Expats (particularly those working in low-tax or high salary jurisdictions), are often the targets of sales people spruiking tax effective offshore investment schemes or tax effective offshore pension funds. In some circumstances they are promoted by well-meaning employers or expat organisations. So, how can you determine which offshore investment schemes are genuinely a good investment proposition, and which ones only exist to make the sales person and fund manager money?
A reader recently shared with me a conversation she had had with a financial advisor who contacted her after getting her details from a well known expat organisation. He was promoting the opportunity to invest in a tax effective UK offshore investment scheme. I cover some of my thoughts on this particular “investment” opportunity in our article – A review of one Offshore Savings Scheme marketed to Australian expats.
In this article I share some questions you should ask yourself (and / or your financial advisor) and some other considerations to keep in mind before you commit to these types of investment schemes.
What is a Dodgy Offshore Investment Scheme?
Firstly, what do I consider a dodgy offshore investment scheme? For me, some of the common ingredients to a dodgy offshore investment scheme are
- Very high fees
- High commissions to the financial advisor / broker
- Hard sell from the “financial advisor”
- Long lock in periods (10 years plus) with compulsory contributions and high early exit fees
- May have a high “tax-effective” element to it allowing you to minimise or defer tax
- Usually operating in a tax haven location
The 10 questions to ask yourself or your financial advisor about the offshore investment scheme they are marketing :
Is the investment scheme being marketed by a registered financial advisor?
This is the first level of screening you probably want to undertake, but also don’t let it give you a false sense of security. Whilst the personal financial advice regulations vary markedly around the world, this should be your first level of inquiry. Obviously you will have more protections if you are dealing with a financial advisor regulated in the UK than one in, for example, Nigeria. In addition, to ensure you gain the full protection of any government regulations, you want to make sure that the company is regulated in the country you are living.
Even so, as this article states in the Doha News “All of the regulations and rules that a Western expat understands, as soon as you get into the Middle East market, none of those protections exist. In Dubai there is no need to disclose fees and commission, no requirement for the adviser to be qualified, and no requirement to provide a suitability assessment.”
Also be aware, even large international corporations have been associated with not so reputable investment schemes. As a result, do not assume that just because you are dealing with a well known company, that you won’t be sold a unsuitable investment product.
What commissions are payable to the financial adviser and the various parties involved in the transaction
One of the biggest issues with dodgy offshore investment schemes is that the broker is incentivised to get you the worst possible deal. I quote from this article which appeared in the South China Morning Post relating to Investment Linked Assurance Schemes (ILAS).
“How much commission is your plan generating? For a regular contribution to an ILAS savings plan multiply the monthly or annual premium by the number of years the policy is taken out for by the commission payout of 4.2 per cent. For example, a 20-year policy with a monthly premium of HK$10,000 would generate gross commission of 20 [years] x 12 (months in the year) x 10,000 x 4.2 per cent. This equates to HK$100,800. The lump sum portfolio bond commission is usually 6 to 8 per cent of the total amount invested. So an investment of HK$1 million would generate HK$60,000 to HK$80,000 in commission. Commission is split between the broker and his or her employer.”
Compounding this is that most of the commission is usually paid upfront to the broker, further creating a misalignment of interests between the broker and the client. This large amount of commission usually results in these products having a minimum investment term (to ensure the product creator is able to recoup the commission they have already paid to your broker – see more on this later).
Before investing in something, make sure you get your financial advisor to disclose in writing, the amount of commission they are being paid for recommending you invest in the product. While I don’t deny that people should be paid a commission for selling a product, very large commissions or commissions that create a misalignment between client and broker should ring alarm bells for you. If they are not willing to disclose their commission, then don’t deal with them.
What fees are charged by the broker and the fund manager that the broker puts your money into?
Fees that you might be charged when investing into any investment scheme include an upfront fee, an ongoing management fee, an exit fee, or an early exit fee. You also need to check if there are multiple levels of fees. By this I mean, does the company marketing you the investment scheme charge fees, as well as the company managing the investment scheme.
Many financial advisors will talk about how they only charge 1 or 2% of your investment balance per annum to manage your investments, but then they fail to tell you that the investment funds they then put your money into will also charge another 2 or 3% per annum on your investment balance. Before you know it, your investments need to start earning at least 5% per annum just to pay for your investment managers before you start earning any money. As I have written about in my article on index and managed funds, the average professional fund manager fails to outperform the perform of the underlying index they are trying to beat (eg. the ASX200, or S&P500). That means, on average, the performance of your investment is already more than likely going to be below what you can get by just investing directly in the index yourself.
Do not accept that you need to pay ongoing advisory fees to the financial advisor or broker that are a percentage of the value of your investments. Do not accept that it is normal to pay high entry or exit fees. If the fee structure is so complicated it can’t be explained in a couple of sentences, then you should ask yourself what are they trying to hide?
Are you required to invest in any insurance products
Dodgy offshore investment schemes often have some form of “life insurance” policy included with them. Make sure you understand how this works, and what fees are charged for it. Does the insurance product lock you into a minimum term and are there penalties for terminating early and stopping monthly contributions?
Insurance products can also sometimes sit outside of financial regulators scope of responsibility, and allows the creators of these products to charge higher fees.
What are the minimum instalments and over what term do you need to make instalments
As I stated earlier, the investment scheme may lock you into minimum monthly contributions over a fixed term. Terminating this arrangement can be costly as we saw when we reviewed this offshore savings scheme.
Is there a break fee if I stop making instalments or want to withdraw your money early.
As I just said, terminating these policies early can be costly. It is common with these types of products that terminating your policy can cost you a break fee equivalent to up to two years of investment contributions (often to cover the cost of the commission paid to the “financial advisor”.
Does the offshore investment scheme remain tax effective if I move countries?
In which countries can you live for the investment scheme to be “tax effective”? One of my personal golden rules of investing, is only invest in things you understand. If you don’t understand it and don’t understand how it works, then don’t invest in it.
Ask the broker or financial advisor if the investment remains tax effective when you move back to Australia? On what basis can they assure you that it remains tax effective? Does the investment scheme have a product ruling with the Australian Tax Office?
Are there alternative options for me to invest that are tax effective?
Just because you are being told the investment is tax effective does not mean there are not better investment alternatives out there. It also doesn’t mean the tax benefits outweigh the fees that the offshore investment scheme promoters will charge you.
I have previously written about the tax effectiveness of investing in the sharemarket for Australian expats, as well as the negative gearing benefits of investing in Australian property as an expat. Before committing to an offshore investment scheme or product, you should fully evaluate your options with your registered financial advisor in Australia.
If I live in a country where the tax rates are low, do I really gain anything from investing in one of these offshore investment schemes?
Understand whether there is truly any tax benefit based on your specific circumstances.
Do I really need the additional life insurance?
If the investment scheme is rolled up with life insurance, understand how it works and how much it is going to cost you. Is the life insurance cover giving you the cover you really need, and is adequate to replace your existing life insurance policy. Life insurance products in Australia vary widely, and overseas it is no different.
I would love to hear your experiences? Share in the comments below.
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Disclaimer : This information is for educational purposes only and does not constitute financial or taxation advice. As this information is not advice and has been prepared without taking into account your objectives, financial situation or needs you should, before acting on this information, consider its appropriateness for your circumstances. Independent advice should be obtained from an Australian financial services licensee before making investment decisions, and a registered (tax) financial advisor/accountant in relation to taxation decisions. To the extent permitted by law, we exclude all liability for any loss or damage arising in any way.