Can you plan your retirement to sunny southern Europe and at the same time avoid some of the widely expected future Labour tax increases? Many sunny European countries have lower tax rates and there are specific financial products which you can invest in to make your move tax efficient.

ISAs could be used to shelter some spare cash, but what if the sum exceeds the £20,000 per person, per year ISA limit?  “An option could be an offshore investment bond,” said Jason Porter, director of specialist expat financial advisory firm Blevins Franks. “This is an insurance policy provided by a non-UK insurance company based in an international jurisdiction such as Ireland, Luxembourg or the Isle of Man. The rules for offshore bonds are such that they are single premium life insurance policies, as they pay a small element of life insurance upon death, but they are really a tax-wrapper investment product.”

A single or more regular lump sum investment (deemed a premium) in most cases will be used to acquire a discretionary investment fund portfolio for the medium to long term, much as you would if you directly handed your capital over to a discretionary investment manager.

But the life policy provides unique tax efficiencies. No tax is payable on any investment growth unless a withdrawal, or ‘chargeable event’ occurs. If you had no need to access the funds for a number of years, then gross roll-up of income and gains can considerably benefit the ongoing value of the investment.

“This means you can time the tax liability to when it best suits you,” said Jason Porter. “This might be when you are a lower rate taxpayer, or when you are living somewhere more tax efficient. This is also the opposite of a personally held investment portfolio, where tax would be due on interest, dividends and gains that accrue annually.”

In most cases, a policy will be divided into 1,000 segments. You can choose to wind up whole policy segments or withdraw a percentage of each segment across the board. The best option might depend upon the sum required, whether this exceeds 5% of the cost of each segment, and the availability of any 20% tax band.  

The former basis means tax is due on the profit over and above the capital invested in each policy segment. So, if you invested £100 in a policy with 10 segments, which in year two is worth £110, it has roughly gone up in value by 10%. If you withdraw £11 in year two, you will be taxed on £1 of gain, as it represents the 10% profit in one segment (and not the £10 of profit if you took £11 from a directly held portfolio). 

“The tax can be reduced even further if the policy has been in existence for more than one year,” said Jason Porter. This is called ‘top slicing relief’, where the gain on the withdrawal is divided across the years, with one year’s worth added to the income of the year of withdrawal. The tax on this sum is calculated, and then multiplied back up by the number of years to get the actual tax due.

“It might sound like you should end up with the same amount as if you simply taxed the whole profit, but not if the year of withdrawal happens to be one where you have some or all your 20% rate band to spare, which might be the case if you are in retirement.”

How does retiring abroad affect how the offshore bond is taxed? Most EU states where UK nationals like to retire have their own offshore bond legislation, and again there are various tax efficiencies to benefit from.

Though it depends on the country, the basic tax deferral position continues to apply, with gross roll-up and the possibility of timing when it is best for you to take a tax liability. While policy segmentation is irrelevant abroad and there is no top slicing, the fundamentals of only taxing the profit percentage within a withdrawal remains.

In addition, in Portugal the gain is reduced by 20% after the policy has been in existence for five years and then by 60% after eight years. There is also a choice as to whether to pay tax at a flat 28% or through the scale rates in Portugal.

In Cyprus, there is no tax payable on offshore bond withdrawals and similarly in Malta a UK national would not normally suffer any tax on a withdrawal from an offshore bond. 

Both France and Spain only tax the increase in value contained within the sum withdrawn, while France includes significant succession tax benefits and the policy is French wealth-tax-free. In Spain, the bond could fall outside of Spanish succession taxes if the beneficiary is not Spanish resident.

“If we take our example even further and assume at some point you decide to return to live in the UK, this can be hugely beneficial when you make a subsequent withdrawal or wind up the policy,” said Jason Porter. “Any gain is averaged across the whole period of ownership and the years of residence overseas are deemed exempt, with HMRC only taxing the years when you lived in the UK.”