The purpose of investing is to increase the value of your assets over time. Unnecessary tax can chip away at your gains and hinder your progress. With tax allowances falling it can be useful to look at how you can structure your investments to ensure they are as tax-efficient as possible. Claire Spinks, our Head of Tax Technical and Development, looks at what options you might find helpful to factor into your portfolio.
When investing, it’s useful to always take stock. As well as reviewing your progress in the way of returns, it’s helpful to check that you’re investing your money in a tax efficient way. This might be particularly relevant if you’re paying the higher or additional rate of tax or have recently triggered a capital gain.
What is a tax-efficient investment?
Your portfolio of investments can help you shield money from a range of taxes including Income Tax, Capital Gains Tax and Inheritance Tax. Choosing the right options can help reduce the amount which is lost in tax as a result of any income or gains which the investment is making. So, what should you consider when it comes to making your investments tax-efficient?
Step 1 – make use of your allowances
With some allowances falling, it’s increasingly important to make the most of any tax-free thresholds whilst you can. Capital Gains Tax offers an annual exemption of £6,000 in 2023/24 (anticipated £3,000 2024/25) whilst dividends have a 0% tax rate of £1,000 in 2023/24 and £500 in 2024/25. It remains to be seen what will happen after 2025 – all we do know is it’ll very much depend on the outcome of the next general election, although it’s likely this direction of travel in freezing or lowering thresholds will continue.
Step 2 – exploit your ISA
If you are UK resident, ISAs (Individual Savings Accounts) remain one of the most tax-efficient ways to save and invest for the long-term. They currently offer a very generous annual allowance of up to GBP20,000 each year, with your capital building through compound growth. ISAs are free from Capital Gains Tax and Income Tax, and you can withdraw your funds free of tax too. As a result, they can be a valuable tax-efficient investment tool, and very useful as part of a blended approach to your retirement income.
Step 3 – top up your pension
The amount which you can contribute to a pension every year has recently increased, for some individuals, to £60,000. This offers a substantial amount of tax efficient saving opportunity, especially if you remember that 25% of your pension pot can then be taken tax-free at retirement. Anything else you withdraw will attract tax in line with the usual Income Tax thresholds. Pensions are also tax efficient for estate planning purposes, sitting outside of your estate with the ability to be passed on to your chosen beneficiaries free from Inheritance Tax.
Step 4 – think about some broader investment options
Once you’ve covered the basics there may be some other tax-efficient investments to consider including:
- Enterprise Investment Scheme (EIS) – introduced in 1994, EIS offers investors the option to subscribe for new shares in a qualifying company. EIS is one of the 4 venture capital schemes, designed to incentivise investment into smaller higher risk trading entities. With 30% Income Tax relief used as an incentive for the understandable risk to the capital investment. The benefits of an EIS investment are multifaceted, with the amount used to make the investment being available to defer the taxation of gains on other investments. In respect of the EIS investment itself, if a gain is made, that gain is exempt from Capital Gains Tax so long as the investment was held for 3 years. If a loss is made, the loss can be offset against Income Tax, which is a great benefit of this scheme; seeing tax relief at your marginal rate, as opposed to a flat CGT rate. EIS generally also qualify for business relief meaning they’re free from Inheritance Tax, as long as you’ve held the shares for at least two years. Returns are usually through capital growth.
- Seed Enterprise Investment Scheme (SEIS) – an extension to EIS, SEIS were introduced around ten years ago and offer investors the opportunity to help smaller and newer businesses raise funds and grow. SEIS offer 50% tax relief and any growth, after the investment is held for 3 years, is free from tax too. Furthermore, SEIS reinvestment relief allows up to 50% of the eligible subscription to exempt a capital gain, where the Income Tax relief was claimed in the same year. Helpfully these schemes (and EIS) offer a ‘carry back’ option where you can offset Income Tax from the previous year too.
- Venture Capital Trust (VCT) – VCTs are investment companies listed on the London Stock Exchange or AIM who in turn invest in small companies looking to grow. VCTs tend to take a majority stake in new companies, with the understanding that some will be successful and others won’t. They were initially established to encourage investment into UK firms to benefit the economy, with tax breaks of up to 30% relief on offer to encourage investors to get involved. They can be very useful if you have a high surplus income, and up to £200,000 can be invested each year. VCTs tend to return in the form of tax-free dividends.
Step 5 – investigate offshore bonds
Offshore bonds are a tax wrapper which are particularly suitable if you’re looking to invest over the medium to long term. A lump sum can be invested in the bond, with no tax levied on your investment growth and income as it occurs. There is a withdrawal allowance, available each year equivalent to 5% of the bonds original value. This withdrawal allowance rolls up cumulatively i.e. if you don’t use it, you don’t lose it and you can draw down your accumulated withdrawal allowance at any rate – it’s fully flexible. This can be particularly effective if you’re using the bond to help create retirement income.
There are a number of ways to structure your investments to make the most of various allowances and tax-efficient vehicles. Working through the options which are most suitable to you and your personal circumstances is vital, and seeking the advice of a specialist team of tax and investment professionals is a sensible first step.