Tactics for tax-efficient investing
- 27 July 2020
- 10 mins
Make the most of opportunities to invest in a more tax-efficient way.
Investing tax efficiently can make a significant difference to your overall gains over the longer term.
Consider your portfolio and financial situation as a whole to maximise your tax savings.
When we invest we’re setting aside something today in the hope that it will benefit us even more in the future. In financial terms, success depends on all kinds of factors: What will you invest in? How much? Will your investment grow? How much will you pay in management fees? And how much will you pay in tax?
Take time for tax
Taking some time to understand the tax landscape may help you reduce your tax bill and give your investments a healthy boost. Here’re three of the most relevant taxes that could affect your investments:
Capital gains tax is due when you sell or give away something that’s gone up in value. So it could kick in if you’re selling shares, for example. It doesn’t apply to your main residence or personal possessions worth less than £6,000. See Table 1 below, for how it works in practice.
Income tax has two effects. Unless investing in a pension scheme, you pay it on your earnings, potentially lowering the amount you have to invest in the first place. Then it can eat into your future returns. See this year’s rates below.
Dividend tax applies to any dividends that you’re paid from the shares you own.
Our recent Family and Finances Report found that 65% of those over the age of 60 plan to pass on their wealth to their children or grandchildren after they die, and a further 17% plan to share their wealth during their lifetime. With mounting education costs and house prices, helping your grandchildren could be rewarding in more ways than one.
What are your annual tax-free allowances?
You can earn up to £12,500 this tax year without having to pay any income tax. Capital gains tax is only paid on personal gains above £12,300 each year. Finally, you can earn £2,000 from dividends before paying tax.
How can you invest tax efficiently?
Over the years successive governments have created various tax-efficient savings regimes to encourage us to put something aside for the future. The two most commonly used are: ISAs (individual savings accounts) allow you to save or invest up to a set limit each tax year: this year it’s £20,000. Once saved or invested, any income or capital growth is free of tax both within the account and when you decide to take it out. What’s more, you don’t need to declare it on your tax returns.
Pensions allow you to save for your retirement by putting money in your pension pot free of income tax (see below). Again, any capital growth or income reinvested is free of tax. However, you cannot access your savings until you reach the age of 55 (although this is due to rise to 57 in 2028). When you come to withdraw your investments the first 25% is tax free and the remainder is taxed as normal income.
These are both great tax-efficient ways to save and Table 2 provides a summary of their key features.
Combining both pensions and ISAs can give you the best of both worlds. Check out our article How your ISA could rescue your retirement for more on this.
But as always, all your decisions need to be considered in relation to your long-term goals. How much can you afford to invest? What are you saving towards? When do you think you’ll want to access your savings? What if you needed cash tomorrow? Talking to an adviser could help you make the most of the opportunities available to boost your investments whilst keeping your long-term objectives the key priority.
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