Albert Einstein wasn’t wrong, despite coming up with the theory of relativity and it is quite revealing to hear that even he found tax as complicated as everyone else!
Like most people at the start of the New Year I set myself some resolutions, and like most I will have failed or neglected to keep most of them by the second week of January, especially if it’s dry January! However, there is one resolution that I try to keep every year, and that is to review my finances, specifically my investments and how to make them as tax efficient as possible. With stagnant wages, inflation and increasing taxation, it is not only important that your savings work hard for you, but that they do so in the most tax efficient way possible. January is the perfect time to review your finances, as there are a little over three months until the end of the tax year. This allows sufficient time to ensure that you have made use of your allowances, or if you need to speak with a tax adviser, financial adviser or stockbroker you can still do so.
The most basic savings tool available is the Individual Savings Account (ISA), specifically the Stocks & Shares ISA. With a current annual allowance of
£20,000 this not only offers a great way of saving efficiently, but also comes with tremendous flexibility. You can access your money any time you like, and any withdrawal is not subject to taxation. Within an ISA there is also no capital gains or income tax to pay. Albert Einstein would have liked an ISA!
Often ISAs were snubbed in the early days by high net worth individuals, because the amount they could shelter was tiny when compared to their total wealth, however, if you are able to contribute to your ISA in full for thirty years at current contribution rates, assuming a growth rate of 7% per annum, your ISA could be worth just over £2 million! Unlike a pension you are also not limited to a lifetime annual allowance; you can go on contributing to your ISA for the rest of your life.
Please note, this is an illustration and is not necessarily a projection. It does not take into account any charges and rates are not guaranteed. It also assumes that the ISA allowance won’t increase; nevertheless, I believe it does illustrate the importance of taking advantage of your ISA allowance every year.
From April 2016 the additional permitted subscription was introduced, so like pensions, ISAs can now be left to your spouse within a tax efficient wrapper. The ever decreasing dividend allowance is another reason to save into an ISA or pension. With the introduction of a £5,000 dividend allowance in April 2016, this is now dwindling to £2,000 in the 2018/19 tax year but does not apply to income taken from an ISA.
A pension is a necessity and while most will have some form of pension it is important that it is being managed effectively. There is a pension annual allowance
(£40,000 for most people), and a lifetime annual allowance of £1,030,000 will apply in the 2018/19 tax year (increased from £1 million). If you are contributing through work it is important to ensure that you are putting enough away for your retirement.
Most will be saving into an occupational pension scheme, and if you have had multiple jobs then the chances are that you may have a few of these scattered about. Pension transfers to a SIPP can be done to consolidate and simplify pension arrangements, as well as giving you the potential for better performance. You can find old or lost pensions at: www.gov.uk/find-pension-contact-details.
We always recommend that you seek financial advice when transferring a pension, especially if it is a defined benefit or final salary pension. Please get in touch for more information.
Many people may contribute to both an ISA and a SIPP in full and think that there is nothing else to do to make their investments more tax efficient, however there is the potential to further protect your investments from tax.
If you are a sophisticated investor, one option is investing in Venture Capital Trusts (VCTs). These are collective investment vehicles that invest in small fledgling companies. Small businesses are a vital part of the UK economy and accounted for 99% of all private sector business at the start of 2016 (source: fsb.org.uk). Investment into a VCT can qualify for up to 30% income tax relief, up to a maximum investment of £200,000. So, for example if you invest the maximum then you are able to reclaim £60,000 in income tax, however, please note, this is tax that you must have paid or are due to pay HMRC. To qualify for the 30% tax relief you would need to apply for the VCT as a new issue.
Furthermore, you must hold the shares for minimum of 5 years to benefit from any tax relief. At the end of this period, the VCT normally offers investors an exit route by buying the shares back (Structured buyback) at a price closer to the value of the underlying investments.
All dividends in VCTs are free from income tax and capital gains tax. However, most VCTs do not generate any gains, as VCTs are unique in the fact that any gains are returned to the investor by way of dividends. Your adviser can advise on how to maximise the tax relief with this vehicle.
Another option to consider is an investment into an Enterprise Investment Scheme (EIS). At the last budget somewhat surprisingly, Chancellor Philip Hammond, announced that the allowance for the Enterprise Investment Scheme was to increase from £1 million up to £2 million.
Again, an investment qualifies for up to 30% tax relief, which means theoretically you can claim up to £600,000 in income tax relief, although the number of people in the fortunate position of paying this much tax annually will be limited.
Both VCTs and EISs are characterised as high risk investments, but EISs are considered of higher risk as you can invest in a single company EIS or an EIS portfolio, but generally they are not as well diversified as VCTs.
One quirk of an EIS is that you can defer capital gains tax you have made on the disposal of a different asset. To put this into context, the CGT rate on shares has fallen from 28% (in 2015/16) to 20%. Assuming this doesn’t change, investors who defer gains from 2015/16 by investing in an EIS today could end up paying 20% rather than 28%! The EIS investment does need to be made up to three years after the gain arose. Some of the key characteristics and differences between VCTs and EISs are detailed below:
|Income Tax Relief||30%||30%|
|Minimum Holding Period||5 Years||3 Years|
|Maximum Annual Investment||£200,000||£2 Million|
|Capital Gains||Tax Exempt||Tax Exempt|
|IHT Relief||No||100% After 2 Years|
Death and taxes is a statement that everyone will be familiar with, but while both are inevitable, efficient tax planning is something that everyone should undertake and not ignore. Income tax bands for the 2018/19 tax year (after any personal allowance of £11,850).
|Rate||Tax Band||Income Tax Rate||Dividend Tax Rate|
*Income Limit for the personal allowance is £100,000 therefore; the personal allowance will decrease by £1 for every £2 of income above £100,000. The personal allowance will be lost if taxable income exceeds £123,000.
Not all products will be suitable for all investors, and therefore you should seek financial advice before making any investments. This article is not intended as advice. Rowan Dartington is not regulated to give tax advice, therefore this article is for information purposes only. We recommend that you seek advice from a tax adviser before making any investment decisions.