The Portuguese compliant investment bond plays an important role in financial planning for expats. Picture your planning strategy as a cake with each slice allocated as a constituent part of the whole. Tax can represent one of the larger slices unless we do something about it. An ideal situation is where we have our cake and eat it. In other words, we optimise our investment and tax planning without the fiscal authorities taking a hefty chunk of our income and assets.
Very few EU countries operate a tax system that combines low taxation with a relatively low cost of living. That is, other than The Florida of Europe, Portugal. The Non-Habitual Residence (NHR) tax regime offers huge tax advantages to expats and has led to a flood of retirees who have moved or are planning to move to Portugal. Other attractions such as the weather, food, history, golf courses and friendly people add to the high quality of life.
The Portuguese tax system can be penal for those who do not arrange their financial planning in the most optimal way possible. However, for those with NHR status, foreign-sourced income is usually untaxed as long as the asset is potentially taxable in the country where it is based. UK Individual Savings Accounts (ISAs) are an exception as they aren’t taxable in the UK and would therefore fall under Portuguese general taxation rules. The tax would be payable on the gain every year, whether withdrawals were made or not. Taxation is levied at a rate of 14.5% to 48%, depending on the individual’s overall tax position.
The NHR regime allows foreign pensions to be taxed at 10% for ten years. The 2020 budget included a change from the zero rate to 10% after pressure from other EU countries. Those who were granted NHR status before 2020 are still able to benefit from the zero rate.
It, therefore, makes perfect sense to draw down as much of your pensions while still within the qualifying period. Of course, everyone’s situation is different; this would not be the best strategy if it meant having little or no pension entitlement afterward.
Taxation of the Portuguese compliant investment bond
A Portuguese compliant investment bond qualifies for favourable tax treatment if issued by an EU-based company and meets the fiscal criteria. The bond offers access to a wide variety of funds and securities managed by the world’s most respected and prestigious companies. Plan-holders can select a spread of investments without entry or exit fees.
The first thing to note about the tax treatment of Portuguese compliant investment bonds is that no Capital Gains or Savings Income tax will be charged if no withdrawals are made in any given year.
If withdrawals are taken, a sliding scale of tax rates is applied based only on the taxable income. This is not the same as the amount withdrawn. It is optimised after eight years when only 40% of the taxable income is subject to tax.
An example would look like this:
- Original Investment premium: €250,000
- Value of investment bond after eight years: €400,000
- Withdrawal of: €25,000
|Step 1. Calculate the percentage gain||Portion of value surrendered: €25,000 / €400,000 = 6.25%|
|Step 2. Calculate the taxable income: premium deemed surrendered||Taxable Income of €250,000 x 6.25% = €15,625 (premium surrendered)|
|Step 3. Calculate the taxable income: withdrawal amount minus premium deemed surrendered||€25,000 – €15.625 = €9,375|
|Step 4. Calculate the tax after eight years: only 40% of the taxable income is taxed at 28%||€9,375 x 40% = €3,750 x 28% = €1,050 (equates to tax of 4.20% on withdrawal of €25,000)|
Financial Planning strategy
There are a multitude of ways to apply these principles to an individual’s situation. A relatively straightforward strategy would be to withdraw as much of the pension plans over the first ten years of NHR status, then revert to the bond at any time from year eight onwards. Excess income can be added to the bond each year to boost future income requirements.
Substantial succession and inheritance tax benefits also apply by regularly adding to a Portuguese compliant investment bond. Wealth can be passed to beneficiaries tax-free in Portugal and tax-effectively from a UK perspective.
Combining NHR status with a well-organised financial plan can considerably reduce Portuguese taxation if structured correctly.
Although it is not possible to avoid taxation entirely, investors can minimize tax exposure. You can therefore have your cake and eat most of it! Finally, the cherry on top is also yours for the taking as there is no wealth tax in Portugal!
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