There are two elements to this solution. The first is the investment vehicle which is the offshore bond and the second part is the discretionary trust. Firstly, let’s consider the offshore bond.
Offshore is a common term used to describe a range of locations where companies could offer customers growth on their funds that's largely free from tax. This includes "true offshore" locations such as the Channel Islands and the Isle of Man, and other locations such as Dublin. Tax treatment can vary from one type of investment to another, and from one market location to another.
Investment bonds are usually classed as a single premium ‘life insurance’ policy because a portion (often less than 1% of cash-in value) of the ‘life insurance’ policy can be paid out upon death. They are more of an investment product though as the premium you pay is invested on your behalf in investment funds of your choice with the aim of achieving capital growth.
Investment bonds mainly fall into two categories, onshore and offshore. In high-level terms offshore investment bonds are similar to UK investment bonds but there is one main difference. With an onshore bond, tax is payable on gains made (and investment income received) from the underlying investments of the life fund(s) invested in, whereas with an offshore bond no income or Capital Gains Tax is payable on the underlying investment. There may be an element of Withholding Tax that can't be recovered with certain funds. Withholding Tax is deducted from interest and dividends received by the fund(s).
The lack of tax on an offshore bond means that it could potentially grow faster than one that is onshore, although this isn't guaranteed. But, note that when you take withdrawals from the bond it may give rise to what’s called a chargeable event gain and these gains are subject to income tax. However, with careful planning by a financial adviser it’s possible to realise these gains without paying any tax. This is often the case for young adults who are non-taxpayers by making use of their available personal allowance, starting rate for savings and personal savings allowance.
The next part of the solution is the trust. There are three parties to a trust:
- The “settlor” – the person who puts assets into the trust (the asset being the offshore bond).
- The “trustees” – the person(s) appointed to manage the trust (you would normally be a trustee and you can appoint other people who you trust to be additional trustees).
- The “beneficiary” – the person(s) who benefit from the trust
Life insurance companies generally offer two types of gift trust; an absolute trust and a discretionary trust. In high-level terms the difference between the two is that with an absolute gift trust you name the beneficiary and their share of the trust fund at outset. This cannot be changed at a later date and the beneficiary becomes entitled to their share at age 18 (or 16 in Scotland).
With a discretionary gift trust the trust deed will have a standard class (list) of “potential” beneficiaries, which are normally your children, grandchildren and remoter decedents. You also have the option to add or remove beneficiaries e.g. you could add a niece or nephew.
None of the beneficiaries are legally entitled to the trust fund. Ultimately it’s up to the trustee to decide who benefits from the trust fund and when. It’s this level of trustee discretion that makes the discretionary gift trust a popular option for those wishing to invest for minor children but want to retain an element of control over when the child gets the money. Furthermore, the ability to add or remove beneficiaries offers flexibility should you change your mind on who should benefit.
By transferring the offshore bond into a discretionary gift trust you are making an outright gift. You would be excluded from being a beneficiary so you can’t get your money back at a later date.
Which one of the above two options could be used to achieve your goals will depend on a number of factors and a financial adviser will be able to help you make a decision. But if you need to know a little bit more before approaching a financial adviser here are five key areas to consider.