Why is tax-efficient investing important?
Ensuring your investments are as tax-efficient as possible can significantly impact your wealth. Therefore, it is essential to fully utilise the various allowances and opportunities available to reduce your overall tax liability. At Consilium Asset Management, our expertise and experience allow us to support you in doing this. We ensure the decisions you take are in line with your financial goals.
Pensions are tax-efficient investments by nature. However, we have a section of our website dedicated to retirement planning. In this section, we will focus on the other wrappers and schemes that can help minimise the tax you pay.
Individual Savings Accounts (ISA)
An Individual Savings Account (ISA) is a tax-efficient savings and investment account. The main benefit is that your investments can grow mainly free of tax. Also, there is no tax on withdrawal. Non-ISA investments are usually subject to income, savings, dividends, or capital gains tax. These taxes do not apply to money held in an ISA.
However, the restriction is that you can only invest up to £20,000 per tax year. There is no carry-over to future tax years, so if you do not utilise your total allowance in one tax year, the remainder is lost.
There are various types of ISA available. The two most common types are Cash ISAs and Stocks & Shares ISAs. Your £20,000 allowance is a total across all types of ISA, so you cannot deposit £20,000 into each type.
Cash Isa
Holding money in a Cash ISA is like having it in a savings account with your bank. The benefit is that the interest you earn is tax-free, and it does not need to be declared with HMRC. However, with the current extended period of very low interest rates, their attractiveness has significantly reduced. Whereas 20 years ago, you may have enjoyed higher interest rates in your cash ISA, you would now be lucky to get more than inflation.
Stocks and Shares Isa’s
This has led to most people using a Stocks & Shares ISA instead. You can invest in many investment types within these, including individual stocks, funds, bonds, and commodities. If you held stocks outside of an ISA and were then paid a dividend, this would be taxable. But once held inside your Stocks & Shares ISA, you can enjoy these benefits tax-free. Furthermore, your portfolio can grow free of capital gains tax.
For these reasons, utilising your ISA allowance each year is generally a good idea. Topping up your ISA each year and seeing some investment growth can provide a large sum to assist your long-term financial goals.
Using your Capital Gains Tax Allowance
When an asset you own grows in value and is sold for a profit, this growth is known as a gain. This could be on a property you own, or it could be on your investment portfolio. Once you sell that asset, the gain can become liable to capital gains tax.
As mentioned in this article, you can avoid paying this tax by investing in a pension or an ISA. Still, if you have a significant gain elsewhere, your Capital Gains Tax liability could be large. Gains are taxed at 10% for basic rate taxpayers and 20% for higher or additional rate taxpayers. This can be even higher for some properties, at 18% or 28%. Furthermore, it is possible that future changes to CGT could occur. The effect of any potential changes is unknown. However, there is a possibility that tax rates might increase.
The good news is that UK taxpayers are entitled to a tax-free allowance yearly. This is known as your Capital Gains Tax allowance. Like with the ISA allowance, this cannot be carried forward to future years, so you lose it if you don’t use it. Therefore, it is wise to use this if you find yourself with a large gain you have yet to cash in.
Although this sounds complicated, having a financial planner can be significantly helpful. Unfortunately, it is impossible to sell your investments and buy the same ones immediately, but some strategies will leave you far better off in the long term. Remember that you would not necessarily need to sell all your investments, as you would only want to sell enough that gives a gain equal to the £12,300 allowance. As soon as you reinvest this money, you will have another Capital Gains Tax allowance to use the following tax year.
Business Property Relief
When a loved one passes away, it is always an extremely emotional and distressing time. The burden of a large Inheritance Tax bill can only add to these troubles. Business Property Relief was first introduced over 40 years ago. Its aim is to allow small family businesses to be passed down generations free of inheritance tax. This idea still applies, but the scope has widened over the years.
Nowadays, small businesses that you own and investments in small businesses qualify for Business Property Relief. This has opened up a huge opportunity to invest your capital in qualifying companies. The benefit is that your investment will be completely free of Inheritance Tax when you die. This enables you to leave more of your hard-earned cash for those you love the most.
So, which companies qualify for Business Property Relief? The company must not be listed on the leading London Stock Exchange. In addition, it cannot be in the FTSE All-Share Index. Some companies listed on the AIM (Alternative Investment Market) do qualify, but not all. It is, therefore, wise to exercise caution. There are also investment companies that offer products that invest in qualifying companies. As you can tell, it is not straightforward. If you are interested in Business Property Relief, please contact us. We can assist you in finding a solution that works for you.
Like with anything, there are, of course, drawbacks to this kind of investment. To qualify, you must have held the investment for at least two years at your death (and still be holding it). The other aspect to be aware of is that the qualifying companies are small, making them riskier investments than large companies on the FTSE exchange. Being prepared to accept this additional risk is a crucial part of utilising the scheme. Still, you may feel the benefits outweigh the risks if you have a potentially high Inheritance Tax liability.
Other forms of tax-efficient investing
To match willing investors with young companies that require investment, the government created a number of schemes that give significant tax advantages. However, investors need to be aware these schemes may carry significant risks to investors. The schemes are Venture Capital Trusts, Enterprise investment schemes and Seed Enterprise investment schemes. The tax advantages vary across the schemes, as do the requirements for the qualifying companies that you invest in.
The available tax benefits involved with the schemes involve varying amounts of:
- Income Tax relief – up to 50%
- Capital Gains Tax relief – up to 100%
- Inheritance Tax relief (using Business Property Relief as mentioned above) – up to 100%
- Capital Gains Tax deferral – defer tax on the gain if reinvested in the scheme
Certain restrictions exist, such as the maximum allowed to invest in each scheme and how long you need to hold the shares to qualify for the tax benefits. Again, these vary from scheme to scheme, so they have been left out of this article for simplicity.
If you would like to learn more about tax-efficient investing, please contact us. We can assist you with finding a suitable plan.
