When it comes to investments, tax efficiency is everything given that taxes largely affect how much return one will get when the investment and savings mature. UK individuals and businesses either pay inheritance tax, capital gains tax, or income tax on investments, but fortunately, they have a handful of savings and investment options that can exempt their income from taxes or at least trim them down.
Anyone who wants to make the best out of their tax reliefs and allowances preferably should get into the planning by the start of the tax year. It’s crucial to note that once they miss out on allowances for a certain year, they are never going to get them back. That is, they either use it or lose it.
This article focuses on the various ways individuals in the UK can cut their income tax bill on their investment profits. They include National Savings and Investments (NS&I), Individual Savings Accounts (ISAs), Junior ISAs, Enterprise Investment Scheme (EIS), Seed Enterprise Investment Scheme (SEIS), Venture Capital Trusts, Self-Invested Personal Pensions (SIPPs), and Small Self-Administered Schemes (SSASs).
All these investment options have varied levels of tax advantages and some cons, so it’s wise for savers and investors to do intensive research first or consult tax professionals or financial advisors before putting their money out there.
National Savings and Investments (NS&I)
The only ever government-backed bank in the UK, particularly by the HM Treasury, is National Savings and Investments (NS&I). This means the safety of one’s money is guaranteed, although the returns aren’t. Returns would depend on the kind of NS&I product one obtains.
NS&I only allows UK residents to save, not borrow, and their money is basically considered a lending to the bank. Furthermore, the bank changes the product they offer from time to time, so one must be on the lookout for the best options available at a certain period.
Some savings and investment products they offer are taxed (e.g., Guaranteed Equity Bonds, etc.) whilst others are tax-exempt. Tax-efficient investment products are most commonly preferred by savers. They include Cash ISAs and Junior ISAs, both of which will be discussed further in the article, as well as Premium Bonds.
Premium bonds don’t work through interests or dividends. Instead, the government enlists the saver into a prize draw conducted each month and gives those prizes away tax-free. The prize people can win ranges from £25 to £1 million.
It’s crucial to note that savers can only get the sum total of their money if they claim it at the right time. Withdrawing the money earlier will subject them to a penalty. How much return they get also depends on the inflation status, just as it is with any other kind of investments or savings products—the higher the inflation, the lower the value of their return.
Individual Savings Accounts (ISAs)
To encourage UK residents to invest and save, Individual Savings Accounts (ISA) was offered in 1999, wherein they can set aside £20,000 for themselves without worrying about taxes. This proves to be a very fair tax allowance.
Since then, the original ISA has evolved into plenty of other types, with four main products—Cash ISAs, Stocks and Shares ISAs (S&S), Innovative Finance ISAs (IFISA), and Lifetime ISAs. One may choose to put money in each of these accounts for the annual tax period, free from tax, as long as the sum total is £20,000.
For instance, they put into their Cash ISA £10,000; S&S ISA £3,000; IFISA £3,000; Lifetime ISA £4,000. They may choose to either spread over the amount in two or all of the accounts or deposit them in one. One thing about Lifetime ISA though is that it has a limit of payable amount each tax year, which is £4,000.
“Savers may put their money into one ISA account or spread it over two or more accounts. ”
Cash ISA, years ago, had been very popular among UK households, with 40% of them enlisted for the account, given that any kind of savings are generally taxed. That is until many other non-ISA savings options emerged and Personal Savings Allowance was introduced, thereby enabling them to save and procure higher returns whilst still getting tax exemption, as opposed to the low return that Cash ISA can give.
But whatever amount is put into Cash ISA can be transferred to S&S ISA so that savers or investors can at least increase their returns whilst maintaining their ISA allowance from the last years.
On the other hand, they can also choose Innovative Finance ISAs wherein they can use their ISA allowance whilst growing their money through peer-to-peer lending and many other kinds of debt securities, allowing them to receive a fixed income from the reimbursements of interests.
Lifetime ISA, as its term suggests, is for the long haul, only capped at £4,000 of contribution for each annual tax period. Savers get excluded from paying their taxes for the long term; plus, they’re given a bonus of 25% by the government, which could potentially reach £1,000.
Some types of ISA offer a certain form of flexibility, except Lifetime ISAs, such that savers can withdraw their money for as long as they replace it within that tax year, making sure their yearly tax allowance isn’t affected. But to be sure, they may need to ask their ISA provider first and see if their account has this function.
The types of ISAs above are apparently for adults, and whilst it’s true one can’t hold an ISA account on behalf of other people, it’s a different rule for Junior ISAS. This is the most tax-effective way for parents to save up for their children, specifically under 18. Any gains from the Junior ISAs investments aren’t charged with taxes.
Junior ISAs are now the primary option to save up for a child’s future as Child Trust Funds are currently unavailable for new applications. But for those who were able to set up Child Trust Funds before it closed, parents, other family members, and friends can contribute altogether to the fund a maximum amount of £9,000 for each tax year.
Parents who had set up Child Trust Funds cannot apply at the same time for Junior ISA. They will have to request their provider to have their money from the fund transferred to the Junior ISA, or when it’s already a matured account, to the rest of the ISAs that cater to adults.
Self-Invested Personal Pensions (SIPPs) and Small Self-Administered Schemes (SSASs)
Self-Invested Personal Pensions (SIPPs) and Small Self-Administered Schemes (SSASs) are very tax-efficient ways for businesses and individuals to invest. These two give investors a certain control over their pension pot, especially the means it is invested.
In Self-Invested Personal Pensions, an individual takes control of the investment and owns the whole pension pot whilst in Small Self-Administered Schemes, the control and ownership of the pension pot go to the company directors and all the enlisted trustees.
Between the two, SSASs are the most flexible as investors can expand their funds to various investment resources, and of course, in a tax-free environment.
It’s also called family pension as even the family members who are not connected to the company can join. However, it also comes with a drawback, the main one being that it limits membership to only eleven individuals.
What’s guaranteed in these two pension wrappers is that they can either trim the investors’ or savers’ income tax liabilities or grow the returns they will receive.
Enterprise Investment Scheme (EIS)
Enterprise Investment Scheme (EIS) is one of the three types of Venture Capital Schemes. The other types are Seed Enterprise Investment Scheme (SEIS) and Venture Capital Trusts, which will be discussed further below.
Introduced in 1994, EIS helps small businesses to obtain funds for their capital needs and flourish by giving significant tax breaks to investors. This scheme mostly attracts investors who are liable to a huge income tax responsibility (or capital gains tax liability) whilst finding ways for their money to grow as they get income tax break of up to 30%, subject to the changes in tax rules and their circumstances.
“EIS provides income tax relief for investors of up to 30%.”
Businesses that receive EIS funds need to be knowledge-intensive (KI); that is, they’re young companies yet in the process of innovation. Take for instance a company that experiments on novel treatments or drugs. As long as they meet the rest of the criteria, knowledge-intensive companies may qualify for EIS.
There are two ways investors can put their money into the EIS. It’s either they buy shares from just one company or EIS funds that spread their money to several companies (portfolio). Whilst both of these are risky, the first option proves to be a lot riskier.
Small businesses tend to be volatile, so there could be a possibility that investors lose more than they gain when they invest in only one company. This is why EIS investors are usually investment experts or with a really hefty net worth as they could still bounce back from any possible loss.
Not to mention that their returns depend on whether the company/companies they’re investing in maintains their EIS status. If not, the investors will have to do without tax reliefs.
The whole Venture Capital Scheme of investment is risky, so it’s a money-efficient decision to hire a fund manager who can research the profit-reliability of businesses on the investor’s behalf. These fund managers can ensure their client investors get their deserved returns by making effectively diversified portfolios.
Seed Enterprise Investment Scheme (SEIS)
Introduced in 2012, Seed Enterprise Investment Scheme (SEIS) is somehow EIS’ younger sibling as it provides fund-procurement opportunities for the youngest of the young companies in the UK. For the investors, this means a very high risk.
SEIS works similarly to EIS but given the level of risk it poses to investors, the government has set a higher income tax relief for the brave. They could get a tax break of up to 50% alongside other types of tax allowances.
“SEIS provides income tax relief for investors of up to 50%.”
Investors have to weigh the pros and cons before they risk their money out. They need to be aware of the scheme’s limit in liquidity, and leaving SEIS may take a long time to wait.
Venture Capital Trusts
“CVTs allow investors to spread their funds over a wide range of businesses.”
Where to Save or Invest
Among all these choices, one may wonder which of them to put their savings and investments in. The best they can pick is the one that offers the most tax efficiency given their circumstance and caters to their purpose of investing or saving.
If their focus is on reducing income tax on their investments or other types of taxes, they can turn to tax professionals at Legend Financial who are real legends in helping UK individuals and businesses make the best out of their taxes and finances. Reach us today and find out why our clients have chosen and stood by us for many years.
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