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In the UK, there are many tax efficient investments. Most people know about ISAs, but there’s also income tax investments which give tax refunds. If you make a SEIS investment of £10,000, then the Government will give you tax relief of £5,000. In this article, I explain the most popular tax efficient investments in the UK.
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Different investments have different levels of risk - you’ll need to decide which investment is most suitable for you. I’m not an accountant - before making any tax decision, please speak to a qualified advisor. Nothing in this article constitutes advice on investment decisions. If you want advice on how to invest your money, then speak to an Independent Financial Advisor.
ISAs are the most well known tax investment scheme in the UK. Each adult is allowed to invest £20,000 per year into their ISA. There are different ISAs for cash, stocks & shares and innovative finance.
With an ISA, you can invest in cash, stocks & shares and innovative finance products tax free. That means no stamp duty on purchases, no tax on dividends and no capital gains tax upon sale of assets. View your ISA as a bubble, and any investment inside that bubble is tax free. Innovative finance refers to things like peer to peer lending.
There’s also a lifetime ISA, which works differently. Lifetime ISAs are designed to help people save for retirement or to buy their 1st home. You can pay £4,000 per year into your lifetime ISA, and the Government will give you a top up of 25%. You can withdraw money from your lifetime ISA when you’re 60, or when you buy your 1st home.
How to choose an ISA provider? Many people get an ISA from the bank they have an account with. If you want a cash ISA, you can go to Compare the Market and find the one with highest interest rate. If you want a stocks and shares ISA, then be careful of providers that charge a monthly fee. Interactive Investors charge £9.99 per month, and this can get very expensive for small investors.
Pensions are designed to encourage people to save money for retirement. Once you put money inside a pension, you don’t get access to it until you’re 55. To get people to save in pensions, the Government provides generous tax incentives.
The idea is that the money you put into your pension, should be free of income tax. If your employer puts money into your pension, then you don’t need to pay income tax on that. If you put money into your private pension, then the Government will refund the income tax you’ve paid. The more you earn, the higher the tax benefit.
Example 1: Jim is a basic rate taxpayer earning £40,000. He puts £10,000 of his money into a private pension. The Government will top up this £10,000 with £2,500, so Jim has £12,500 in his pension. The reason for this is that Jim earned £12,500 in pre tax income, and the Government took 20% of that in income tax (£2,500).
Example 2: Juan is a higher rate taxpayer earning £80,000. He too puts £10,000 of his money into a private pension. The Government will top up this £10,000 with £2,500, so Juan has £12,500 in his pension. Juan is a higher rate taxpayer, so he has a marginal rate of 40%. This means that he has another 20% of tax relief to receive. Juan will receive £2,500 in cash at the end of year. This means that Juan got a total tax benefit of £5,000.
There’s some limits to be aware of. You can’t pay more than £40,000 per tax year into your pension – this limit is lower for people earning more than £150,000. There’s also a lifetime allowance, which was £1.073 million in 2021. If your pension pot grows above this, then additional taxes are payable on the excess amount.
Overall, pensions are a generous income tax investment.
A Venture Capital Trust (VCT) is a listed entity that invests in small companies. These are typically growing companies that need further investment to grow. A manager will decide where to invest the money. VCTs are an income tax investment.
To encourage investment into VCTs, the Government provides a 30% tax rebate on qualifying investments. Any dividend paid by the VCT is also tax free. To benefit from the tax rebate, you need to purchase new shares of the VCT, in the primary market.
VCTs were introduced in 1995, so many of the VCT managers have a long track record of performance.
You need to hold shares for at least 5 years, to get the tax relief. Many investors will sell their VCTs after 5 years, and purchase a new VCT to get the tax relief again.
Not all brokers will provide primary issuance of VCTs. I used Hargreaves Lansdown to purchase my VCTs.
The Enterprise Investment Scheme (EIS) is another tax investment you should know about. The scheme enables you to invest in small companies, and obtain 30% tax relief. You need to hold the investment for at least 3 years, to keep the tax relief. Many EIS investors will sell out after 3 years, and then re-invest - to attain that 30% tax relief again.
The Seed Enterprise Investment Scheme (SEIS) allows you to invest in very small companies and attain a 50% tax rebate. These companies are smaller than the companies in the EIS. Because these very small companies are viewed as riskier, a higher level of tax relief is provided. You need to hold the investment for at least 3 years, to keep the tax relief. The SEIS scheme is a very generous tax investment.
Social Investment Tax Relief (SITR) is another tax investment. The SITR scheme allows you to invest in social enterprises and attain a 30% tax rebate. The minimum period of investment is 3 years.
Limited companies are not an income tax investment. They’re a tax efficient structure, applicable to many types of activities. The key benefit is that you pay 19% corporation tax on your profits. This compares to income tax rates of 20% to 45%. To spend the money, you’ll need to take the money out of the limited company, which may attract tax. I’ve written a separate article on the different ways to do this.
You might think that a limited company doesn’t apply to you, but you may be surprised. In addition to traders, they’re used by people working on fixed term contracts, and by property investors.
Many company directors pay themselves a salary up to the basic rate threshold for income tax (£12,500 in 2021). This £12,500 will be taken out of the limited company, without attracting income tax. It will also reduce the profits of the company by £12,500, and reduce the corporation tax liability.
Limited company taxation is a large and complex area. You must speak to a qualified tax expert before making any decisions.
The UK has a number of income tax investments, that give you a tax refund. I’ve summarised some of the most popular ones in this article.