The topic of clients holding cash in a foreign bank account is one that we have discussed extensively over the past few years. One of the main challenges we sought to address was the poor returns on offer due to persistently low-interest rates post the 2008 global financial crisis. However, the recent unprecedented levels of inflation experienced globally have caused aggressive hikes in interest rates worldwide over the past 12 months, making the returns available from the asset class more attractive, on a nominal basis, at the very least.
Our previous articles on the topic have motivated clients with cash in foreign bank accounts to consider taking action to increase their investment risk to improve their outcomes. The volatility experienced across a broad range of offshore asset classes in 2022 has made many clients reluctant to do so. As a result, they have maintained their default position of keeping this 'lazy cash' in their foreign bank account. However, many factors cause sub-optimal outcomes for investors who default to this position.
Punitive taxation
South African investors are taxed on their worldwide assets, and for higher rate taxpayers, 45% of the interest on offer will be lost to tax. But when clients are adamant that they do not want to increase their investment risk, advisors can offer a solution to these clients via the Ninety One Global Life Portfolio product.
All funds offered via the Ninety One Global platform are "roll-up" funds, meaning that all income does not accumulate to the investor but is instead 'rolled up' in the fund's price. This has two significant benefits; firstly, it converts what would typically be an income event into a capital event, reducing the rate of tax that will be applied. And secondly, it defers when that tax would be payable because it will only take place on disposal of a unit. The second point means that the client effectively controls when the tax is payable.
You can amplify these advantages by combining a roll-up fund with an offshore policy wrapper like the Ninety One Global Life Portfolio. Under this scenario the effective rate of capital gains tax (CGT) is only 12%. This presents a substantial tax arbitrage opportunity, where a higher rate taxpayer could transition from paying 45% on interest in a foreign bank account (annually) to just 12% upon disposal in a money fund through The Ninety One Global Life Portfolio. The graph below illustrates the potential hypothetical benefit of this strategy.
What is the most efficient solution for cash in offshore bank accounts?
Source Ninety One, for illustrative purposes only. Yield on offer will fluctuate over time. Assumed growth of 4% assumed in both scenarios. 0.33% platform fee and 0.25% advice fee deducted from policy wrapper example. 45% income tax deducted annually from bank account example, CGT of 12% deducted at end of illustration from policy example.
This allows the advisor to create an improved outcome for the client net of fees and taxes while also allowing the advisor to bring more assets into their advice net, which can enhance revenue. The above graph demonstrates that even where the assumed gross yield of the bank account and the money fund are identical, there is room for an advice fee (assumed to be 0.25% here) and a platform fee (assumed to be 0.33% here) and the client can still be better off. The advisor has then placed the client in a tax-efficient environment where a switch into growth assets can be made quickly and efficiently when the client is more comfortable.
We still feel, however, that even conservative investors with a medium to-long-term horizon should consider taking on some investment risk to earn a positive real (above inflation) return on their offshore assets. This is discussed in the previous version of this article. Besides having lazy money that has little opportunity to grow, a South African resident may not realise the unintended tax and estate planning consequences of having an offshore bank account. On death, dealing with an offshore bank account can be complex and expensive.
Potential adverse consequences on death
When an investor passes away, the location of their bank account can determine whether offshore probate applies. In such cases, the investor's family might need to engage an overseas agent, akin to a South African executor, to handle the affairs related to the bank account. It's important to note that this process can be time-consuming and financially burdensome.
In addition to offshore probate considerations, the location of the bank account can also determine the applicability of overseas inheritance tax (situs). Depending on where the account is held, this tax can reach a high rate of up to 40%. Moreover, as a South African resident, estate duty may be payable on your worldwide assets, including the bank account. While a double taxation agreement between countries could offer some relief, there remains a possibility that the higher foreign inheritance tax will still apply.
The foreign bank account will be frozen while the estate is being finalised, and the deceased's family and dependents will be unable to access the funds until the estate has been wound up.
However, the move to the Ninety One Global Life Portfolio also helps to counter these challenges and can protect against unintended consequences.
Some key estate planning benefits include:
- Investors in the Ninety One Global Life Portfolio can nominate a beneficiary who will receive the benefits on their death. Having a nominated beneficiary helps to avoid some of the offshore estate costs associated with offshore assets not held in a policy.
- There is an opportunity to nominate an alternative beneficiary to create a 'plan 'B' for a scenario where the primary beneficiary is already deceased when the owner dies or dies simultaneously. This also helps to avoid the unnecessary cost associated with death.
- There is no need to appoint a foreign agent to deal with this asset if there is a nominated beneficiary, and no offshore inheritance tax nor South African executor fees will be payable. However, estate duty may apply in South Africa.
- This investment structure also offers liquidity on death. The nominated beneficiary will have access to the investment proceeds within a short period as the asset does not go through the estate. Also, the policy proceeds will be exempt from capital gains tax (CGT) if the policy is transferred to the nominated beneficiary. Access to the investment will be unrestricted after the transfer as any remaining term applicable falls away on death.
Conclusion
Investors need to consider the investment vehicle they choose when investing offshore carefully. While opening a foreign bank account may seem the simplest way to move money offshore, the investor's estate could face double taxation. It will be subject to executor fees in South Africa. The process will likely be drawn out and costly as a foreign agent may need to deal with the offshore bank account.
The Ninety One Global Life Portfolio offers a valuable solution for addressing these challenges, allowing advisors to exert greater control over the amount and timing of tax payments when investing offshore. This investment structure allows for tax efficiency and ensures liquidity in the event of death. By bypassing the estate, the nominated beneficiary gains prompt access to the investment proceeds, avoiding the freezing of assets and potential additional fees and probate processes associated with a bank account.
Ideally, all clients would align their risk tolerance with their investment time horizons. However, we understand that many clients hesitate to take this necessary step. Nevertheless, the above points have demonstrated that products like the Global Life Portfolio can significantly enhance outcomes for apprehensive clients. Furthermore, these products create opportunities for advisors to generate additional revenue by delivering added value to their clients.