The Costa Rica Star has recently reported on a Facebook founder renouncing his US citizenship to avoid paying taxes, and of course Mitt Romney’s offshore accounts have sparked discussion on the topic.

If you’re following this year’s election news, you’ve probably seen Romney come under fire for his offshore accounts. While his campaign isn’t offering explanations for keeping money in places like Switzerland or the Cayman Islands, it’s probably safe to assume he’s not doing anything illegal. But it begs the question: Why do the rich keep money in foreign accounts?

Offshore accounts – legal or illegal?

One of the confusing things about offshore investing is that it does often involve breaking the law. For example, strict bank secrecy laws in places like the Cayman Islands and Switzerland allow those with ill-gotten gains to hide their money and thus keep it from being confiscated. Everyone from terrorists to drug smugglers use offshore accounts this way.

So it’s tempting to believe that anyone with an offshore account is doing something illegal. After all, if they weren’t, why would they care about secrecy? But sending your money overseas is no more illegal than sending yourself overseas. And there are logical reasons to do it.

The mechanics

In the past, to open an offshore bank account you would typically either visit the bank in person or use a liaison in the United States. For example, an offshore bank located in Belize or Switzerland works with a law firm in New York. To open an account, you visit the law firm and a lawyer sets up the account on your behalf for a fee.

Today, you also have the option of opening an offshore bank account online or over the phone yourself, eliminating the expense of a liaison. However, because of their complexity and depending on what you’re attempting to do, lawyers can still be necessary to set up and manage an account.

In some cases, investing offshore includes creating a company and incorporating in the host country. In an article recently published by The New York Times, Adam Davidson chronicled how he could have incorporated and started an offshore bank account in 10 minutes for less than $3,000.

The full article is worth reading, but here is a breakdown of what Davidson did. First, he located an offshore bank in Belize that was willing to set up an account through email and over the phone. Then he contacted the bank and got a list of fees, including:

$900 for basic incorporation in Belize
$85 for a corporation seal
$650 to open a bank account in a second country, Singapore
$690 to assign an account manager
Total startup cost – $2,415

But cost is related to exactly what you’re doing with an offshore account. Some require a corporation, some might even require you to own a home in the country where the account is located. And some accounts may have steep minimums: from $100,000 to a million or more.

The benefits of offshore investing

1. Privacy Under U.S. law, it’s fairly easy for the government, or in some cases even private citizens, to gain insight into your financial activities. But some countries have laws preventing banks from giving out any information about account holders. For example, the Switzerland Banking Act of 1934 makes it illegal for bankers to share any information about your bank account, unless you’re suspected of an offense like drug trafficking or money laundering.

For example, if you’re a famous corporate raider who wants to take over a company, when you start buying stock, small investors could see what you’re doing – big trades are public record. Other investors could then jump onboard and drive the price of your target company higher. An offshore corporate or trust account could shield your identity.

2. Asset protection, Since your offshore bank account is protected by privacy laws, that makes it difficult for anyone to find your account or learn how much money you have. That could protect your assets from being seized. For example, if a surgeon is sued for medical malpractice, he might be able to shield assets this way.

3. Higher return, The average interest rates on savings accounts have plummeted in recent years. For example, as of Sept. 6, the highest rate Bankrate found on savings and MMA accounts was 1.05 percent, with a $25,000 minimum opening deposit. Other countries might offer higher rates.

4. Tax Deferral Companies can use offshore accounts to defer their U.S. taxes. For example, if you own a company that does business outside the United States, depositing international profits into a U.S. bank account means paying taxes on them. Put those profits in an offshore account, however, and you won’t have to pay taxes until the money comes back into the country.

Bottom line? Offshore accounts can offer advantages for those who can afford them, but the complexity and high cost keep them out of the reach of average people.

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