Tax efficient Investing UK: Tax efficient Investments & Savings

Tax-efficient investing: Why is it important?

Tax-efficient investing is asset allocation that enables an investor to enjoy some form of tax relief. Strategic placement of assets to reduce tax liability enables individuals to have more finances to save and invest in assets that appreciate. People lose money in taxes; therefore, preventing losses while saving is prudent, especially for old age when retirees need more money.

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The five (5) main ways to make tax-efficient investments in the UK

There are various ways in which you can engage in tax-efficient investing in the UK, as shown below:

1. Saving in ISAs

An individual savings account (ISA) is a platform that allows you to save or invest up to £20,000 in a particular tax year. Any gains, including dividend income, interest, and capital gains from the investment, are tax exempt. The types of ISAs are innovative finance ISA, cash ISA, stocks and shares ISA, and lifetime ISA. UK citizens can start saving at 16 years and invest in stocks at 18 years.

2. Principal Private Residence Relief – PPR

PPR is a relief that exempts individuals from paying capital gains tax on a home that they have considered their primary residence. You benefit from a capital gains tax when you sell a property as a primary residence. The capital gains from part of your ownership and the last nine months of ownership are tax exempt.

3. Enterprise Investment scheme – EIS

This scheme secures UK investors from high taxes, especially when they have bought shares in high-risk businesses like start-ups approved by the plan. The investors fund the business while bearing the risk. UK Investors receive a maximum of 30% tax relief on the first £1 Million they invest within a year. Investments must be held for at least three years or face clawback of tax relief. If such an investor decides to sell the high-risk company shares, they do not have to pay a capital gains tax. However, investors must pay tax on any dividends from the investments. The investors also get tax relief on any suffered losses.

4. Venture Capital Trusts – VCT

Venture capital trusts are investments made in new or young companies to earn above-average risk-adjusted returns. VCT companies do not appear on a recognised stock exchange list. Venture capital trusts help support small and upcoming businesses and are tax exempt. UK Investors are allowed a tax relief of 30% on the first £200,000 invested yearly. The dividend income earned from the trust is also untaxed. However, investors must hold the investment for five years or lose the income tax relief they claimed upfront.

5. Pensions

Pensions are a sure bet of reducing the tax payable to the federal government while saving for retirement. For instance, a person contributes £100 into their self-invested personal pension (SIPP) while claiming a minimum of 20% tax relief on pension contributions from the UK government. Higher rate taxpayers can get up to 45% tax relief in the UK. Also, SIPP can be free from inheritance tax. The pension fund allows members to save more at a minimal cost. Also, a ‘small self-administered scheme’ (SSAS) can help clients save on tax, grow their income and diversify their portfolio. If you sell a property bought under the SSAS scheme, you will not pay capital gains tax. You are also not required to pay income tax on the SSAS rent.

How do I maximize tax efficiency?

• You can maximise your tax efficiency by investing in ventures or choosing an asset allocation that guarantees you reduced or low taxes. The possible investment assets options include individual savings accounts (ISAs), venture capital trusts, seed enterprise investment schemes, enterprise investment schemes and self-invested personal pensions.
• Invest in a tax-free savings account that allows you to earn interest on your savings without paying tax. You qualify for tax-free savings account if you make less than £18,500 annually. A cash individual savings account also allows you to save about £20,000 every tax year.
• Investing in children’s pension accounts or a junior individual savings account (JISA) could also help to maximise your tax efficiency. With a child pension, one must save a maximum of £2,880 every tax year, which automatically qualifies for a 25% tax relief, which tends to increase the contribution by a similar margin. However, children cannot access the money until they are 55 years old.
• After retiring, they can withdraw a maximum of 25% tax-free and the rest is taxed with the prevailing income tax rate. With JISA, a parent can contribute up to £9,000 in a tax year per child, and all interests and gains are tax-free.
• A personal savings allowance can also help you maximise tax efficiency. Individuals can earn interest up to a specific limit in personal allowance savings account without paying tax. For instance, basic rate taxpayers can earn up to £1,000 in interest, while higher rate taxpayers can earn up to £500 on their savings. If the groups surpass the allowance, the interests from the extra savings are taxed at 20% for the basic rate taxpayer and 40% for the higher rate taxpayers.
• Giving to charity also enables individuals to claim tax relief at a rate of 25% for every £1 given out. If possible, you can donate the appreciated assets to your children or charity.
• Gift and loan trusts. This method allows people to invest in a trust for their beneficiaries. The individual can make regular payments without paying tax.

Which tax-efficient investment strategy is best for you?

Your investment strategy may depend on your goals, the years in which you seek to make the investment, the need for liquidity, and your financial position. Always strive to diversify your portfolio to benefit from various returns and shield yourself from the risk of a single investment. It is worth noting that tax-efficient investing and portfolio diversification are perfect matches.

A tax-efficient strategy would entail investing in tax-efficient accounts such as personal pension funds, ISAs, and venture capital trusts. These accounts would enable you to reap many benefits at a minimal cost. Although all ISAs are capped at £20,000 per tax year, their returns are not taxed.

A tax-efficient strategy would entail investing in tax-efficient accounts such as personal pension funds, ISAs, and venture capital trusts. These accounts would enable you to reap many benefits at a minimal cost. For example, although all ISAs have a £20,000 allowance per tax year, their returns are not taxed.

Strategic investment, which entails investing in long-term assets, is also a tax-efficient strategy. Appreciating assets such as stocks tend to attract a high capital gains tax when withdrawals are made in less than a year. However, an investor may qualify for a lower tax due to capital gains treatment by holding the stock and selling it after one year.

Tax-loss harvesting is also a tax investment strategy. As an investor, you may choose to sell an investment that has continuously incurred losses and is underperforming. You can offset any tax liability with the losses realised from such a venture. In this case, you only pay taxes on your net profit after deducting the losses incurred. You can use the proceeds to invest in an asset that is appreciating and tax-efficient to recoup the losses, thus saving on tax.

Are there any tax-free investments in the UK?

As mentioned earlier, there are five main tax-free investments for people living in the UK. They include individual savings accounts (ISAs) such as junior ISAs and cash ISAs, pensions, venture capital trusts, principal private residence relief (PPR), and enterprise investment schemes (EIS). Other tax-free investments in the UK include: 

• Seed Enterprise Investment Scheme (SEIS): Offers income tax and capital gains tax relief
• Venture Capital Schemes: Offers income tax and capital gains tax relief
• National Savings and Investments (NS&I): Offers income tax and capital gains tax relief
• Social Investment Tax Relief (SITR): Offers income tax and capital gains tax relief
• Investors’ Relief: offers capital gains tax relief
• Business Asset Disposal Relief (BADR): offers capital gains tax relief

Unlisted and listed tax-efficient investments: what is the difference?

Unlisted tax-efficient investments are not listed or available for trading in a publicly-traded share market like the London Stock Exchange. On the other hand, listed tax-efficient investments are available for trading through a share market. Shareholders own listed companies, while the unlisted ones belong to founders, families, peers, and private investors. Some of the tax-efficient investments not listed on the London Stock Exchange include the enterprise investment scheme and seed enterprise investment scheme. Venture capital trusts, Stocks and shares, ISAs, and pensions are good examples of listed tax-efficient investments.

Tax-advantaged accounts

Tax-advantaged accounts are either tax-exempt or tax-deferred. A tax-deferred account allows you to pay for tax in the future, while tax-exempt funds do not require you to pay any tax. For instance, the personal pension fund is a defined contribution plan that gives savers a tax relief on the pension contributions, which can even be 100% worth their yearly proceeds. The personal pension allows people to save for the future while minimising any tax debt. Even after retiring, you can withdraw up to 25% without paying tax. Since the income tax rate is 20%, the pension provider claims the tax relief, which helps to add to your contribution.

Tax-efficient investing allows you to minimise or avoid paying taxes while gaining maximum returns from your investments. As a result, you can reduce your tax amount and save money for retirement when you need it the most. You should learn and take advantage of the various ways to ensure that your investments are tax-efficient. You can think of ISAs, personal pensions, enterprise investment schemes and venture capital trusts. As an investor, you should embrace various tax-efficient investing strategies like diversification, holding appreciating assets for a more extended period, and tax loss harvesting. You ought to consider your investor profile, investment options, age, availability of funds, and financial goals before choosing the appropriate tax-efficient investment.

Tax relief calculator

The are several tax relief calculators available online on various sites. You will find personal pension tax relief calculators or income tax relief calculators. These calculators help you calculate how much you need to contribute, the tax relief from the government, and how much you can claim depending on your tax bracket.

Tax-efficient investing for high earners

The best tax-efficient investments for high earners living in the UK are 

• Personal pensions: Although pension is taxable, high earners get 40% to 45%  tax relief.
• Individual savings accounts (ISAs): Especially stocks and shares ISAs with an annual ISA allowance of £20,000 per tax year.
• Venture capital scheme: This scheme includes enterprise investment scheme (EIS), seed enterprise investment scheme (SEIS) and venture capital trusts (VCTs).