Tax efficiency in Investing

Taking the time to sit down and really get to know them; understand where they see themselves in the short, medium and long term as these milestones are going to be the drivers for implementing an appropriate strategy. Once these have been established, the next step is to decide which vehicles are going to be the most appropriate to help reach the objectives.

There is a known phrase in the financial planning world, ‘the tax tail shouldn’t wag the investment dog’, which is true to some extent; however, we cannot ignore the tax benefits of certain investment vehicles and wrappers, particularly in instances where they can be so lucrative to the client.

Before touching on the technicalities of some of the options, I will mention one important allowance that should not be ignored: the capital gains tax (CGT) allowance. Direct holdings in shares or collectives can still be useful for helping with income with a CGT allowance of £12,300 available (for an individual in the current tax year 2022/23). Effectively, this will provide tax free drawings so long as the gains on any withdrawals within one tax year do not surpass £12,300.

Now for the wrappers. Any short-to-medium term savings are most likely to be placed in an Individual Savings Account (ISA). Here we have the opportunity to hold cash or invest in a vehicle that will allow any funds to be drawn free of any income tax and CGT. There is a £20,000 per annum allowance to bear in mind, but if you are looking at a married couple, that is up to £40,000 between them that can be put away each year. Not to mention the junior version (JISA), with a savings limit of £9,000 per annum, allows for a great saving tool if you are looking at putting some money away for your children or grandchildren (although it is important to consider that the savings cease to be yours and they can access them at age 18!).

ISAs are also available for more specialist areas, like the Lifetime ISA (LISA). With those aspiring to buy their first home no longer able to open a help-to-buy ISA, a LISA is a great alternative. An individual can only place up to £4,000 per annum into the account (leaving £16,000 available for another ISA), but the government will provide a 25% bonus of the amount placed (potentially an additional £1,000 in the account by the end of the year) and the funds must be used towards that all important deposit of your first home or retirement income. It should be borne in mind that LISAs can only be opened by those between the ages of 18 and 40 and there is a 25% penalty if the savings are withdrawn and not used to purchase your first house, or before age 60.

Thinking longer term, pensions remain one of the most tax efficient vehicles out there. With a £40,000 annual allowance (provided no tapering is applied for higher earners or unused allowance from the previous three tax years is available), they are an integral part of most people’s financial planning. With many changes to pension regulation over the years, they are a lucrative and tax efficient way to invest for the future, including for your children and grandchildren. Every non-earner has an annual allowance of £2,880 (£3,600 once basic rate tax relief has been given), so starting a pension for the youngsters of the family can be a great way to ensure you leave behind a legacy, particularly when considering they will not be able to access the pension until age 55 (according to current rules, but this increases to 57 in April 2028) giving peace of mind the money is secure.

Another point to consider in respect of legacy planning is that a pension does not fall subject to inheritance tax (IHT). There could still be a tax charge to pay by way of income tax on the beneficiary depending on whether you pass before or after age 75, but in some cases, this would be less than the 40% potentially payable in IHT.

With the £40,000 allowance, pensions may not always be the most suited vehicle for long term planning. When considering larger sums for investment, single premium bonds remain a great option. Whether you go onshore or offshore is very much dependent on client circumstances as each have their own merit. However, regardless of where the money is held, the bond will provide 5% withdrawals tax deferred every year. For example, if £100,000 was placed in a bond, £5,000 can be drawn each year without paying any tax at the time. It is important to note these are not entirely tax free and instead defers the payment of tax until a chargeable event occurs – such as death of the life assured or assigning part or all of the bond to someone else as examples.

There are also some key investment opportunities that provide tax benefits, namely Venture Capital Trusts (VCTs), Enterprise Investment Schemes (EIS) and Seed Enterprise Investment Schemes (SEIS). We need to be careful with these types of investment though; the tax benefits may be tempting – 30% tax relief with VCTs for example – but they are deemed to be high risk by the FCA so may not be suitable for a lot of clients, but that is what great factfinding and objective setting is for!

For some there will be IHT planning that needs to be undertaken however, some of the above can help in this regard as well as looking at how a trust can help with addressing the issue.

When it comes to financial planning, there are various routes that can be taken and various vehicles that can be used to get the client to their destination, wherever that may be. The key, as mentioned at the start, is to sit down and get to know the client to figure the best method of getting there.