Tax-efficient investing is a big part of many clients’ needs: many are high-net worth clients, and will be on a higher rate tax bill and looking to mitigate some of that liability.
Nonetheless, a number of vehicles are available that come completely without controversy, that are useful to advisers and clients, especially at this time of year.
Pensions are “as good as it gets” when it comes to tax planning, according to Ian Browne, pension expert at Quilter.
This is because of the “EET” concept; that is the money is exempt from tax on the way in, exempt when it is invested and taxed on the way out.
On top of this, you have access to a totally tax-free lump sum at the age of 55 of 25 per cent of the pension pot value.
Mr Browne says: “There’s a lot of incentive to contribute to a pension. If you’re a basic-rate taxpayer you get basic-rate relief, so you don’t have to pay tax on that income that you’ve earned. After paying tax, the government will then put that tax into your pension.
Say if you pay £8,000 into your pension, you will have paid £2,000 on that money. What the government will do, it will put that £2,000 you’ve paid into your pension.
From a financial advice perspective, you’re more likely to be dealing with people who are higher-rate taxpayers and they get even more tax relief.”
On top of this, if you are a higher-rate taxpayer, you are getting even more from the government, as you get tax relief at the higher rate, but get taxed at the lower rate when you draw an income.
Mr Browne says: “These promises are really powerful from a pensions perspective. Knowledge of these tax reliefs and how it works really make a difference when encouraging people to engage with their pensions.”
Venture capital trusts
VCTs are incredibly popular, and are a means by which the government brings in money to young companies needing capital. Not all of them will necessarily be successful, but the VCT is run by a professional manager, who selects the companies to invest in.
A client will invest a certain amount of money into the VCT, and can claim that amount back on his tax bill at 30 per cent. This means that if a client invests £20,000 in a VCT, he will get £6,000 of that back that he can offset against his tax.
This will only work up to that amount he has paid in tax to start with, so if he has only paid tax of £6,000 that year, he cannot claim more than £6,000 through the VCT.
The investor has to hold the investment for five years, and you access it by buying shares in a new issue, while cashing in by selling the shares.
Clearly this does not work with people who pay no tax as they will not get any benefit, and for high-net worth taxpayers who are paying 40 per cent, there will be a 10 percentage point disparity.
But understandably this tax incentive is incredibly popular, not least because of changes to the pension allowance rules brought in a few years ago.
Andy Gadd, head of research at Lighthouse Group, says: “You used to be able to put £255,000 in a pension [each year]. They’ve reduced it to £40,000, and for some high-net worth people you can only put £10,000 into a pension.”
The other problem is that it is very easy to go over the allowances, in which case you would get fined by HM Revenue & Customs, and to pay that fine, you cannot resort to taking your money out of your pension.
Mr Gadd says: “VCTs are the next best area they could consider investing in. But it’s high risk, so don’t let the tax tail wag the investment dog.
The very generous tax relief where you get 30 per cent income tax relief isn’t the reason you should buy a VCT. Where’s it going to invest the money?”
This is another, more risky way of mitigating tax, and work on similar principles to VCTs in that the government is trying to encourage investment into early stage companies.
Investors can invest as much as £1m a year into a qualifying company, for which they receive 30 per cent income tax relief. Once held beyond three years, the investment gains are free of capital gains tax and exempt from inheritance tax as well.
John Glencross, co-founder and chief executive of Calculus Capital, which is a provider of enterprise investment scheme funds, says: “They’re a good tool for clients who have had a particularly successful year and are looking for a way to mitigate a painfully high income-tax bill or defer a [CGT] liability.”
The EIS is considered to be highly risky as the chance of losing an investment is relatively high, compared to mainstream schemes, so it is not for the unsophisticated investor.
Mr Glencross says: “Most advisers opt to invest their clients in an EIS fund rather than a single company. It is worth thinking whether to invest in a specialist fund – perhaps one that focuses on a single area like leisure – or a fund with a generalist strategy.”
Cash, stocks and shares Isas
Isas are the original tax-efficient vehicle. They started out offering a stocks and shares, cash and life insurance Isa, where all the gains or interest are received tax-free.
Now we have cash, stocks and shares, innovative finance, and lifetime.
The maximum amount you can put into your Isa in the 2018-19 tax year is £20,000, which can be put in its entirety into one type of Isa or spread across different types of Isas.
Historically, the initial route into saving was through a cash Isa, when banks and building societies were paying a decent rate of return. But with interest rates still at historic lows, cash Isas are barely paying 1 per cent, although those topping the best buy tables are offering 2.5 per cent or 3 per cent.
Stocks and shares Isas are more complicated and are offered by a range of investment houses as well as direct-to-consumer platforms, and are the entry point for many getting involved in the stock market.
Patrick Connolly, chartered financial planner at Chase de Vere, says that clients actively choosing to get into stocks and shares for the first time (they may already be exposed through their pensions) have to think about what they want to invest for, how long they are investing and how much risk they want to take.
“People are likely to get a better return by investing in a stocks and shares Isa rather than cash. It’s better to have some money sitting in useable cash for a short-term emergency, but longer-term, cash isn’t the best option.
“For stocks and shares we would hope they have a reasonably long timeframe, certainly more than five years. We would hope they would be willing to take a degree of risk.
“Most people when they are starting out will be saving regular premiums, for example about £250 a month.
“If people don’t have much experience of investing it doesn’t make sense to invest in something that is too high risk.”
He recommends for the novice investor to start off with passive investments or trackers: “UK tracker or global equity tracker is a really good choice for people starting out on that basis.”
The Lisa is a form of savings vehicle, either for buying a home or building up a pension. It has an opening age limit of 40, and the maximum you can put in it is £4,000 a year, as part of the annual Isa allowance.
You can keep adding money to it until the age of 50, after which point the account stays open until you want to access it.
The government puts in a 25 per cent bonus each year, up to a maximum of £1,000.
You can take money out if you are is buying a home, or withdrawing for a pension.
Mr Connolly says: “The focus for many will be on saving to buy a property.
“This is an aspiration for many young people, but can also seem like a distant dream with property prices in many areas out of reach of those without high salaries or financial support from their parents.
“The [Lisa] allows people to save up to £4,000 each year and benefit from a 25 per cent government bonus, which is very generous.”
National Savings and Investments premium bonds
A lesser known form of tax-efficient savings are NS&I premium bonds. While some might consider it a form of gambling, premium bonds allow people to invest up to £50,000 into the ‘prize draw’ and then hope to get a premium – which can vary from £25 to £1m, all of which is paid tax-free.
Each £1 is counted as a unit that goes towards being entered into the draw, and NS&I says that each £1 has a 24,500-to-one chance of winning some ‘interest’.
So it therefore pays to invest more with the institution, and also means that the bonds work completely differently to conventional savings accounts.
Tom Adams, head of research at, says: “For many it’s a nice, straightforward savings account to use. Some people may argue that as interest rates are historically low, the gamble is less.
“The amount of money they would get in a savings account as interest is variable and the rates can change, and you will get some interest each year.
“You’re taking more of a gamble with a premium bond, and if you get regular prizes you get a regular return.”
The bonds do allow easy access.
The seed enterprise investment scheme is similar to the EIS, but the companies being invested in are at an even earlier stage of development.
This means the tax benefits are greater, so that you get 50 per cent income tax relief, as opposed to 30 per cent and this can be received in the tax year the investment is made.
An investor can only put in a maximum of £100,000 a year, which can be spread over a number of companies.
However, these investments are very risky and so should only be used by sophisticated investors – the company must be no more than two years old.
Anyone wanting to mitigate their IHT bill can invest in AIM shares. These will be exempt from IHT if held for more than two years, as they qualify for business property relief.
However, they are considered to be extremely risky investments, and some experts say they may not be good for a lot of people, as the risks can outweigh the tax advantages.
Mr Connolly says: “There is a strong argument for including smaller company shares in your investment portfolio.
“They are usually more dynamic and have greater growth potential than larger firms, which are often at the consolidation stage of their development.
“However, there are greater risks involved with smaller companies.
“Not only are they usually less secure than larger firms with less financial backing, but their shares are more illiquid with fewer people willing to buy them when times are difficult. This means it can be difficult to sell when you want and at the price you want.”
Profits from woodlands run on a commercial basis are free from income tax and exempt from CGT. There can also be some IHT benefits.
But Mr Connolly says: “However, these investments are only suitable for wealthy individuals because of the high costs involved.”
Originally posted by Melanie Tringham of FT Adviser
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