Aside from pensions and stocks and shares ISAs, did you know there are other ways to invest while keeping the taxman at bay? So, with the end of the tax year fast approaching, have you considered all of them?
Here’s the lowdown on how expert investors legally avoid tax on their investments.
[top_pitch]
What are tax-efficient investments?
Tax-efficient investments refer to investments that take the tax-man out of the equation. In other words, if you invest in a tax-efficient manner, you won’t pay tax on any returns or dividends.
You may already be investing in a way that is tax-efficient via your workplace pension, or SIPP.
For example, the government allows you to save into a pension tax free, partly because it is keen to encourage workers to save for their future. The theory goes that by offering pension savings tax free, pension pots will be higher in future. This should reduce future poverty levels, as well as the number of people solely reliant on the State Pension.
On a similar note, ISAs – including stocks and shares ISAs – provide another way to invest tax free. Every adult in the UK gets an annual ISA allowance where they can invest (or save) without having to pay tax on returns or dividends, year after year.
The ISA allowance for 2021/22 is £20,000, though the end of the tax year is just around the corner. As ISA allowances don’t roll over to the next tax year, you may wish to act to make the most of it before 5 April.
[middle_pitch]
How are expert investors investing in a tax-efficient manner?
As well as traditional tax-free investing, there are other ways to avoid having to pay tax on your returns. According to Wealth Club, here are the investment options being considered by expert investors ahead of the current tax year ending.
1. Venture Capital Trusts
Venture Capital Trusts trade on the London Stock Exchange. They provide up to 30% tax relief on investments of up to £200,000 per year. Dividends are also tax free.
In order to get the tax-free benefit, you usually have to buy new shares, and you also typically have to hold them for at least five years.
2. Enterprise Investment Scheme
Enterprise Investment Scheme (EIS) investments provide 30% tax relief. However, they don’t give you the option of tax-free dividends.
One big benefit of this type of investment is that it provides the option of deferring capital gains tax. The allowance under EIS is £1 million per year, though this can be boosted to £2 million if you choose to invest at least £1 million into companies that are considered ‘knowledge intensive’.
3. Seed Enterprise Investment Scheme
Seed Enterprise Investment Scheme (SEIS) investments allow you to half the amount you pay in Income Tax and Capital Gains Tax. The annual allowance is £100,000, so it’s considerably less than the schemes above but still sizeable.
How else are expert investors reducing their tax bills?
While EIS and SEIS investments can be free of Inheritance Tax after two years, this is not the case for investments held in a traditional ISA.
As a result, Wealth Club warns that typical stocks and shares ISAs could be liable for a 40% Inheritance Tax bill. To avoid this, the wealth management firm explains how expert investors may look towards Alternative Investment Market (AIM) ISA products. These products contain a portfolio of AIM shares and are targeted towards investors who have large estates and could therefore face a huge Inheritance Tax bill.
AIM ISA investments can be tax free after two years, giving investors who hold them the ability to reap the benefits of an ISA, without having to worry about the taxman grabbing a slice of their wealth when they’re no longer around.
To learn more about this type of investment, take a look at our article that explains how to protect your ISA holdings from a hefty Inheritance Tax bill.
Please note that tax treatment depends on your individual circumstances and may be subject to change in the future. The content in this article is provided for information purposes only. It is not intended to be, nor does it constitute, any form of tax advice. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.
