Tax-Efficient Investing

Shares and investment funds can be taxed in various ways. At the most simple level, you may pay stamp duty when you purchase a share, you pay income tax on any dividends received, and capital gains tax (CGT) on any profit made when sell them. And if you hold shares when you die, then they will typically be part of your estate, which could end up paying inheritance tax.

The good news is that the government generally wants us to invest (so that we are not dependent on the state in our retirement) therefore it offers various tax incentives and schemes that anyone can use to reduce their tax liability.

Please be aware that nothing in this guide should be regarded as a substitute for professional tax advice. That said, when it comes to sensible tax planning, one overarching guideline we would suggest is to first and foremost concentrate on the underlying investment rather than any tax incentive you might get. Or, as it is commonly expressed, “don’t let the tax tail wag the investment dog!”


Let’s start with two of the most popular tax-efficient ways you can shelter shares and investment funds.

ISAs

If you keep shares in an Individual Savings Account then they should be protected from any income tax on dividends and capital gains tax on any profits you make. The annual ISA allowance, meaning the amount of cash you can put in, is £15,240 for the current tax year of 2016/2017, rising to £20,000 in 2017/18.

For most people the annual allowance is sufficient to cover all the amount they want to invest each year, and it generally makes sense to use up your ISA allowance where you can before you consider investing outside of an ISA. Both you and your spouse can take out separate ISAs, and a child can have a Junior ISA. There is more on the ins and outs of how ISAs work in our dedicated ISA guide.

Pensions

Although most pensions invest in a relatively narrow of funds, it is possible to get Self Invested Personal Pension, or SIPPs, where you can much more freedom to invest in individual shares. We’re not going to cover all the rules regarding pensions here, as there are too many of them and they change on a regular basis, but the Pensions Advisory Service is well worth checking out for detailed information, as is gov.uk.

Whether an ISA or a pension is the best investment shelter is subject to much debate, and will depend on your personal circumstances. You can usually put more into a pension, and you get tax relief upfront on any contributions you make. But there are restrictions on when you can withdraw the money, so ISAs are generally considered to be more flexible.


Before we dive into the rest of this guide, it’s worth highlighting a couple of specialist investment types that offer additional tax relief.

Venture Capital Trusts

A venture capital trust (VCT) is a share that trades on the London Stock Exchange that receives various tax exemptions. Generally these only apply if you subscribe for new shares, and hold them for 5 years, rather than buying them in the open market via a broker. 

The main attraction is that you get 30% income tax relief on up to £200,000 each tax year. You also don’t get charged income tax on any dividends received. However, many venture capital trusts have performed pretty poorly in the past, in some cases wiping out any tax relief received in the first place. It’s worth noting that the Fool has a very active discussion board on venture capital trusts if you are interested in them.

Enterprise Investment Schemes

Enterprise Investment Schemes (EIS) offer a similar incentive to VCTs. You can get 30% income tax relief on any new shares you subscribe for. The maximum relief limit is somewhat higher, though, at £1,000,000. Typically you have to hold the shares for 3 years, after which time you can dispose of the shares without paying any capital gains tax.

 


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