The 4 Tax Efficient Investment Strategies in The UK

Savings and investments are smart, long-term ways to increase your income passively. However, such income sources are not exempt from taxes. Fortunately, there are several methods to getting the most out of your savings and investments thanks to government-mandated incentives.

Here are four of the primary tax-efficient investment strategies you can take advantage of, including their variations.

1. Individual Savings Accounts

Individual Savings Accounts (ISAs) are some of the most common investments, with 10.8 million adult ISAs active as of the latest government report. Setting up an ISA lets you invest up to £20,000 a year. You won’t have to pay income tax on interest or dividends earned. You are also exempt from capital gains tax when profiting from your investments.

An ISA can be opened at 16 years old, but the account holder has to be at least 18 years old to start investing.

There are different types of ISAs, each with their own use. The £20,000 that you can put into ISAs can be used for just one type or portioned out into multiple accounts.

Cash ISAs

These are basically savings accounts where you can earn interest tax-free. This is a simple and secure way of investing money, with your original savings protected by the Financial Services Compensation Scheme. However, interest rates are generally low.

Stocks and Shares ISAs

A Stocks and Shares ISA lets you make various investments tax-free. These include:

  • Exchange-traded funds
  • Corporate and government bonds
  • Individual stocks and shares
  • Investment trusts
  • Open-Ended Investment Companies (OEICs)
  • Unit trusts

You have the option of making regular or ad hoc contributions in a tax year and/or a lump sum investment. You are restricted to paying into one stocks and shares ISA in a year, but you are allowed to start a new ISA with a different provider each year.

Lifetime ISAs

If you have yet to buy a home, a Lifetime ISA can help. You can put in up to £4,000 each tax year. You will receive a bonus worth 25% of your investment from the government, maxing out at £1,000. This is paid monthly.

You can only withdraw money from your account without paying tax once you are 60 years old, if you are diagnosed with a terminal illness, or if you’re buying a home and you’ve had your account for at least 12 months. Otherwise, you will be charged 25%.

Junior ISAs

Parents or legal guardians can open a Junior ISA for their children under 18. The maximum amount that can be put into it annually is £4,368 as of the 2019/20 tax year. The child who the account was opened for owns the money. They can start managing their account when they reach 16. Outside of extreme situations, money cannot be withdrawn until the account holder is 18.

Innovative Finance ISAs

You can take part in peer-to-peer (P2P) lending with an Innovative Finance ISA. By lending parts or all of your ISA allowance, you can receive interest over time and earn more depending on how risky your investments are.

2. Enterprise Investment Scheme

If you are willing to take a risk on unlisted startups, an Enterprise Investment Scheme (EIS) can be highly rewarding. You can put in as much as £1 million into a newly incorporated company. Whatever amount of money you invest, you will get 30% income tax relief.

You won’t have to pay capital gains tax and inheritance tax on your investment gains if you hold on to your investment for over three years. You can also get loss relief on your shares if you don’t get returns.

The chances of earning through an EIS are not especially high, considering how 60% of new businesses fail within three years and 20% don’t make it out of the first year. However, you should not feel pressured to invest anywhere close to the amount of £1 million trying your hand at an EIS. You can invest as low as £2,000 to help jumpstart local businesses.

The 2017-18 tax year saw £1.9 million raised in total by 3,920 companies under an EIS, showing some confidence around the country in this investment strategy.

Seed Enterprise Investment Scheme

For even greater tax relief at a greater risk, you can invest in a Seed Enterprise Investment Scheme (SEIS). The investment allowance is £100,000 a year with 50% income tax relief. You are also entitled to 50% relief if you choose to reinvest your gains. These benefits are in addition to the capital gains tax and inheritance tax relief for holding on to investments for over three years and the loss relief for shares with no returns.

Such schemes are restricted to businesses that have only been in operation for not more than 2 years. There is a significant risk to an SEIS, but this can be mitigated by spreading your allowance across multiple companies.

3. Venture Capital Trusts

With a Venture Capital Trust (VCT), you have a manager who will choose which companies to put your money in, resulting in a diverse portfolio of investments. These companies can be unlisted startups or businesses listed in the Alternative Investment Market (AIM), so there is still a little more risk involved compared to investing in established companies.

The maximum amount you can invest in a VCT is £200,000 a year. You get 30% income tax relief, no income tax on dividends paid, and no capital gains tax on growth. The 30% income tax relief is only applicable up to the amount of tax you have already paid in the year.

Unlike an EIS or SEIS, there is no loss relief available. You will also have to pay fees to the manager at the start and every year you have money in the VCT.

There have been more VCT investors claiming income tax relief, with 18,890 taking advantage in 2017-18, which is 24% more than in 2016-17.

4. Pensions

Making contributions to your pension scheme is a stable method of being tax-efficient with your investments. You get tax relief proportionate to your current income tax rate. This can make your tax bill lower or make the amount paid into the pension higher. You still get tax relief on your contributions even if you do not have to pay income tax either.

You can pay up to £40,000 in contributions a year or all of your income if it’s lower. The pot grows tax-free, and investments made through your pension scheme are also exempt from capital gains tax. When you reach the age of 55, you can also get 25% of the pot tax-free.

Take Advantage of Tax Reliefs

Taxes cannot be completely avoided even through investment strategies. The best you can do is to capitalise on the incentives the government has laid out for investors and new businesses.

Get a trusted accountant to guide you on using these strategies and maximising your income by getting in touch with us today.