. The ability to easily change discretionary fund managers in the future can be done within the bond wrapper without incurring a tax charge. It is also possible to have multiple discretionary fund managers under one arrangement, and this will be attractive to advisers.
- Pension provision and retirement income planning: clients can accumulate money in a range of assets to maximise tax allowances and tax rates. How many clients are really prepared for the different choices available at retirement? Most advisers believe this offers a fantastic opportunity to create real value for their clients.
Plenty to offer
An offshore bond is a highly complementary and tax-efficient vehicle in the accumulation phase. As the amount of pension contributions that benefit from tax relief are capped, we believe it has a place in accumulation. When you consider the decumulation phase and estate transfer stages of retirement, the offshore investment really does offer some positive advantages.
An offshore bond can be best utilised with other investments to provide flexible retirement income strategies. The 5% tax deferred withdrawals, top slicing relief, and full segment surrender can all play a part in providing tax efficient income and flexibility.
In the order of taxation, offshore bond gains are treated as savings income, and are therefore taxed after earned income, but before dividends, so for some individuals it is possible to utilise the 10% tax band with gains from an offshore bond.
From an estate transfer perspective, an offshore bond or segments can be assigned without creating a chargeable event, but may be treated as a transfer of value for inheritance tax purposes. Other retirement assets may not have the same flexibility and/or suffer penal tax consequences. ISAs provide similar tax-efficient growth but lack the ability to be assigned and will remain part of a client’s estate.
Pension arrangements could incur tax consequences for lump-sum death benefits depending on whether the pension assets are crystallised and whether the client is over 75.
Some commentators suggest that offshore bonds will be less popular among UK advisers after the RDR is implemented, owing to their opaque charging structures.
But we believe this maybe an historic perception. Most offshore providers offer clear and transparent charging structures with a choice of options, which can be tailored to suit a range of advice models.
Pricing differences
In the past there may have been a pricing differential between onshore and offshore investments. This has been due to some offshore life companies not being able to offset their expenses against their income. The position on an onshore bond will change in the post-RDR environment, as there will be no commission to be factored-in as a business expense.
Canada Life International will be able to facilitate a comprehensive range of adviser charging options, including initial, ongoing and ad-hoc adviser remuneration. This will be available from quarter four of 2012.
The offshore market is not only ready to support advisers in the RDR journey, but can offer real tangible benefits for clients. The future for the offshore investment market in the UK will not be without its challenges, but as whole it is a robust market and provides an excellent opportunity for professional advisers and their clients.
Andy Marks, head of institutional relationships at Canada Life International
