Roll up formoney fornothing
As an actuary, I am always sceptical when I hear the phrase "money for
nothing". I do not seem to be alone in this, as some 80 per cent of IFAs
out there appear to be so sceptical about the free lunch which investment
in offshore bonds can offer that they do not recommend them to their
But sometimes, when initial scepticism has been overcome, it is possible
to see that your clients can get money for nothing.
Gross roll-up is usually touted as one of the most important benefits
available to those who choose to invest in offshore bonds.
The most common descriptionof this benefit runs like this - weall
understand the benefits ofcompound interest and if theInland Revenue is
removing partof investors' compound interest through taxation, the benefits
of compounding are substantially reduced.
Given my background, I have a compulsion to sit down and work out the
maths behind these statements because the best way to see the extra benefit
offered by gross roll-up is to go back to basic algebra.
These are easy to see. The factor lost when interest is taxed within a
bond is quite simple and can be seen as early as year two. When part of the
interest is removed at the end of year one through taxation, it is not this
part that is lost - as the investor will probably have to pay tax on all
growth ultimately - but the interest on this part in year two. In year
three, the investor then misses out on the interest on the tax paid out in
years one and two, and so on.
So far, so good. But this does nothing to quantify the value that can be
added. For this we need some real numbers. Like all factors involving
compound interest, the longer the term, the greater the benefits.
I compared two basic-rate taxpayer investors, both placing £20,000 in
a bond for 20 years which grows at 7 per cent each year. The first investor
invests onshore and is taxed within the bond each year. The second investor
invests in an offshore bond and is taxed at 22 per cent on the total gain
at the end of the 20-year term.
The results are quite impressive. The first investor onshore ends up with
a total net fund of £57,914 while the second investor offshore gets
nearly 12 per cent more with £64,767 net.
The difference for higher-rate taxpayers is relatively less at 6.5 per
cent, with £51,090 onshore and £54,436 offshore. The reduced
difference arises because higher-rate taxpayers only get taxed at the
excess over the basic rate at the end of the term.
This is quite astounding. Taking none of the other benefits of offshore
products into account, by keeping your clients' savings onshore you are
saying goodbye to an extra return which truly represents money for nothing.
But the expenses on offshore bonds are higher, is the usual counter-cry
from the onshore brigade. Not true. The simple fact is that although
investment returns offshore roll up free of tax until maturity, offshore
companies do not receive tax relief on their expenses, unlike their onshore
counterparts. The slightly higher charges resulting from this are of little
significance, however, when compared with the figures overall.
Gross roll-up is of particular benefit when combined with another factor
of investing offshore. Offshore bonds are still classed as
non-income-producing assets, just like their UK counterparts. This means
that withdrawals of up to 5 per cent of your original investment may be
made each year for 20 years and is counted as capital withdrawals. Being
capital withdrawals, there is no immediate liability to tax.
This benefit is more meaningful if it is translated into figures. Take the
same example as before but with both investors taking withdrawals of
£1,000 each year for 20 years.
At the end of the 20-year term, the basic-rate taxpayer onshore is left
with £23,194 net while the equivalent offshore is laughing all the way
to the bank with 22 per cent more, or £28,391. For the higher-rate
taxpayer, the respective figures are £19,019 and £21,839 net, a
difference of 14 per cent.
Some quite thought-provoking results, I think you will agree. Perhaps we
in the offshore industry should be shouting these figures from the rooftops
of our offshore havens so that IFAs everywhere begin to embrace offshore
bonds as the grown-up, tax-efficient siblings of fledgling Isas - and not
just the 20 per cent or so of IFAs who appear to have overcome their
initial scepticism and allowed their clients to benefit from money for