In Spain, as in many other developed financial markets around the world, investors have for decades been advised by locally-based expat advisory firms to entrust their savings and their pension assets to insurance bonds, on grounds that such investments could offer them such advantages as additional protection, easy access, and the ability to declare or defer tax. In Spain, though, there has always been a slight complication, in that such bonds must comply with local regulations, in order for these investors to avoid suffering penal rates of tax.
Lately, expressions of concern over the use of this time-honoured investment strategy, particularly in Spain, and among expatriate investors, have been growing louder, driven by various “action groups” formed as a result of loses suffered by investors.
Among those who have been monitoring the situation closely over the past few years has been James Pearcy-Caldwell, chief executive of the UK-based Aisa Group, which has fee-based advisory firms operating in a number of EU countries that specialise in cross-border financial planning. Aisa Group is the parent organisation of OpesFidelio, a pan-EU financial network.
As reported here today, the mounting concern and apparent confusion over the question of how best to advise clients with respect to insurance bonds has led OpesFidelio to create a “Bond v Platform Spreadsheet”, to enable its advisers to review and compare the relative benefits of charging structures and tax on investments held inside insurance bonds or outside of one, typically on a platform.
Below, Pearcy-Caldwell explains the thinking that led to the creation of the spreadsheet, and why OpesFidelio is passionate about calling attention to the need to consider, and discuss with clients, the actual investment returns investors are likely to receive, and the various options they may wish to consider.
Marius Hampden is a Spain-based Chartered Financial Planner and OpesFidelio member who completely stopped recommending Spanish-compliant bonds some years ago.
As Hampden, who has just written a book on financial planning for those retiring to Spain (Spanish Retirement Road-Map) explains, he did this because Spanish-compliant insurance bonds, whatever their attractions, typically come at a higher price than they ultimately are worth in terms of tax benefits.
To judge by the numbers of investors – mainly from Spain, but also from a number of other EU countries – who have increasingly been contacting action groups such as Pension Life with complaints about not only the investments they were encouraged to invest in via their Spanish-compliant bonds, but also the charges that have been applied to them, Hampden was spot-on in his decision to keep his clients well clear of these “tax-efficient” and “assisted tax reporting” investment products.
And lately, expressions of concern over the use of this time-honoured investment strategy, particularly in Spain, and among expatriate investors, have been growing louder, driven by various “action groups” formed as a result of loses suffered by investors.
Review of Spanish compliant bond cases
Just how spot-on Hampden was, in fact, is something he, and OpesFidelio, have recently worked out.
Over the last eight months, Hampden, wearing his OpesFidelio hat, has been reviewing cases of advice provided by other advisory firms, in which a Spanish-compliant bond had been recommended for tax reasons – specifically, on the grounds that it would make tax reporting easier for the client as well as, in more than 50% of the cases, that it would be more tax efficient than the other investment options available. (It should be noted that not all of the cases involved Spain-based investors.)
The outcome of the review has surprised even the OpesFidelio researchers. All of the 32 cases reviewed had seen lower investment returns for the respective clients in the first five years than a passive tracker investment – split 50% FTSE and 50% S&P500 – would have delivered for them.
In carrying out this research, taxes on direct investments were taken into account annually, where investments were encashed or dividends taken.
In the cases where clients had additional access penalties, and wanted to also access their money from an insurance bond (also known as an investment bond) structure in the first five years (or longer in some cases), the returns realised obtained were, on average, at least 25% lower.
The multi-layering of internal charges within the insurance bonds, meanwhile – especially during the first five years, and thereafter besides in many cases, it emerged – had, in effect, self-defeated the tax efficiency argument.
Had these clients invested directly in a passive tracker portfolio over the five-year period in question, and paid an accountant to declare all taxes due each year at current Spanish tax rates, every single one of them would have been better off than they were as a result of investing within their Spanish-compliant bonds.
Of course, as all investment professionals are told to tell their clients early and often, past performance is no guarantee of future results. In other words, the passive tracker investments used to compare the insurance bond results with might conceivably have performed less well during a different time period than the one used.
What’s more, Hampden and his colleagues at OpesFidelio accept that their findings, conclusive as they appeared to be, were based on a relatively small sample of 32 cases.
Nevertheless, the conclusion that Hampden and his fellow researchers at OpesFidelio came to, as a result of the research, was that on many commission-based bonds, “the charges far outweighed any of the alleged tax reporting [advantages] or tax savings”.
They add that anyone who, like them, has spent any time talking to some of the action groups currently helping disgruntled and in some cases, out-of-pocket investors in Spain, would urge anyone in the EU who is considering investing in insurance bonds to ensure that they get good advice, which would include a full range of the options available to them.
Hampden is clear that the 32 cases he and his OpesFidelio associates reviewed were all commission-based – a remuneration system that is gradually being replaced across Europe by fee-based advice – and that the investors may not have seen the same results if their original advice had come from a fee-based adviser offering a “clean-charged” insurance bond.
In addition, Hampden and his colleagues note, some insurance product providers actually do offer a very good, clean charging structure as well.
So the key is ensuring that the client understands what type of remuneration structure they are committing themselves to, as well as what the full range of their investment options are.
The OpesFidelio ‘Bond v Platform Spreadsheet’
Following on from this research, our experts at OpesFidelio put together what they’re calling their “OpesFidelio Bond v Platform Spreadsheet’.
This new OFBvPS spreadsheet is designed to calculate, and thus compare, the returns investors receive if they directly invest a certain amount on a platform, and if they invested, or might have invested, an equivalent sum, at the same time, in a standard offshore bond or a Spanish-compliant investment bond – with the taxes that would apply upon withdrawal in both cases, over any five-year period of projection.
The calculations are based on linear investment growth, but they also allow for direct fees to be taken up front, allowing complete disclosure of charges.
In other words, the results for a fee-based projection actually start from a lower initial investment value than that of a insurance bond, as the fee is presumed to come from the initial investment. (The typical fees for advisers are assumed to be between 1% and 4%, depending on the amount being invested.)
In considering the returns from the various types of offshore bond, compared with those that would accrue to an investment held outside such a bond, it will be assumed that 50% of growth is dividends taxed, while 50% is capital growth taxed.
By comparison, outside of an offshore bond, 50% of all growth is taxed annually, whereas within the bond, there is no annual tax charge other than a stipulated “unrecoverable tax charge on investments held within a bond”. For Spanish-compliant bonds it allows for the declaration and payment of tax annually in or out of the bond.
OpesFidelio advisers using this spreadsheet, though, will be allowed to insert all the explicit costs of both bonds and directly-held platform investments, and also specify when surrender charges expire –thus allowing advisers to provide themselves with guidance as to when they should use a bond for tax reasons, and when they should not.
The OpesFidelio Bond v Platform Spreadsheet has been designed to enable different growth rates and tax rates for income and capital gains to be applied, using additional sheets.
Registered and regulated advisers interested in obtaining more information about the OpesFidelio Bond v Platform Spreadsheet, which is available only to OpesFidelio members, are urged to contact Shane Wood at OpesFidelio.