Tax-efficient investments for higher-rate taxpayers

For higher-rate taxpayers, tax-efficient investing is a crucial component of financial planning. With those on higher incomes in the UK facing high tax rates on both capital gains and dividend income, the difference between pre-tax and post-tax investment returns can be substantial, and without a carefully-planned tax-efficient investment strategy high earners run the risk of facing formidable tax liabilities.

Fortunately, there are a number of ways that higher-rate taxpayers in the UK can invest tax-efficiently and bring down their overall tax bills. Here’s a look at several tax-efficient investment strategies that can help those on higher incomes reduce their tax liabilities significantly

ISAs

One of the most straightforward ways to invest tax-efficiently in the UK is to invest within a Stocks & Shares ISA (Individual Savings Account). Within this investment vehicle – which is very flexible and allows you to access your money at any time – all capital gains, dividend income, and interest are completely tax-free. In recent years, annual ISA allowances have been increased considerably to £20,000 per person. This means that a couple can now potentially save £40,000 per year between them into two Stocks & Shares ISAs, sheltering a significant sum of money from HMRC.

Once higher-rate taxpayers have used up their own ISA allowances, they could also consider investing for their children or grandchildren by putting money into a Junior ISA. The current annual allowance for Junior ISAs is £9,000 and each child can own one as long as they are under 18, living in the UK, and they don’t have a Child Trust Fund. Bear in mind, however, that on the child’s 18th birthday, money in a Junior ISA becomes theirs.

Pensions

Contributing into a pension is another tax-efficient strategy that those on higher incomes may wish to consider. When invested within the pension wrapper, funds are free of income tax, capital gains tax and inheritance tax, furthermore when you contribute into a pension the government will reward you for saving for retirement by providing you with tax relief. This is paid on your pension contributions at the highest rate of income tax you pay, meaning that higher-rate taxpayers receive 40% tax relief, while additional-rate taxpayers receive 45% tax relief.

For 2021/2022, the annual pension contribution limit for tax relief purposes is 100% of your salary or £40,000, whichever is lower. However, if you are considered to be a ‘high-income individual’ and have an ‘adjusted income’ of more than £240,000 per year and a ‘threshold income’ of more than £200,000 per year, your annual allowance will be tapered. That said, you may be able to make use of any annual allowance that you have not used in the three previous tax years under pension carry forward rules.

While contributing into a pension can be a very effective strategy due to the generous tax breaks on offer, the downside to pensions is that money cannot be accessed until age 55, and at this age you can only take 25% of your pension pot tax-free. Higher-rate taxpayers should also be aware of the Lifetime Allowance – the total amount of money you can build up in your pension accounts while still enjoying the full tax benefits.

Venture capital schemes

Experienced investors that are comfortable with high levels of risk may also want to consider venture capital schemes. These are investment schemes that have been set up by the UK government in an effort to promote investment into small, early-stage companies and offer very generous tax breaks. Three such schemes include:

• The Enterprise Investment Scheme (EIS) – this scheme is designed to encourage investment into early-stage companies that are not listed on a stock exchange. It offers investors a range of tax breaks, including; income tax relief of 30%, no capital gains tax on gains realised on the disposal of EIS investments provided the investments are held for three years, capital gains tax deferrals if proceeds are reinvested in qualifying EIS investments, and inheritance tax relief if the investments are held for two years.
• The Seed Enterprise Investment Scheme (SEIS) – this scheme is designed to promote investment into start-up companies that are raising their first £150,000 in external equity capital. Like the EIS, it offers a range of generous tax breaks, including; income tax relief of 50%, no capital gains tax on gains realised on the disposal of SEIS investments provided the shares are held for three years, reinvestment tax relief, loss relief and inheritance tax relief if investments are held for two years.
• Venture Capital Trusts (VCTs) – VCTs are investment companies that are listed on the London Stock Exchange and invest in smaller companies that meet certain criteria. VCTs offer investors a range of tax breaks including; 30% income tax relief, tax-free dividends, and tax-free growth.

While all of these schemes offer generous tax breaks, it’s important to be aware that due to the high-risk nature of investing in small, early-stage companies, they will not be suitable for everyone. Only those who can afford to take the risk should consider these tax-efficient investment schemes.

Given the complex nature of many tax-efficient investments, it is a good idea to seek tailored financial planning advice from a qualified expert before investing. A financial planner will be able to provide you with a plan that is most suitable for your own situation and requirements.

To find out more, or if you have any questions about tax-efficient investing, request a call back.

Please note that any tax benefits will depend on your personal tax position and rules are subject to change. The value of investments can go down as well as up and you may get back less than you invested. This article is not intended to be an offer or solicitation to buy or sell securities, nor does it constitute a personal recommendation.