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A Guide to Tax Efficient Investing in the UK

Ruby Layram 10th Jun 2024 No Comments

Reading Time: 6 minutes

One of the most frustrating things about investing is seeing returns accumulate in your portfolio, only to have to hand them over to the tax man! In the UK, you must pay capital gains tax on any profits that you make when you sell investments. The current rate of capital gains tax (CGT) is 10% – 18% for basic rate payers, and 20%-24% for higher or additional rate taxpayers. So, if you made £10,000 in profits, you may be required to hand over as much as £2,400 to Mr Taxman!

If you’re anything like me, this probably seems a little unfair. After all, the Taxman didn’t spend hours researching different stocks and shares or building a solid investing strategy.

Luckily, it is possible to find tax-efficient investing solutions that can reduce the amount of tax you pay on your profits. Here, we will take a look at tax-efficient investing in the UK, what it is and 4 different tax-friendly investment options that you might want to consider.

tax efficient investing uk

What is Tax Efficient Investing?

Tax efficient investing refers to the process of picking investments that reduce the amount of tax that you are required to pay by law. By picking smart investments, it is possible to minimize taxable-profits and keep more of your gains.

It is a common misconception that tax-efficient investing is a bit dogdy. But this is far from the case! it simply means choosing to invest in assets that do not follow typical CGT requirements.

4 Tax Efficient Investments to Consider

Tax-efficient investing requires a lot of research and careful consideration. We recommend seeking help from a financial advisor before making any final decisions.

This is because tax conditions differ from person to person. So, what might work for one investor might not work for you!

However, there are a handful of investment options which are widely considered to be tax-friendly. Here are 4 different investments that you could consider.

1. ISAs

One of the most popular types of tax-efficient investments are ISAs (individual savings accounts).

In the UK, it is possible to invest up to £20,000 per year tax-free into ISAs. This means that you do not have to pay capital gains tax on profits that are made (up to the £20,000 limit).

Investing in an ISA is similar to opening up a savings account. There are various different types of ISA that you can open in the UK:

You can spread your £20,000 allowance across different types of ISA. For example, you could invest £10,000 into a stocks and shares ISA and another £10,000 into a cash ISA.

The only ISA that has limits is a lifetime ISA in which you can only invest up to £4000 per year.

Cash ISAs come with the least risk. These are similar to regular savings accounts and allow you to withdraw money at any time. The benefit is that Cash ISAs often offer higher returns than regular savings accounts.

Stocks and shares ISA provide exposure to the stock market. The money that you put into these accounts is invested into the market according to your risk appetite and investing goals.

The riskiest type of ISA is the innovative finance ISA. This ISA allows you to invest in peer-to-peer lending – which means lending your money to other people. In return for lending, you can earn considerable interest. However, peer-to-peer lending comes with inherent risk.

Many online brokerages and investing platforms offer ISAs. It is a good idea to shop around before signing up, you could start here.

Your money is at risk.

2. Self-invested personal pensions

Pensions are another tax-efficient way to invest in the UK.  Up to 25% of the money that you invest into a private pension can be withdrawn tax-free (up to certain limits). The rest of the money in your pot will be taxed accordingly.

The exact rules that apply to private pensions vary depending on the pension provider and your personal circumstances. However, investing your cash into a pension could be more tax-efficient than alternative investment options.

The exact amount that you can withdraw tax-free depends on various factors such as the age at which you withdraw your pension and the value of other pensions that you hold. It is important to speak to an expert if you are interested in investing in a SIPP.

3. Venture Capital Trusts

Venture Capital Trusts (VCTs) were introduced in the 90’s to support the growth of new, innovative companies.

A VCT is a company that trades on the London Stock Exchange. Like a fund, a VCT company aims to profit by investing in a basket of smaller companies. The funds were introduced to provide new companies with venture capital.

VCTs come with a range of tax benefits for UK investors. Firstly, any capital gains that are made from the trust can be withdrawn tax-free. Moreover, investors can claim up to 30% upfront income tax relief on the amount that they invest into a VCT. However, it is worth bearing in mind that this benefit is only applicable if you hold your shares for a minimum of five years.

Lastly, VCT dividends can be claimed tax-free. This means that you will not need to claim them in your tax return.

4. Enterprise Investment Schemes

Enterprise Investment Schemes (EIS) are another type of investment that were created to support new businesses.

At first, this might sound quite similar to VCTs. However, an EIS works very differently. EIS investments are not traded on the stock market. Instead, you will need to go through a brokerage to invest in them.

It is possible to invest in either an individual company EIS or an EIS fund. If you pick the first option, you will need to spend time researching the best new companies to invest in.

EIS investments are risky because there is no guarantee that new companies will grow. However, they come with several tax benefits.

Investors can claim up to 30% income tax relief on EIS investments up to £1 million. Additionally, profits can be withdrawn tax-free (as long as you hold the shares for at least 3 years). EIS investments also offer loss-relief due to the high-risk nature of investing in start-up companies.

**It is important to understand that tax laws and regulations can change in the United Kingdom. It is also a good idea to familiarise yourself with current legislation before making any decisions. 

tax-free investing uk

The risks of tax-efficient investing in the UK

Tax-efficient investing can be used to minimize the amount of tax that you pay on returns from your investments. The thought of reducing tax is appealing to just about everyone! However, it is important to consider the risks that come with these investments.

Firstly, tax laws and legislation are subject to change in the UK. This means that tax benefits are not guaranteed. Building your entire portfolio on the promise of tax-friendly returns could lead to disappointment if tax laws change and the benefits are no longer applicable.

It is also worth noting that many tax-efficient investments come with high risk. In particular, VCTs and EIS investments are very risky! This is because new companies are prone to volatility and may not manage to see the growth that they originally expected. These investments are most suitable for experienced investors who have money that they can afford to lose.

How to start tax-efficient investing in 2024

If you’re interested in using tax-efficient investments to reduce your taxable income, you should start by making a plan.

This means understanding your long-term investment goals, your risk appetite, and your budget. Developing a solid investing strategy is key to making informed investment decisions. At this stage, you should also consider which tax benefits could be the most beneficial to you.

VCTs and EIS investments may appear to be the most ‘beneficial’ however, both of these investments come with minimum holding periods that may mean that they are not suitable for you.

Once you are clear on your plan, the next step is to select a diverse range of investments that you could spread your money across. Diversification reduces the risk of investing and allows you to benefit from various different types of investment.

For example, you could open a Cash ISA and a Stock and Shares ISA.

It is a good idea to regularly spring clean your investment portfolio to ensure that it stays in line with your long-term goals. It is also a good idea to seek advice from a financial advisor before making any tax-efficient investing decisions. Advisors could help you to maximize the benefits of these investments and provide advice around minimizing risk.

Are you interested in learning more about investing? Why not sign up to the MoneyMagpie bi-weekly Investing Newsletter? It’s free and you can unsubscribe at any time if you find it isn’t for you.

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Disclaimer: MoneyMagpie is not a licensed financial advisor and therefore information found here including opinions, commentary, suggestions or strategies are for informational, entertainment or educational purposes only. This should not be considered as financial advice. Anyone thinking of investing should conduct their own due diligence. When investing your capital is at risk.

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Jasmine Birtles

Your money-making expert. Financial journalist, TV and radio personality.

Jasmine Birtles

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