Contents
When it comes to investing, tax efficiency is everything given that tax fees largely affect how much profits investors will get when the investment and savings mature. UK individuals and businesses need to pay income tax, inheritance tax, stamp duty reserve tax (SDRT), or capital gains tax (CGT) on investments, but fortunately, they have a number of savings and investment income sources that can make their savings income tax free or at least trimmed.
Anyone who wants to make the best out of their tax reliefs and allowances preferably should get into taxation planning by the start of the tax year. It is crucial to keep in mind that once they miss out on allowances for a certain year, they are never going to get them back. That is, they either use the benefits or lose them.
This article provides various advice on how individuals in the UK can cut their income tax on investments profits. They include the annual investment income and gains starting rate thresholds, National Savings and Investments (NS&I), Individual Savings Accounts (ISAs), Junior ISAs, Enterprise Investment Scheme (EIS), Seed Enterprise Investment Scheme (SEIS), Venture Capital Trusts, Self-Invested Personal Pensions (SIPPs), and Small Self-Administered Schemes (SSASs).
All these investment account choices have varied levels of tax advantage and some cons, so it is wise for savers and investors to exhaust information first or ask guidance from a top-notch financial or tax adviser before putting their money out there.
Quick Guide to Income Tax on Investments
Before delving into various means for reducing investment income tax, know the income tax rates first. For the 2023/24 tax year, income tax is as follows:
| Tax Band | Taxable Income | Tax Rate |
|---|---|---|
|
Personal Allowance |
Up to £12,570 |
0% |
|
Basic Rate |
£12,571 to £50,270 |
20% |
|
Higher Rate |
£50,271 to £125,140 |
40% |
|
Additional Rate |
More than £125,140 |
45% |
That is, when the profit exceeds the annual personal savings allowance, taxpayers will either fall into the basic rate, higher rate, or additional rate. Basic rate taxpayers pay 20% and so forth. Taxpayers have to file their self assessment tax return before the end of the tax year.
National Savings and Investment (NS&I)
The only ever government-backed bank in the UK, particularly by the HMRC’s Treasury, is National Savings and Investment (NS&I). This means the safety of savings is guaranteed, although the interest proceeds are not. Profits would depend on the kind of NS&I product someone would purchase.
NS&I only allows UK residents to save, not borrow, and their investment income is basically considered a lending to the bank. Furthermore, banks change the product they offer at some point in time, so investors must keep up to date with the information on which type of investment is available at a certain period.
They may have to pay tax on their savings and investment (e.g., Guaranteed Equity Bonds, etc.) or choose anything that allows them to invest without paying tax on interest. Tax-efficient investment products are the top choices among savers. A couple forms are Cash ISAs and Junior ISAs, both of which will be provided further guide in the article, as well as premium investment bonds.
Premium bonds do not work as dividends or interest payments. Instead, the government enlists the saver in a prize draw conducted each month and gives those prizes away tax free. The prizes people can win range from £25 to £1 million.
Please note that savers can only get total amounts of their investment income if they claim it at the right time. Withdrawing the amount earlier will subject them to a penalty. How much return they get also depends on the case of inflation, just as it is with any other kind of investments or savings products—the higher the inflation, the lower the value of their profit.
Individual Savings (ISAs)
To encourage UK residents to invest and save, Individual Savings was great news in 1999, wherein they can set aside £20,000 for themselves without paying tax for that tax year. The tax free starting rate for savings allowance is something that attracts a lot of investors to this setup. They will be paying tax for the excess part of the investment income they receive.
Since then, the original individual savings have evolved into plenty of other kinds, with four main products—Cash ISAs, Stocks and Shares ISA (S&S), Innovative Finance ISAs (IFISA), and Lifetime ISAs. Investors may choose to put a certain share amount into each of these for the annual tax period, tax free, as long as the total interest gains are £20,000.
For example, they put into their Cash ISA £10,000; S&S ISA £3,000; IFISA £3,000; Lifetime ISA £4,000. They may choose to either spread a portion of their amount into two or more allocations or put them in a single deposit. A fact about Lifetime ISA though is that it has a limit of taxable income amount each tax year, which is £4,000.
“Savers may allocate their shares into a single ISA or spread it over.”
Cash ISA, years ago, had been very popular in the UK, taking up 40% of households, as before that they need to pay tax on any kind of shares savings. That is until many other non-ISA savings choices emerged, and Personal Savings Allowance was introduced, thereby enabling them to save and procure higher savings income whilst still enjoying tax free benefits, as opposed to the low investment income or shares interest that Cash ISA can give.
But whatever share amount is put into cash savings can be transferred to S&S savings so that savers or investors can at least accumulate more savings income whilst maintaining their personal savings allowance from the last tax years.
On the other hand, they can also choose Innovative Finance ISAs wherein they can use their personal savings allowance whilst making more profits through peer-to-peer lending and many other kinds of debt shares securities, allowing them to receive a fixed income from the reimbursements of savings interest.
Understanding life insurance investments, as its term suggests, is life-long and for retirement, only capped at £4,000 of life annuity payments for each annual tax period. Savers get excluded from paying tax for life; plus, they are given a bonus of 25% by HMRC, which could potentially reach £1,000.
Some forms of ISA offer a certain form of flexibility, except Lifetime ISAs, such that savers can withdraw their money for as long as they replace it within that tax year, making sure their yearly personal savings allowance is not affected. But to be sure, they may need to ask help from their savings provider first to guide them throughout their policy’s functions and all other crucial details.
Junior ISAs
Examples of ISAs above are apparently for adults, and whilst it is true that investors cannot hold a savings product on behalf of other people, it is a different rule for Junior ISAs. This is the most tax-effective way for parents to save up for their children, specifically under 18, as it is tax free. Investors do not pay tax on the gains they made from Junior ISAs investments.
Junior ISAs were a great help for parents to save up for their child’s future as Child Trust Funds are currently unavailable for new applications. But for those who were able to set up Child Unit Trusts before they closed, parents, other family members at home, and friends can contribute altogether a maximum amount of £9,000 for each tax year.
Parents who had set up Child Investment Trusts cannot apply at the same time for Junior savings. They will have to request their provider to have their money from the fund transferred to the Junior savings, or when it is already a matured account, to the rest of the ISAs that cater to adults.
Adult’ ISAs and Junior ISAs work somehow in a parallel manner, as Junior savings also comes in the form of Cash or Stocks and Shares ISA (S&S). Parents can avail, on their children’s behalf, one or two of these Junior savings types and manage them until their children reach 16 years of age in which they can already hold the policy by themselves. The money can only be withdrawn when the child turns 18.
Self-Invested Personal Pensions (SIPPs) and Small Self-Administered Schemes (SSASs)
Self-Invested Personal Pension (SIPPs) and Small Self-Administered Schemes (SSASs) are very tax-efficient ways for businesses and individuals to invest. These two give investors a certain control over their pension pot, especially the means it is invested.
In Self-Invested Personal Pension, an individual takes control of the investment and owns the whole pension pot whilst in Small Self-Administered Schemes, the control and ownership of the pension pot go to the company directors and all the enlisted trustees.
Between the two, SSASs are the most flexible as investors can expand their savings income to various investment sources, and of course, in a tax free environment.
It is also called family pension as even the family members who are not connected to the company can join. However, it also comes with a drawback, the main example is that it limits membership to only eleven individuals.
What is guaranteed in these two pension wrappers is that they can either trim the investors’ or savers’ income tax liabilities or earn more savings income. For more information, browse through your provider’s website page or seek advice from trusted tax professionals to know how much tax you pay or if you pay tax at all.
Enterprise Investment Scheme (EIS)
Enterprise Investment Scheme (EIS) is one of the three kinds of Venture Capital Schemes. The other types are Seed Enterprise Investment Scheme (SEIS) and Venture Capital Trusts, which we will provide further guide below.
Introduced in 1994, EIS helps small businesses to obtain funds for their capital needs and flourish by giving significant tax breaks to investors. The latter receives a certificate that proves the company is compliant with HMRC’s specifications. This scheme mostly attracts investors who need to pay a huge amount of tax on their income (or capital gains tax) whilst finding a way for their investment income to grow as they get income tax break of up to 30%, subject to the changes in tax rules and their circumstances.
“EIS provides income tax relief for investors of up to 30%.”
Businesses that receive EIS investment income need to be knowledge-intensive (KI); that is, they are young companies yet in the process of innovation. Take for example a company that experiments on novel treatments or drugs. As long as they meet all the eligibility criteria, knowledge-intensive companies may qualify for EIS.
There are two ways investors can contribute to EIS. It is either they purchase asset shares from just a single company or spread their share assets to several companies (portfolio). Whilst both of these are risky, the first part is a lot riskier.
Small businesses tend to be volatile, so there could be a possibility that investors lose more than they gain when they invest in only a single company. This is why EIS investors are usually top investment experts or with a really hefty net worth as they could still bounce back from any possible loss.
Not to mention that their earnings depend on whether their investment companies maintain their EIS status. If not, the investors may have to pay tax after submitting a tax return.
The whole Venture Capital Scheme of investing is risky, so it is a wise decision to seek financial and tax advice professionals who will do the job of researching the profit-reliability of businesses on the investor’s behalf. These policy managers help ensure their client investors increase the value of their returns by making effectively diversified portfolios. They may introduce open-ended investment companies (OEICs) or general investment account (GIA) to streamline shares diversification and ensure their shares do not suffer significant losses.
Seed Enterprise Investment Scheme (SEIS)
Introduced in 2012, Seed Enterprise Investment Scheme (SEIS) is somehow EIS’ younger sibling as it provides capital-procurement opportunities for the youngest of the young companies in the UK. For the investors, this means a very high risk.
SEIS works similarly to EIS but given the level of risk it poses to investors, HMRC has set a higher income tax relief for the brave. They could get a tax break of up to 50% alongside other kinds of tax allowances.
“SEIS provides income tax relief for investors of up to 50%.”
Investors’ job is to weigh the pros and cons before they risk their assets. They need to be aware of the scheme’s limit in liquidity, and leaving SEIS may take a long time to wait.
Venture Capital Trusts
Two years after SEIS was introduced, the government regulations introduced another type of Venture Capital Scheme called Venture Capital Trusts (VCTs). VCTs are somehow viewed as cousins to EIS and SEIS; just with one major difference.
“CVTs allow investors to do capital distributions over a wide range of businesses.”
The reliefs provided through VCTs are relatively similar to EIS and SEIS. The main difference is that VCTs offer a wider range of company options compared to the other two. This means that investors can put their profit not just into businesses at the early unlisted stage but also Alternative Investment Market (AIM), the latter supporting companies from small to medium sizes.
Efficient Tax Treatment of Salary and Dividends
Once employment salary exceeds the starting rate for savings threshold, set at £12,570 for the 2023/24 tax year, UK employees will have to pay tax on their National Insurance via self assessment tax return. Dividend income, on the other hand, is not deducted with any amount of tax upfront. Directors pay 19% corporation tax before they can distribute the dividends interest payments, also called dividend tax. It is a wise move to receive salary within the starting rate for savings allowance and obtain dividend income for the rest.
Dividend income’s starting rate for savings or dividend allowance is at £2,000 for the 2023/24 tax year. Getting dividends for the rest of the taxable income will exempt the taxpayer from NICs, as NICs can take a hefty rate. The dividend allowance rate applies to all dividends from all sources. Any dividend income that exceeds the annual tax free personal allowance, the taxpayer will need to pay a dividend tax rate for.
Dividend income tax rates are lower than employment income. Like income tax band, dividends tax rates follow the same tax bracket—personal allowance/ starting rate for savings allowance, basic rate, higher rate, and additional rate. The tax you pay will depend on which income tax band your dividends interest payments belong to. See the table below for the rates:
| Tax Band | Rate |
|---|---|
|
Personal Allowance |
Up to £2,000 |
|
Basic Rate Taxpayer |
8.75% |
|
Higher Rate Taxpayer |
33.75% |
|
Additional Rate Taxpayer |
39.35% |
Exceeding the dividend allowance or starting rate for savings, basic rate taxpayers pay tax at 8.75%, higher rate taxpayers pay tax at 33.75%, and additional rate taxpayers pay tax at 39.35%, as opposed to the amount of tax paid on salary, which are 20%, 40%, and 45% for the 2023/24 tax year.
Maximise Personal Savings Allowance on Gains
Aside from savings and investments, taxpayers may also have to pay rental income, capital gains tax (CGT), and stamp duty reserve tax (SDRT), which are all related to property. Rental income follows the same income tax rates, whilst CGT and SDRT impose different rates, discussed further below.
CGT is imposed on the capital gains made from disposing of a property or asset. SDRT is the tax paid when a person buys land or property in the UK. For the 2023/24 tax year, the capital gains tax allowance is at £6,000. Following the income tax band, when the starting rate for savings or annual personal allowance are exceeded, a taxpayer will have to pay capital gains tax. See the table below for CGT rates:
| Tax Band | Taxable Income | Assets CGT | Property CGT |
|---|---|---|---|
|
Personal Allowance |
Up to £6,000 |
0% |
0% |
|
Basic Rate Taxpayer |
£12,571 to £50,270 |
10% |
18% |
|
Higher Rate Taxpayer |
£50,271 to £125,139 |
20% |
28% |
|
Additional Rate Taxpayer |
More than £125,140 |
20% |
28% |
Investment gains on assets and properties have different rates. Exceeding the capital gains tax personal savings allowance, a basic rate taxpayer will pay 10% on assets and 18% on property capital gain; a higher rate and additional rate taxpayer will pay the same on both asset and property capital gains—20% and 28% respectively.
There are several means to reduce or avoid capital gains tax on property aside from maximising CGT personal savings allowance, which is the tax free amount of up to £6,000. Tax experts can provide comprehensive information on this matter and recommend suitable means according to the taxpayer’s situation.
Usually, to avoid higher rate of tax on capital gains, experts would recommend for example offsetting gains against losses, gifting assets to a partner, buying and selling within family members, spreading gain over several tax years, putting gain in ISAs and using its personal savings allowance, investing in small businesses where their gain is automatically tax free, and more.
Use Stamp Duty Reserve Tax Exemptions and Reductions
As if buying a property in the UK is not expensive enough, buyers will also have to pay stamp duty tax according to their property’s location. England and Northern Ireland has different versions and rates of stamp duty from Scotland and Wales. The former pays Stamp Duty Land Tax (SDLT), Scotland pays Land and Buildings Transaction Tax (LBTT), whilst Wales pays Land Transaction Tax (LTT).
All three have different starting rate for savings. Take note that there is no personal allowance for properties aside from main residence, imposing an additional rate. See the table below for stamp duty rates and their additional rate:
| Stamp Duty | Tax Free Range (Main Property) | Additional Rate (Second Property) |
|---|---|---|
|
SDLT |
Less than £125,000 |
3% |
|
LBTT |
Less than £145,000 |
4% |
|
LTT |
Less than £225,000 |
4% — up to £180,000 7.5% — £180,001 to £250,000 |
LBTT or Scottish stamp duty’s personal allowance is different for first-time buyers, which is up to £175,000. LTT in Wales also has different additional rate rules. The additional rate for properties up to £180,000 is 4%, whilst the additional rate for properties between £180,001 and £250,000 is 7.5%. Whilst there is no share of allowance on additional rate for non-main residence properties, there are other ways to save on stamp duty tax.
If property owners bought a second home a few years ago and would like to sell the first home, they can get a stamp duty additional rate refund for it. Be sure to reach a tax adviser on this matter as they can give specific advice on which tax-efficient means are most suitable for your circumstances.
Where to Save or Invest
Among all these choices, investors may wonder which of them to put their savings and investment in. The top choices for making investment income are anything that offers the most tax efficiency given their situation and caters to their purpose of investing or saving.
If their focus is on reducing income tax on investments or other kinds of taxes, they can turn to tax advice professionals at Legend Financial who are real legends in helping UK individuals and businesses make the best out of their taxes and finances. Reach us today and find out why our clients have chosen and stood by us for many years.
References
The 5 main ways to make tax efficient investments in the UK. (n.d.). Retrieved from GCV: https://www.growthcapitalventures.co.uk/insights/blog/the-5-main-ways-to-make-tax-efficient-investments-in-the-uk
10 ways to reduce your tax bill. (n.d.). Retrieved from The FJ Blog: https://frazerjames.co.uk/10-ways-to-reduce-your-tax-bill/
ISAs and other tax-efficient ways to save or invest. (n.d.). Retrieved from Money Helper: https://www.moneyhelper.org.uk/en/savings/types-of-savings/isas-and-other-tax-efficient-ways-to-save-or-invest
Individual Savings Accounts (ISAs). (n.d.). Retrieved from Gov.Uk: https://www.gov.uk/individual-savings-accounts
Tax on your private pension contributions. (n.d.). Retrieved from Gov.Uk: https://www.gov.uk/tax-on-your-private-pension
Tax when you sell shares. (n.d.). Retrieved from Gov.Uk: https://www.taxcafe.co.uk/resources/taxoninvestmentincome.html
How do your investments affect tax? (n.d.). Retrieved from Royal London: https://www.royallondon.com/articles-guides/financial-wellbeing/managing-your-money-and-other-assets/
National Savings & Investments (NS&I). (n.d.). Retrieved from Money Helper: https://www.moneyhelper.org.uk/en/savings/types-of-savings/nsi-saving
EIS Explained. (n.d.). Retrieved from WealthClub: https://www.wealthclub.co.uk/eis-explained/
About small self-administered pension schemes (SSAS). (n.d.). Retrieved from unbiased: https://www.unbiased.co.uk/life/small-business/about-small-self-administered-pension-schemes-ssas
