Onshore vs offshore investment bonds
Investment bonds fall into two categories, and the difference between them is mostly about where the issuing life company is based and how the underlying fund is taxed.
An onshore bond is issued by a UK life insurance company. The funds within it are subject to UK tax internally, which the provider handles on your behalf. As a result, when you eventually make a gain, you’re treated as having already paid the equivalent of basic-rate tax. Basic-rate taxpayers often have no further tax to pay on a gain, while higher and additional-rate taxpayers may owe the difference.
An offshore bond is issued by a life company based in a jurisdiction with a favourable tax regime, commonly the Isle of Man, Dublin, Luxembourg or the Channel Islands. Crucially, the funds within an offshore bond grow largely free of tax internally, a feature known as ‘gross roll-up.’ This allows the full return to compound without the annual drag of internal tax, which can boost long-term growth.
The trade-off is that, on cashing in, the entire gain is taxable as income with no basic-rate credit attached.
Neither is universally better. Offshore bonds offer stronger compounding but a larger potential tax bill on exit; onshore bonds offer the comfort of an internal tax credit but slightly lower growth potential.
Which comes out ahead depends on your tax rate now, your expected tax rate when you cash in, and how long you hold the bond. This does feel in some ways similar to how ISA and SIPP contributions are both tax-advantaged but serve different purposes.
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