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In general, three forces can undermine your investment returns – fees, inflation and taxes. The first can be mitigated, for instance, by choosing a cost-efficient investment platform and set of funds. The second cannot be controlled by investors (although you can try to limit its impact by using a prudent investment strategy). The third can be mitigated by a tax-efficient investment plan. Here, it can help to speak with a financial adviser to discuss your unique options due to your financial goals and circumstances. However, it can help to know the broad UK landscape for tax planning in 2023 and how this could affect your strategy. Below, we offer some ideas on how to build a tax-efficient set of investments in 2023-24. We hope this content is useful to you. If you want to discuss your own financial plan with us, please contact our team for more information or to access personalised financial advice:
020 8366 4400 or enquiries@cedarhfs.co.uk
#1 Pensions
There are different types of pensions in the UK. One is your State Pension which is built up via National Insurance (NI) contributions. Another is a final salary (or defined benefit) pension which offers a guaranteed retirement income from your former employer. A third type is the defined contribution pension. Here, you build up a “pot” of money (perhaps with an employer in the case of a workplace pension) which is typically invested in assets such as shares and bonds. Over time, the aim is to grow the value of this fund to later use as a source of retirement income – e.g. via income drawdown or by using funds to buy an annuity.
A pension is a very tax-efficient way to invest your money assuming you do not need it until you are at least age 55 (or, age 57 in 2028 when the Normal Minimum Pension Age is expected to rise). All capital growth inside your pension pot(s) is tax-free. Moreover, your contributions can receive tax relief equivalent to the marginal rate of income tax that you pay. For instance, an individual paying the Higher Rate gets 40% relief. In effect, this means that it “costs” this person only 60p to put £1 into his/her pension. In 2023-24, you can commit up to £60,000 into your pension(s) each tax year – or, up to 100% of your earnings (whichever is lower).
#2 ISAs
An individual can contribute up to £20,000 into ISAs each tax year in 2023-24. All capital gains and dividends inside are tax-free. The ISA types you choose to build a tax-efficient portfolio may vary depending on your goals and situation. For instance, suppose your goal is to build up a pot of money for a mortgage deposit on your first property. In which case, the Lifetime ISA (LISA) may be an attractive option. Similar to other ISAs, any returns generated inside it will be tax-free but your contributions also benefit from a 25% “boost” from the UK government. The latter will add up to £1,000 per year and you can put up to £4,000 inside your LISA. Alternatively, if your goal is to save tax-efficiently for your child, then a Junior ISA will likely be an attractive option.
#3 Tax allowances
In 2023-24 two primary tax-free allowances for investments have been reduced – the tax-free capital gains tax (CGT) allowance and the tax-free dividend allowance. Yet these can still be leveraged to maximise your returns in 2023. For example, suppose you want to build a portfolio to generate income. Two taxes might affect you here. Firstly, dividend income from the portfolio will be subject to dividend tax if this goes over £1,000 in 2023-24. Additionally, any interest (e.g. from bond income) will also be taxed at your marginal rate of income tax once you go over your Personal Savings Allowance (e.g. £500 for a Higher Rate taxpayer). In light of these tax rules, an investor might choose to balance her tax-free allowances for dividends and interest to lower her bill. For instance, once her dividend income nears £1,000, she may wish to start building up her bond investments if she still has unused Personal Savings Allowance. Bear in mind that the tax-free dividend allowance is set to go down to £500 in 2024.
#4 Tax-efficient investment “vehicles”
For investors who are comfortable taking on a higher level of risk (in exchange for the potential of higher returns), the UK offers certain schemes which can reduce taxes on your returns. The Enterprise Investment Scheme (EIS), for instance, allows investors to claim up to 30% income tax relief on EIS investments. EIS shares held for at least two years are exempt from inheritance tax, too. Venture Capital Trusts (VCTs) all allow 30% up-front tax relief and also offer investors tax-free dividends which do not need to be included on your tax return. Please speak with your financial adviser before committing to these types of investments, however, to be sure that you are comfortable with the associated risks.
Conclusion
Interested in discussing your financial plan with an experienced financial adviser? Get in touch today to discuss your financial plan with a member of our team here at Cedar House via a free, no-commitment consultation:
020 8366 4400 or enquiries@cedarhfs.co.uk