Pretty much all the money your earn is subject to some degree of taxation, but you can protect some of it from income tax, Capital Gains Tax (CGT), and inheritance tax. The easiest way to prevent all of your money from falling into the taxman's clutches? Wrap it up in an ISA, pensions, and trusts.

The Individual Savings Account (ISA)

The simplest way to protect your money from income tax and CGT is to hold your savings and investments in an Individual Savings Account, or ISA. An ISA is essentially a tax-proof wrapper for your money: as long as it's tucked inside an ISA, you won't have to pay tax on any income or gains you make from your money.

There are limits to how much you can put in an ISA in each tax year. For one tax year, the quota is up to £3,000 in cash or up to £7,000 in shares, with the total amount you put in your ISA not exceeding £7,000. You can reach your £7,000 quota with one maxi ISA or with a mini cash ISA and a mini stocks and shares ISA:

Annual ISA Limits for Maxi & Mini ISAs

	Annual ISA Limits
	Mini ISA	Maxi ISA
Stocks & shares	£4,000	£7,000 (less any money contributed to cash)
Cash	£3,000	£3,000

Mini ISAs come in two varieties: cash, and stocks and shares. You can put up to £3,000 in a mini cash ISA and up to £4,000 in a mini stocks and shares ISA, and in one year you are permitted to have both a mini cash ISA and a mini stocks and shares ISA.

Maxi ISAs can contain a mixture of cash, stocks, and shares. You can invest up to £7,000 in each tax year, but a maximum of £3,000 of that can be cash.

There are a few types of ISAs – cash, share, and index tracker ISAs are the most popular.

Cash ISAs are just what they sound like - your money sits in its ISA wrapper, protected from income tax, in cash form. When shopping for these most liquid of ISAs, you'll want to compare interest rates carefully. Cash ISAs are popular – around 10m of us took one out last year.

Share ISAs are less popular, but still some 3m people took one out last year. Share ISAs let you invest your money in the stock market, whether in funds or in shares you choose (a self-select ISA), and protect you and your money from CGT. Share ISAs also protect higher-rate taxpayers from income tax on any dividends (basic-rate taxpayers don't have to pay this anyway). No ISA can protect you from the 0.5% stamp duty payable on all share or fund purchases.

If you have an index tracker, you should consider putting it in an ISA. It's a tax-savvy move that won't cost you anything extra, and it could significantly boost your returns in the long run.

Pensions

We talked about pensions in step six, when we looked at retiring. If your employer offers an occupational pension scheme, you're best to take part - as we demonstrated earlier, the contributions your employer will make to your pension fund amount to free money. If you don't have the option of an occupational scheme, you can start a personal pension, a stakeholder pension, or even a self-invested personal pension (SIPP).

All pensions offer relief from income tax, but they work slightly differently than ISAs: if you're a basic-rate taxpayer and you put £200 a month into a pension, the Government will give you tax relief on this amount, boosting your investment to £256 a month. Higher-rate taxpayers are able to claim more tax back - in this example they would be able to claim a further £46 a month back from the taxman via their tax return.

Money within your pension is free to grow without being taxed. However, once you begin to draw your pension, the money you draw from it - your income - is then taxed at that point, although you will be able to withdraw up to 25% of your pension as a tax-free lump sum, if you want to.

Inheritance tax: the taxman's last hurrah

Inheritance tax is the last tax you will ever have to pay, although technically your estate pays it as by the time inheritance tax is to be paid in your name, you will no longer be with us. Here's how it works: your estate is valued at the time of your death, and a certain amount (£285,000 in 2006/7) is tax exempt. The balance is then taxed at 40%. Your estate is the aggregate of all property owned as well as all chargeable transfers made within seven years of death.

A number of exemptions arise with inheritance tax, including transfers between spouses, gifts to charities, annual gifts, gifts in consideration of marriage, and a lifetime gift. The most effective, but most complex, way to avoid inheritance tax is through the use of trusts - and for this we strongly encourage you to seek the guidance of a solicitor or financial advisor.

A final note on tax and your money

With a little time and effort, ISAs, pensions, and even trusts can save you from paying a fortune in tax. Just remember, the more money you put in and the longer you keep it there, the greater your potential tax savings will be.

10 Steps to Financial Freedom