Are you searching for a tax-efficient investment in Spain, perhaps something similar to your UK ISA or US Roth IRA? If so, you've no doubt come across Spanish-Compliant Investment Bonds.
Offered by life insurance companies such as Prudential and Quilter, these mysterious investments are only available through financial advisors so it's not easy to find independent reviews.
This is my opinion and personal experience: I'm not a financial advisor, I'm an expat living in Spain who was almost convinced into investing in a Spanish-Compliant bond once upon a time. After looking into the fee and commission structures, I decided to steer well clear.
So, what exactly are Spanish-Compliant Investment Bonds? Let's take a look.
What is an Investment Bond?
Firstly, let's forget about the 'Spanish-Compliant' part and consider what an investment bond actually is.
Don't be confused by the name – Investment bonds are sold by life insurance companies and have nothing to do with government bonds or corporate bonds.
Basically, you pay a lump sum to the life insurance company and they invest the money for you, usually in your choice of their selection of funds. Although there will be some element of life insurance included, the main purpose of investment bonds is, as the name suggests, for investment.
Investment bonds are intended to be held for ideally 10 years or more. They are NOT suitable for short-term investing – we'll come to that later.
The popularity of investment bonds has fallen in the UK since the introduction of ISAs as, although they do have some tax advantages, ISAs have more. Basically, while ISAs allow you to pay less tax, investment bonds only help to defer tax (i.e. to pay it later).
Of course, once you leave the UK, you can no longer benefit from the tax-free returns of ISAs, so let's move on to the 'Spanish' element.
What is an 'Spanish-Compliant' Investment Bond?
It's an investment bond that has been packaged by the life insurance company to appeal to expats living in Spain.
Along with the so-called tax advantages, Spanish-Compliant Investment Bonds make life easier for expats as the life insurance company will do the reporting to the Spanish tax authorities on your behalf. This means that you won't have to include them on your Modelo 720 (more on this later).
Who do Spanish-Compliant Investment Bonds appeal to?
Spanish-Compliant Investment Bonds are (or at least should only be) marketed to the following investors:
- Those who won't need to touch their investment for at least 10 years. This is extremely important and should be emphasised more by the financial advisors pedalling these products. The penalties for withdrawing some or all of your investment during the early years can be as high as 25%. That means, if you were to invest €100,000, you'd only get €75,000 back.
- Those who have a cautious attitude to risk. One advantage of these kinds of investment bonds are that the life insurance company can 'smooth' the returns, which means that during a bad year, while everyone else sees the value of their investments slashed, the life company will use some of their profits kept aside from the good years to smooth things out (it's important to remember though that the downside of this is that they'll pay out less in the good years).
- Investors who are keen to keep their money out of Spain for reasons such as inheritance tax.
- Those who fear and don't want to deal with the Spanish tax authorities (understandable, we'll cover this below).
Who would NOT benefit from opening a Spanish-Compliant Investment Bond?
- Investors who may need to withdraw funds within the next 10 years (see section above).
- Those who have a more adventurous attitude to risk and want to benefit from upturns in the market.
- Those who have at least a basic knowledge of how to invest (if you are reading this article, chances are, that's you..) and understand the importance of keeping costs down.
- Those who realise that there are better ways to keep your money out of Spain (if you want to, that is) and that you can pay an accountant/gestor a very reasonable fee to deal with the Spanish Hacienda on your behalf.
Spanish-Compliant Investment Bond Myths
Let's take a look at the sometimes outrageous claims made by financial advisors:
Spanish-Compliant Investment Bonds are 'Spanish ISAs' or 'European ISAs'
If only! As we've said, in the case of an ISA, the income and investment gains are tax-free for as long as you remain as a UK resident, but for a Spanish Compliant Investment Bond, the tax is only deferred. This means that you may pay less tax during the first withdrawal, but eventually you'll make up for it.
Growth on Investment Bonds is tax-free whilst invested
This may be true but it's not an advantage – growth on almost all investments are tax-free until you sell them.
Imagine you own a holiday home. You'll pay tax on what you make renting it out to holiday makers, but you won't have to pay tax on the increase in value every year.
Spanish-compliant bonds are exempt from Modelo 720
If you are not familiar with the Modelo 720, it's a tax form which all residents of Spain with assets worth more than €50,000 in countries outwith Spain have to fill out each year. There's no tax payable, it's simply a way for the Spanish Hacienda to prevent and uncover tax evasion.
A Spanish Compliant Investment Bond doesn't have to be reported on the Modelo 720 because the life insurance providers have an agreement with the Hacienda where they report it so you don' t have to.
Until recently, the fines for not filing or for missing out assets from the Modelo 720 were extortionate: for example, the minimum penalty for failing to file the modelo was €20,000. Fortunately, the European Court of Justice ruled that these fines were unfair, and as a result they have been drastically reduced, with the minimum penalty now being a more reasonable €300.
While not having to file a Modelo 720 is an advantage, you are only saving a few hundred euros a year by not paying an accountant to file it on your behalf.
Spanish-compliant bonds are a way to avoid Inheritance and Wealth Tax
These are highly complicated areas and it's important to get legal advice from an experienced lawyer rather than a financial advisor before assuming that this will be the case.
Spanish-compliant bonds are tax-efficient
This is the main selling point of Spanish-compliant bonds but it's important to remember that you'll only pay tax when you make a profit, i.e. if your investment increases in value. There's no guarantee that you'll actually make any profit, especially during the first 10 years, as you'll understand once we start looking at the fees and commissions charged.
What are the fees?
Compared to other investments, the fees charged by Spanish-Compliant Investment Bonds are high and extremely difficult to understand.
Let's consider the Prudential International Prudence Bond as sold to expats in Spain.
Prudential charges a 2.0% - 4.0% annual fee for management and transactions depending on the fund(s) you choose.
There are also penalties for cashing in all or part of the bond within 5 years of making an investment, which are:
- 1st year: 10%
- 2nd year: 8%
- 3rd year: 6%
- 4th year: 4%
- 5th year: 2%
This means that if you were to invest €100,000 in the bond and cash it in within the first year, assuming a 0% rate of growth, you'd pay up to 14% or a whopping €14,000 in fees!
And that's not all! We haven't got to the financial advisor's commission yet.
Prudential doesn't sell this investment bond directly, it's only available through financial advisors. Unlike in the UK, financial advisors in Europe are still allowed to receive commission from product providers.
Financial advisors can choose their own level of commission with a Prudential bond, and the maximum commission which Prudential allows them to take is 5% of the lump sum invested into the bond, plus 1% of the fund value each year. These fees are deducted from the value of the bond.
So, going back to the previous example, for a €100,000 lump-sum investment, a financial advisor could reward themselves with up to €6,000 in commission during the first year and €1,000 each following year.
Taking Prudential and the financial advisors fees/commission together, if you were to cash in a €100,000 bond during the first year, you'd potentially only get €80,000 back.
Spanish-Compliant Bonds are promoted as being tax-efficient but it's important to remember that tax is only payable when you make a profit on an investment.
If your investment goes down in value, as will be the case if you withdraw it within the first 5 years because of the exit penalties, you won't pay any tax anyway.
If you really do hold the bond for over 10 years, perhaps you will make a profit which the crazily-high fees and commission don't eat up. But this really depends on the performance of the underlying investments, and there are far more cost-effective ways to invest, as we will explore in future blog posts.