Offshore insurance policies have increased in attractiveness in recent years. This is because insurance policies are not subject to the EU Savings Tax Directive and because of the reduced opportunities for tax planning for UK resident and domiciled individuals through other structures.

The core attraction of offshore life insurance is the ability to defer tax and the opportunities for IHT planning. If you invest in offshore bonds, you do not pay tax until the money is withdrawn. This allows funds within offshore bonds to grow virtually free of tax and to benefit from reinvestment of growth that would otherwise be taxed. You can also take an annual withdrawal of 5% of the original premium paid, for a period of 20 years, on which you do not pay tax. Surplus funds are taxed when the bond is cashed in.

The downside is that when the offshore bond is cashed in, the capital gains and income will be taxed at your rate of income tax. A higher rate taxpayer will pay tax on an offshore bond gain at 40% whereas the same individual will suffer only an 18% tax charge on an onshore bond gain. You can reduce the tax bill, however, by timing the redemption of your money from the bond. For example, if you retire abroad and cash in the bond after you have left the UK, your tax bill may be reduced.

An offshore bond can also be written with multiple lives assured. If the bond is held in trust, during the tax year following the death of the individual, the income tax charge will fall on the UK trustees of the trust at 40%. Alternatively, the trustees could assign the policy to a UK beneficiary who could cash it in and pay income tax at his or her rates, which may be lower than the trustee’s rate. This works best when you assign the bond to a spouse or adult children who are in a lower tax band than yourself.

Another advantage is that if you switch between funds within an offshore bond then you do not pay CGT on any gains that may be generated. Furthermore, as a non-income producing asset, you do not have to return an offshore bond on your self-assessment form until there is a chargeable event. 

Insurance companies have been active in proclaiming that some of their packaged offshore IHT plans are not subject to the pre-owned asset tax (POAT). They say gift and loan trusts, discounted and retained interest schemes all escape the POAT net.

The POAT came into force on 6 April 2005 and is effectively retrospective because it imposes an annual income tax charge on structures set up since 17 March 1986. POAT is targeted at structures that enable individuals to dispose of an asset but still benefit from it. The annual income tax charge under POAT is intended to be a fix for HMRC’s perceived avoidance of the IHT rules.

The alignment of IHT between interest in possession and accumulation and maintenance trusts with discretionary trusts in the March 2006 Budget has reduced the attractiveness of these trusts. As was mentioned earlier, assets above the nil rate band that are transferred to these trusts are subject to a 20% IHT charge. Every 10 years, assets above the nil rate band face a 6% tax charge.