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Tax-efficient investments

ISAs 

  • You can invest an amount in an ISA every year. The amount invested does not attract tax relief but the income and gains on the investment are tax free, so any taxpayer will benefit from the tax shelter on the income arising.
  • The ISA limit, which includes the Lifetime ISA, is £20,000 for 2020/21.
  • A Lifetime ISA is only available for adults under the age of 40. Individuals are able to contribute up to £4,000 (as part of the overall 2020/21 allowance of £20,000) per annum and receive a 25% state bonus.

Help to save ISA

  • This scheme is available only to low income households and is intended to facilitate savings of up to £4,000 a year.
  • Savings must be made for a fixed two year period. An amount of up to £50 per month (in a NS&I government-backed account) will secure a government exit bonus of 50%.
  • The investment can be rolled over for a further two years, at which point the amount saved would be £2,400 with a government bonus of £1,200.
  • Funds withdrawn can be used for any purpose.

Enterprise investment scheme (EIS) and venture capital trusts (VCTs)

  • These two schemes allow ongoing tax relief on investments that are channelled into share capital for smaller and growing businesses. By their very nature they are considerably more risky than ISAs and other similar investment vehicles.
  • The EIS scheme provides 30% tax relief on investments of up to £1,000,000 (or £2 million for ‘knowledge intensive companies') in a tax year, and investments can be carried back by up to one year provided the limit in the previous year was not reached.
  • The investment must be held for a minimum period of 3 years for the relief to be retained.
  • EIS shares are also exempt from capital gains tax once they have been held for three years and providing you received income tax relief on the investment.
  • Capital gains tax on the disposal of other assets can be deferred by reinvesting the proceeds in EIS shares. This relief is slightly different from the basic EIS relief, as there is no limit on the gain that can be reinvested in this way. However, the tax on the original gain will become payable when the EIS investment is sold. The reinvestment can take place up to three years after (or one year before) the original disposal.
  • With Seed EIS (SEIS) the investor receives income tax relief of up to 50% of the cost of the shares regardless of their marginal rate. Relief is available provided the company meets the SEIS requirements. Investors do not need to be UK resident. Relief is available for those with a shareholding that does not exceed 30% in such companies and can include directors investing in their companies. The relief is limited to £100,000 per investor, with unused annual amounts able to be carried back to the previous year.
  • A capital gains tax exemption of up to 50% of the gains reinvested into a qualifying SEIS investment is available, meaning a £10,000 gain is completely exempt from tax if a £20,000 investment is made.
  • VCT investments are made through a fund, so the risk on individual investments is spread across the fund. The tax relief is 30% of the amount invested, providing you hold the VCT for five years or more.
  • Individual investors can invest up to £200,000 per tax year into a VCT. This is independent of any investments under the SEIS and the EIS which are subject to their own annual investment limits.
  • VCT investments are not subject to capital gains tax, however short the period you have held the investment, assuming the company maintains its VCT status.
  • Dividends from VCTs are not subject to income tax, if the investment is held for five years or more.

Pension contributions

  • Pension contributions are paid net of basic rate tax, and the pension provider recovers the tax element. Up to £3,600 per year (gross) may be invested in a stakeholder pension by any individual irrespective of whether they have net relevant earnings to match it or not.
  • Pension contributions also save higher rate and additional rate tax for those liable, and this relief is normally given through the self assessment return, although it can be received at source via salary sacrifice.
  • Pensions are subject to an annual allowance of £40,000 (gross) per tax year. Subject to certain conditions, the unused amount of an annual allowance can be carried forward for up to three years once the current tax year annual allowance has been fully utilised.
  • The annual allowance of £40,000 is tapered at a rate of 50% down to as little as £4,000 per tax year, if threshold income is over £200,000 and adjusted income over £240,000. Tax charges apply where contributions in excess of the tapered annual allowance are made. As many high net worth clients may not know the total tax adjusted profits from their business or from their investments, this can make planning to avoid these tax charges very difficult.