Get a better rate on your savings by stashing your cash offshore

You can earn high rates of interest by saving offshore, but you must understand the risks.

In recent years, HM Revenue & Customs (HMRC) has been aggressively cracking down on tax evasion by Brits using offshore savings accounts.

According to the taxman, as many as 500,000 British savers have squirreled their nuts offshore. By doing so, they have avoided billions of pounds of tax on interest earned abroad.

Don't break the law

However, in the past three years, UK tax authorities have successfully demanded Brits' account details from various tax shelters around the world, including Switzerland and Liechtenstein. As a result, HMRC has recovered huge sums from individuals in back taxes and penalties.

It's important to note that it is not illegal for a UK resident to keep cash deposits in offshore savings accounts. Indeed, British adults are entitled to open as many offshore accounts as they wish. However, you must declare any interest earned to HMRC. Otherwise, you may be guilty of tax evasion, which is a criminal offence.

How offshore savings accounts work

What is an offshore savings account? Quite simply, it's a savings account located and managed outside of your country of residence. Most offshore accounts are run from the Channel Islands (usually Jersey or Guernsey), Gibraltar, the Isle of Man and Ireland.

Almost all of the offshore accounts advertised in the UK are operated by foreign subsidiaries of UK banks and building societies. As well as saving in sterling (British pounds), you can also open offshore accounts in US dollars or euros. These are especially useful for expatriates ('expats') and Brits working overseas.

One benefit to saving offshore is that you can defer or 'roll up' your interest until a future date. This allows you to manage your tax liabilities by closing your account or taking out interest when your personal tax rate has fallen.

As visiting offshore branches may be difficult, most of these accounts can also be operated via the internet, telephone and post. Generally, they fall into three groups: easy-access accounts, notice accounts and fixed-rate bonds, each of which may pay interest on a monthly or yearly basis.

Savings safety-nets

While offshore accounts may not be suitable for most British savers, they are widely used by Brits who live, work or travel extensively abroad.

It is absolutely essential you understand that offshore accounts are not covered by the UK's safety-net set up to safeguard savers. The Financial Services Compensation Scheme (FSCS) guarantees 100% of the first £85,000 per person per bank for UK-based cash deposits.

Thus, accounts based in Jersey, Guernsey, the Isle of Man and Ireland are not guaranteed by the FSCS. In fact, when Icelandic banks Kaupthing and Landsbanki collapsed in October 2008, Brits saving offshore lost up to 70% of their money!

Some of the savings safety-nets provided by offshore tax havens are weaker than our own FSCS:

• Gibraltar Deposit Guarantee Scheme: 100% of all deposits, up to a maximum of €100,000 (roughly £83,000).
• Guernsey Banking Deposit Compensation Scheme: up to £50,000 per person per bank.
• Ireland Deposit Guarantee Scheme: €100,000 per person per bank, boosted to an unlimited guarantee for six key Irish Banks until 31 December 2012.
• Isle of Man Depositors' Compensation Scheme: up to £50,000 per person.
• Jersey Depositors Protection Scheme: up to £50,000 per person per bank.

While the guarantees offered by these deposit-protection schemes appear generous, they are only as solid as the governments backing them. As small islands, I wouldn't completely trust the guarantees provided by Gibraltar, Guernsey, the Isle of Man and Jersey. Likewise, Ireland's economy is a total mess, so its safety-net is not nearly as strong as the UK's.

Six of the best for offshore savers

According to Moneyfacts, the average rate paid by offshore sterling accounts paying variable rates is 1.31% a year (before tax, of course). Fixed-rate accounts pay much higher rates, with the average being 3.08% a year.

As always, the best way to find the most attractive savings accounts -- offshore or otherwise -- is to shop around online. Here are six of the best offshore accounts, all of which pay more than 2.5% a year:

Source: Moneyfacts, 20/03/12

As you can see, this table is dominated by two banks with five top spots between them. They are Lloyds TSB International and AIB International Savings, a subsidiary of Allied Irish Banks. Also, note that the minimum deposits for these overseas accounts are fairly steep, ranging from £5,000 to £100,000, so they are only for serious savers.

In summary, if you think that saving offshore may be useful to you, then please go ahead. However, never put your cash at risk by saving too much in one particular bank or tax haven!

More on savings:

The UK’s best Cash ISAs

Top Cash ISAs for transfers

The top fixed rate savings bonds