Investing Tax Efficiently

Every industry loves its TLAs: ‘three letter acronyms’. And finance is no different. We try and be as clear as possible because TLAs sound boring, not exactly inclusive and… well, they mask the fact that these things can be very useful for you. Especially when you want to give your wealth a fuel injection.   

Saving on your tax bill 

Pensions, investments and other savings are complex enough. And then – just like in every line of work – our industry shortens them into near incomprehensibility: SIPPs, SSASs, ISAs, VCTs and so on.   

It’s ironic because all these things are there to help you. They can boost your overall investment returns by defending them from tax – as your money grows and / or when you take it out.  

After all, one of the first principles of a sound financial plan is to use all the tax benefits you can. We have a hideously complex tax system – and no one’s planning to simplify it any time soon – so you might as well make the most of every nook and cranny the Government offers you.  

Pensions 

Let’s start with the mothership: your pension.  

This is likely to be the core of your money. There are three types:  

• State Pension. You need 35 years of NI contributions to receive the (current) £11,973 

•  A Year. This rises each year in line with the highest of an inflation measure, average earnings or 2.5 percent. 

• Company Pension. Yours is probably a defined contribution scheme, where you take the investment risk. The old type (defined benefit, where the employer takes the risk) is being phased out.  

• Personal Pension. This might be a self-invested personal pension (SIPP) a small self-administered scheme (SSAS) or a plain personal pension. You choose what to invest in (from shares to company properties) and you manage it yourself, or through experts like us.

The tax rules for each aren’t simple. You must pay income tax when they start to pay out. The latter two give you the opportunity for a 25% tax free lump sum.   

But it’s the tax relief when you save that matters – because the government essentially rebates you your tax through tax relief. A basic rate payer gets this at 20% (an extra £20 for every £80 you put in) and higher and additional rate taxpayers get a higher rate of relief.  

Say you earn £100,000 and you want to put £5,000 into your personal pension. You pay £4,000 and the Government tops it up to £5,000. But, given you’re a higher rate taxpayer, you can claim another £1,000… which means you only really pay £3,000. Nice, eh?  

It probably goes without saying that, compounded over time, these reliefs can be very valuable.  

ISAs 

Individual savings accounts have been around for a generation. They help you shield £20,000 from tax a year. If you’re investing for your family, you can use everyone’s allowance to dial that number up considerably.   

Unlike a pension, you don’t get tax benefits on the way in, but you do get them on the way out. That means no tax on your cash ISA interest and no income tax or capital gains tax from investments in an ISA.  

Also, unlike your pension, you can take your money out at any time.  

We Brits love ISAs. We put millions in each year. But research says we don’t all fully understand them. Perhaps it’s because there are half a dozen types. No wonder most people choose the simplest – and lowest returning – a cash ISA. It’s a glorified building society account.  

In any case, the tax relief can be lucrative. Say you invest the full £20,000, leave it for ten years, at an annual growth rate of 5%. Simple arithmetic says you’ll have £30,400 at the end.   

Even better, you won’t have to worry about a £1,776.00 capital gains tax bill. We think that’s pretty good.  

VCTs, EIS and SEISs 

Right, we’re getting into the weeds now. And the TLAs come thick and fast.   

Here are three ways of investing in smaller or new companies, which might grow your capital at a much faster rate. We’ve talked about them before. In the main, they give you the ability to pay less income and / or capital gains tax:  

• VCT = venture capital trust. This gives you ‘front-end’ income tax relief at 30%; exemption from CGT when you exit and exemption from income tax on the dividends you receive. 

• EIS = enterprise investment scheme. Tax relief of 30% and no tax on capital gains after three years.  

• SEIS = seed enterprise investment scheme. You get income tax relief of 50% and your gains are exempt from CGT.

Here, as in most of this article, we’re simplifying the specific nuances of the tax benefits you’re entitled to. You probably don’t want to read a long technical document… at least not yet.   

Of course what we would never simplify is the absolute fact that these investments are high risk. Your returns might be relatively high, but the risk of loss is also much higher than say, investing in mutual funds through your pension or ISA.  

Overall, there are plenty of ways you can shield money from income and capital gains tax here – boosting your overall returns in the long run.  

If this is something you’d like to discuss – or if you think your tax affairs could be optimised – we’d love to hear from you. We’re on 020 7467 2700 and hello@firstwealth.co.uk.  

A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future performance. 

The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates, and tax legislation may change in subsequent Finance Acts. 

In addition, VCT/EIS/SEIS’s invest in unquoted, growth-oriented companies that involve higher risk than more mainstream companies listed on the main London Stock Exchange and their performance tends to be more volatile. You may experience sudden and substantial falls in the value of your investment. 

There is no guarantee that the qualifying status of the shares will be maintained. This could result in the loss of tax reliefs. 

Shares in unquoted companies may be more volatile and can be hard to sell. An exit is only possible when each individual company is sold. 

This document is marketing material for a retail audience and does not constitute advice or recommendations. Past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amount originally invested.