Whether you’re investing for the long-term, shoring up an emergency safety net, or building a retirement pot, you want to make sure your money is working as hard as possible.

Over time, tax-efficient investments can make a huge difference to the amount of wealth you accumulate, which in turn will impact your quality of life now and in the future.

There are several tax-efficient ways of investing, each with its own focus, benefits and risks. It’s wise to consult with a financial planner before you decide on a strategy, as they will advise you on the best approach for your current situation, priorities and goals for the future.

And because laws and practices relating to taxation are complex and subject to change, what works for you today won’t necessarily work for you tomorrow. Checking in with your financial planner every 12-months will therefore help you stay up to date, and on track.

Tax-efficient products and schemes

In the UK, savers and investors can benefit from a number of tax-efficient investment products and schemes. Below is an overview of the five most common.

As with all investments and any income taken from them, the value of your investment can increase and decrease, and you may not get back the full amount.

1. Individual Savings Accounts (ISAs)

Most people will have heard of Individual Savings Accounts (ISAs). These were introduced in 1999 to encourage people to save by offering generous tax breaks. There are now various types of ISAs for adults to choose from, including:

  • Cash ISAs
  • Stocks and Shares ISAs
  • Innovative Finance ISAs
  • Lifetime ISAs

There is even a Junior ISA for under-18s, which can take the form of a Cash ISA or a Stocks and Shares ISA.

Since their introduction, ISAs have proved popular, with over 40% of the UK population holding some form of ISA. Cash ISAs account for a large proportion of these, but they are struggling to keep pace with low-interest rates and high inflation.

According to money comparison experts, Moneyfacts.co.uk, the average Cash ISA returned just 0.51% between February 2021 and February 2022, compared to an Consumer Prices Index (CPI) inflation rate of 6.2% over the same period.

In 2022/23 you can invest up to £20,000 a year without paying tax on your ISA investment (the limit is £9,000 for the Junior ISA). The capital you invest in an ISA is allowed to grow in a tax-free environment, meaning that any income, be it interest, dividends or capital growth (from a Stocks and Shares ISA), is exempt from tax.

2. Pensions

Pensions are a fantastic tax-free way to invest for your future. You can put up to £40,000 every year into a pension fund without paying tax on it (your ‘annual allowance’), and receive tax relief on that amount (in other words, your contribution will be ‘topped up’ by the government). Plus, you can use up any unused allowance from the previous three tax years. That’s significant, especially if you’re a higher rate taxpayer.

You need to be aware that if you earn over £150,000, the tax allowance tapers, reducing by £1 for every £2 over the £150,000. This is one of the reasons why it’s important to consult
a financial planner before you take any decisions about your pensions and investments.

As with ISAs, once you have paid into a pension scheme, any interest or investment gains receive will be tax-free. Plus, it’s automatically reinvested again and again – so over time you’ll watch your money grow without having to do anything.

Self-Invested Personal Pensions (SIPPs) are becoming ever-more popular with experienced investors who want more choice on how their pension is invested. A SIPP is basically a do-it-yourself pension, where you are responsible for building and managing your investments. Needless to say, you’ll need the time, knowledge and confidence to be able to do this successfully.

The pension ‘wrapper’ will hold your investments until retirement, at which point it can be turned into income.

3. Venture Capital Trusts (VCTs)

A VCT is a government scheme typically used by investors who are High Net Worth Individuals. They are intended to help small and medium-sized companies find investment. As such, they are deemed riskier than a pension or ISA – and that’s why VCTs come with some significant tax advantages.

A VCT is a listed company in its own right, which pools together investments in a number of qualifying businesses. Each VCT has its own VCT manager who identifies the opportunities and is responsible for managing the portfolio.

Investors can claim up to 30% tax relief on an annual investment allowance of £200,000, as long as they hold the investment for five years. Dividends are tax-free, and there is no Capital Gains Tax (CGT) to pay when you choose to sell – but once again, you must hold onto them for five years.

4. Enterprise Investment Scheme (EIS)

The main difference between a VCT and an EIS scheme is that with an EIS, the investor purchases new shares in a specific company. In contrast, the investment risk in a VCT is spread across a number of companies, making it slightly less risky in principle.

With an EIS, you will still receive 30% tax relief on your investment and any growth in value is 100% tax-free. However, the annual investment allowance rises to £2 million, and the time you need to hold the shares reduces to three years in order to receive the full tax benefits.

In addition, to further reduce the risk, EIS shares are eligible for tax relief on any losses on the net amount invested. This could potentially reduce your total overall exposure to 38.5% of the original investment.

5. Seed Enterprise Investment Scheme (SEIS)

SEISs are the most recent investment scheme introduced by the government. Launched in 2012, they provide support for the first £150,000 of external equity capital a new business raises within its first two years of trading.

Of all options above, a SEIS presents the highest level of risk for an investor. This is offset by the fact that investors will receive 50% income tax relief upfront, and reinvestment relief that allows investors to reclaim 50% relief on a reinvested gain. This, along with the similar capital gains exemption as a VCT and EIS, brings the potential total exposure on the original amount invested to just 13.5%.

Investing in start-up businesses can be exciting and rewarding, but many start-ups fail, and others may not go on to achieve their initial growth aspirations. While the returns are potentially very lucrative, they need to be are carefully weighed against risks.

Building a tax-efficient portfolio of investments

Compared to ISAs and pensions, venture capital and enterprise investment schemes come with much higher risks. They are generally suited to more experienced and adventurous investors who have sufficient income to benefit from the tax relief available.

But before investing a significant amount of money in any investment tool, it’s advisable to consult a financial planner. They will assess your appetite for risk, goals for the future, and current financial position to create a tax-efficient plan that suits your individual preferences and tax circumstances.

There have been significant changes to pension savings in the Spring Budget 2023 that may impact your retirement planning. To find out more, see: How does the 2023 Budget affect your pension and retirement planning?

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