What Is the Difference Between Onshore and Offshore Bonds? A Guide for UK Expats

Expats can invest in two types of investment bonds—onshore and offshore bonds. This guide will outline the key differences between them, focusing on aspects such as available investment options, taxation treatment, and policyholder protection.

What Are Onshore Bonds vs. Offshore Bonds?

Investment bonds are tax wrappers issued by life insurance companies and other financial institutions in the UK or overseas jurisdictions like the Isle of Man and the Channel Islands. The former are called onshore bonds, while the latter are referred to as offshore bonds.

Both types of investment bonds allow lump sum investments into a wide selection of assets such as stocks, bonds, and property.

They enable you to defer tax on investment growth until a so-called chargeable event occurs, meaning gains may only be taxed when you make a full or partial withdrawal or pass away.

Investment bonds are considered single-premium life insurance policies because they provide a financial payout—the death benefit—to beneficiaries upon the policyholder’s death.

However, they’re primarily used as investment vehicles since they’re designed to facilitate tax-efficient investment growth and only provide minimal death benefits.

Policyholders typically leave the funds in the bond for 5–10 years to accelerate investment growth.

Regardless, you’re allowed to withdraw up to 5% of your initial investment each policy year without being subject to immediate taxation, and can roll over the tax-deferred allowance to the following years.

However, these withdrawals will become subject to tax when you surrender the bond or trigger another chargeable event.

Onshore and offshore bonds have similar features and provide tax-deferred investment growth, but differ in taxation rules, investment options, and ongoing fees.

Onshore vs. Offshore Bonds—Taxation Differences

Onshore bonds are subject to the UK’s strict taxation laws, while offshore bonds are typically issued in jurisdictions with less stringent taxation rules and a more favourable tax environment. Therefore, the taxation of the two differs in terms of the following:

1. Fund taxation
2. Bond surrender taxation

Fund Taxation

Investment growth within onshore bonds is subject to the UK life fund tax before reaching the investor.

In a single policy year, your fund provider is required to pay a 20% tax on the gains derived from the bond’s underlying investments.

As a result, you’re treated as having already paid the basic income tax rate on those returns. This tax treatment may potentially exempt you from paying additional income tax on withdrawals if you fall within the basic 20% income tax bracket.

Additionally, a non-reclaimable withholding tax may apply to certain foreign asset income, such as interest earned from bonds held in mutual funds.

Conversely, offshore bonds benefit from the gross roll-up feature, allowing investments to grow without incurring immediate income or capital gains tax, potentially leading to higher returns.

However, depending on the provider, they may be subject to irrecoverable withholding tax on dividends and interest.

Once you surrender an offshore bond, you’ll be subject to tax at your marginal tax rate because no UK life fund tax is levied on the funds, meaning you won’t be treated as if you’ve already paid a 20% tax on any gain.

Bond Surrender Taxation

The following table outlines the tax obligations of expats considered UK residents upon surrendering an offshore bond vs. an onshore bond, depending on their tax brackets:

Top Slicing Relief

You can utilise the top slicing relief to avoid crossing into a higher or additional tax bracket and reduce the tax liability of your investment bond gains upon surrender.

This tax relief allows you to divide the gains by the number of policy years the bond was held, and it may be used for both onshore and offshore bonds.

For instance, if you surrender a bond with a £100,000 gain and add it to your annual taxable income, you’d be taxed at a 40% or 45% rate.

However, if the bond was held for ten years, the top slicing relief would enable you to divide the £100,000 gain by 10, adding only £10,000 to your taxable income for the year. Therefore, if your annual taxable income is £40,000, the additional £10,000 wouldn’t push you into a higher tax bracket.

In case you’ve triggered a chargeable event before the full surrender, the number of top slicing years decreases.

For instance, if you withdrew more than 5% of your initial investment in a single policy year, the top slicing relief will equal the number of years that passed between your initial investment and the chargeable event.

For a second chargeable event, top slicing applies to the period since the prior event.

This rule applies to onshore bonds, as well as offshore bonds established after the Finance Act was introduced on 6 April 2013. For offshore bonds established before 6 April 2013, the top slicing years equal the number of years since the policy was established.

Offshore vs. Onshore Bonds—Tax Rules Based on Residency

The tax liabilities associated with holding an onshore or offshore bond will differ if one of the following conditions applies:

1. You are a non-resident for tax purposes in the UK.
2. You are returning to the UK after being a resident of a foreign jurisdiction.

Taxation for Expats Who Are UK Non-Residents

If you hold an onshore bond, but are a resident in a jurisdiction outside of the UK, the funds within the bond may still be taxed in the UK.

While the UK taxes UK-sourced income regardless of the taxpayer’s residency, investment income is subject to special rules limiting the tax liability of non-residents. His Majesty’s Revenue and Customs (HMRC) states that UK non-residents are only liable for the tax withheld at source (if applicable), meaning they won’t incur further taxes on gains from UK-issued bonds.

However, your overall tax liability when surrendering an onshore bond will depend on your country of residence. While UK residents are subject to UK income tax on chargeable gains upon surrender, non-residents are taxed according to the rules of their residential jurisdiction.

Taxation for Expats Returning to the UK

The UK has introduced the time apportionment relief (TAR) to ensure fair taxation of expats who were non-residents in the UK during the bond’s holding period. Initially, TAR was designed as a tax relief on offshore bond income, but since 6 April 2013, it also applies to onshore bonds.

TAR allows you to reduce UK tax liability on the chargeable gains accrued from your onshore or offshore bond while you were a UK non-resident. You can calculate your TAR amount by dividing the number of days you were a UK non-resident by the total number of days you held the bond, and multiplying that fraction by your total chargeable gain.

If a chargeable event arises while you are a UK non-resident, you may still be liable for tax in the UK if you are considered a temporary non-resident under HMRC rules.

This rule applies if you return to the UK within five years of leaving and were a UK resident in at least four of the seven tax years prior to moving abroad.

In this case, any accrued gains are treated as if they arose in the tax year of your return. However, you’re still allowed to claim TAR for the period of non-residency.

If you transfer bond ownership to another person, their tax residency will be used to calculate the TAR, starting from the date of the transfer.

However, if the new owner is your spouse or civil partner, the TAR is calculated based on your (the legal owner’s) residency history.

If you assign an offshore bond to your spouse, time‑apportionment relief remains applicable based on the original policyholder’s UK residence history – preserving key TAR benefits.

Also, non‑recoverable withholding tax on income (such as dividends or interest) may apply if you’re a UK non‑resident, depending on the bond’s jurisdiction.

TAR rules are applicable to any chargeable events arising after 5 April 2013 if an onshore bond was issued on or after 6 April 2013. For onshore bonds established before this date, the rules will only apply if the following conditions are met:

1. The rights to the policy are held as security for a debt.
2. The policy’s terms and conditions allow you to make additional investments in the policy, increasing your bond benefits.
3. You transfer full or partial rights to the bond benefits to another person as a gift assignment or a gift for money.

For offshore bonds, the TAR rules apply regardless of the issue date.

Top-Ups and TAR Continuity:

Additional contributions to an existing offshore bond can benefit from the time apportionment relief already accumulated on the original policy.

This continuity provides a clear tax planning advantage, encouraging earlier bond establishment to maximise relief on future top-ups.

Offshore vs. Onshore Bonds—Other Differences

Apart from tax treatment, onshore and offshore bonds differ in the following aspects:

1. Investment options
2. Investment requirements and fees
3. Policyholder protection

Investment Options

Both onshore and offshore bonds provide exposure to pooled investments, meaning you have access to a portfolio that collects money from multiple investors, creating a large investment fund. These funds are managed by professionals who purchase a specific number of units on your behalf, including assets such as:

• Cash
• Stocks
• Sovereign and corporate bonds
• Shares
• Property

The value of your units will increase or decrease based on the performance of your assets. Diversifying your portfolio enhances the protection of the investment from potential losses.

You can choose the funds according to your financial plans and risk tolerance. In addition, you’re often allowed to switch between underlying funds within a bond, but the change may incur a fee.

The primary difference between offshore and onshore bonds in terms of investment options is that offshore bonds provide access to a wider range of global assets.

This feature, combined with the favourable tax treatment of investment growth within the bond, can result in higher gains in offshore bonds compared to onshore bonds.

Investment Requirements and Fees

Onshore bonds require a lower minimum investment amount, which ranges between £5,000 and £10,000.

Meanwhile, offshore bonds are primarily designed for high-net-worth individuals and expats, and require a lump sum investment of between £20,000 and £100,000, depending on the provider and the range of investments you can access.

Still, some providers may require higher initial lump sum investments for both onshore and offshore bonds.

Apart from the initial investment requirement, both types of investment bonds include fees and charges you must pay while your funds are inside the bond, including the following:

• Setup fees
• Adviser costs
• Annual administration charges
• Fund management fees

Some charges are flat fees, while others are expressed in percentages and vary depending on the provider. However, offshore bonds usually have higher fees than onshore bonds.

Policyholder Protection

Onshore bond policyholders are protected by the UK Financial Services Compensation Scheme (FSCS). If the UK-based provider defaults, the FSCS covers up to 100% of the value of the claim with no upper limit.

Since offshore bonds are issued outside of the UK, they aren’t protected by the FSCS. Instead, the protection an offshore bond provides will depend on the jurisdiction where it was issued.

For instance, if your policy is issued by a company based in the Isle of Man, you will be covered by the Isle of Man policyholder protection scheme. If your policy provider is unable to meet its obligations, the scheme manager will pay compensation of up to 90% of the protected contract’s value. The protection applies regardless of your residency.

What Are the Benefits and Drawbacks of Investing in an Onshore Bond vs. an Offshore Bond?

Onshore and offshore bonds have specific advantages and disadvantages depending on your financial goals, tax residency, and initial investment capital.

Both provide tax benefits, such as top slicing and time-apportionment relief, and include certain drawbacks, like tax charges for withdrawals exceeding the 5% annual allowance.

The following section will explore other advantages and disadvantages associated with each type of investment bond, guiding you in identifying the most suitable option depending on your circumstances.

Pros and Cons of Offshore Bonds

Investing in offshore bonds provides the following benefits:

Nonetheless, offshore bonds also entail several drawbacks:

• High fees: The numerous charges and penalties associated with offshore bonds, including setup fees, annual management charges, and advisory fees, can be as high as 10% of your bond value when combined. Assessing the fees before purchasing a policy is crucial, as the ongoing charges can significantly diminish your wealth.
• Currency risks: Offshore bonds expose you to foreign currency risks, such as fluctuations in exchange rates. Additionally, holding a bond in a country with a less stable currency may erode your returns.
• Cross-border tax navigation: Investing in offshore bonds requires a thorough understanding of international tax laws and reporting requirements, which can be challenging without professional assistance.

Pros and Cons of Onshore Bonds

Like offshore bonds, onshore bonds allow tax-deferred withdrawals of up to 5% of your investment capital and provide inheritance tax benefits. However, they also include the following unique advantages:

However, onshore bonds also include certain disadvantages, most notably:

• Taxation upon surrender: Once you surrender an onshore bond, any taxable gains, including the amounts withdrawn under the 5% tax-deferred allowance, are taxed as income. However, if you are a basic-rate taxpayer, you will only pay tax if the gains push you into a higher tax bracket.
• Lower tax efficiency for UK non-residents: Onshore bonds include a yearly 20% UK life fund tax while the funds are still inside the bond, subjecting UK non-residents to UK taxes. For this reason, residents of lower-tax jurisdictions may benefit more from investing in offshore bonds that don’t impose this tax.
• Currency risk for UK non-residents: If you’re a UK non-resident, making withdrawals from an onshore bond while living abroad will expose you to exchange rate fluctuations, resulting in a potential loss of a portion of your funds.

Who Should Consider Investing in an Onshore vs. Offshore Bond?

You should consider onshore bonds if you plan to remain in the UK and have no plans to move or retire abroad.

As the bond provider pays a 20% tax on investment gains, this can lower your taxable income when you eventually surrender the bond, making onshore bonds especially beneficial if you anticipate remaining within the basic rate tax band in the future.

Offshore bonds are generally more appropriate for high-net-worth individuals due to their larger initial investment requirements and higher fees. They may be particularly suitable for the following types of expats:

• UK expats who live abroad or plan to retire overseas and want to avoid UK taxation of their underlying fund.
• Expats planning to become non-UK taxpayers at the time of the bond surrender.
• Expats interested in a wider selection of international investment opportunities.

Consulting a financial adviser, such as those at Titan Wealth International, can guide you in choosing an investment bond that best meets your investment goals and risk tolerance through an assessment of your specific residency and financial circumstances.