Offshore bonds have been given a double tax boost. Changes to how savings income is taxed will mean a greater number of offshore bond savers will pay no tax on their bond gains.
The twin measures will first see the savings rate tax band extended to £5,000 and the tax rate cut from 10% to zero from April 2015. And from the following April, a further £1,000 may be taken tax free under the new personal savings allowance. Which would mean that in total someone with no other income could realise gains of £15,600 from an offshore bond tax free in 2015/16 and £16,800 from 2016/17.
Who gets it?
These changes only apply to savings income. This includes interest from banks, building societies and non- equity unit trusts/OEICs, as well as gains from offshore bonds. It doesn’t apply to dividends or gains from onshore bonds.
Crucially, the tax free savings rate band is removed where someone has earned income of more than £15,600. This includes pension income in addition to salary or self-employed profits.
To get the most of the tax free allowances may require careful planning and timing. This is where the unique features of an offshore bond can aid tax planning, especially where an individual is able to manipulate their income or where the bond (or segments of it) can be assigned to a non-taxpayer.
Income and gains within an offshore bond roll up gross within the tax wrapper and only become taxable when there’s a chargeable event. Tax deferral can be extremely attractive to those who pay tax at the higher rates. This is especially true should they expect to become basic or non-taxpayers in the future, perhaps in retirement.
Timing these chargeable events to coincide with a year in which little or no other income is taken can mean that any gains escape tax completely. And the new pension freedoms will see a greater number of individuals able to turn their retirement income on and off when they need to.
Bridging the retirement income gap
Some retirement incomes aren’t as flexible. State pensions and defined benefit (DB) benefits, for example, once in payment will pay a fixed amount for life and cannot be stopped and restarted. And these can eat into the tax free allowance for an individual’s savings income.
But there can be a window of opportunity before any fixed incomes commence. And using the bond like a bridging pension can have benefits.
Deferring State or DB pensions can create tax years where no income is being taken. Surrendering part of the offshore bond to realise any accumulated gains can replace the lost income. If that chargeable gain falls within the combined personal allowance and savings rate band, then the gain will escape tax. And in addition, deferring both DB and State pension will mean that the fixed income they eventually pay will have increased.
For example, Roger was 65 on 31 March and decided to retire. He estimates he will need around £30,000 net to live on in retirement.
He had a deferred DB pension worth £12,000 a year from age 65 in addition to a SIPP fund of around £300,000. He was also entitled to a State pension of £6,029 a year.
Roger invested £100,000 into an offshore bond a number of years ago and it’s now worth £200,000.
Roger decided to defer taking both his DB and State pensions and leave his SIPP untouched. Instead, he will take withdrawals from his offshore bond to fund his retirement income needs initially. By doing this he will have both his personal allowance and savings rate band to offset against any chargeable gains that arise.
So if Roger withdraws £30,000 from his bond, there will be a £15,000 chargeable gain but no tax will be payable. Roger is left with the £30k ‘net income’ that he needs.
Compare this to taking the income from his pensions.
|Gross amount||Tax||Net received|
|DB pension||£12,000|| £4,571 @ 0%
£7,429 @ 20%
|SIPP||£15,831|| £3,958 TFC
It’s not just a tax saving of £3,860 which Roger will benefit from. Also his entitlement under the State pension and DB scheme will have increased as a result of the deferral. A 12 month deferral of the State pension will see receive an additional £627 of State pension income each year. If the DB scheme had a deferral rate of say 8%, that would add a further £960 a year to his annual income.
Not everyone will be able to defer their retirement income to get gains out tax free. But it may be possible to assign the bond to someone who pays tax a lower rate.
Assigning the bond or individual segments will shift the taxation onto the new policy owner. This can be a valuable planning opportunity for spouses and civil partners especially if the new owner may be a non-taxpayer.
Also it can be a great way of helping with a child’s or grandchild’s university fees.
Bond segments can be assigned to the student who is likely to be a non-taxpayer if they’re in full time education. Provided gains are kept within the £15,600 allowance, they won’t be taxed.
Over a three year course, that’s up to £46,800 in chargeable gains which can be taken free of tax. That’s an extra £13,500 compared to the equivalent capital gains allowance tax free allowance (£11,100 2015/16).
And remember, the proceeds received could be much more than the gains made, potentially providing the student with more than enough to pay their way through university.
More to come….
The Budget announced the introduction of a personal savings allowance from 6 April 2016. Unlike the savings rate band where only those with little or no earned income can benefit, the allowance is only removed once income from all sources exceeds £150,000. This means everyone who isn’t an additional rate taxpayer will receive some of the interest from their savings tax free.
The first £1,000 savings interest will be tax free. This amount reduces to £500 for higher rate taxpayers. That means £40,000 on deposit and earning 2.5% a year will be tax free for a basic rate taxpayer saving them £200 in income tax. A higher rate taxpayer would be able to hold £20,000 on deposit in the same account and the tax saving will be the same.
But it also means that most offshore bond savers will get some of their gains tax free. And in essence it increases the amount that can be withdrawn each year without incurring a tax charge. In addition to the 5% withdrawals, a basic rate taxpayer could take a further £1,000 without paying any tax on the withdrawal.
Source: Standard Life