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3 simple steps to a tax efficient review
Your financial circumstances and ambitions are unique to you. Every single one of us has different requirements and expectations, and our approach to investments should reflect this.
With that said, there are three headline characteristics that recur with sufficient regularity to make developing a basic understanding worthwhile.
On a high level, these considerations are income, assets, and time horizon.
All three are interlinked - your financial position could involve any combination of the three.
A matrix of eight unique scenarios materialises if these three considerations are binary. Income is high or modest, assets are large or small, and time horizon is short or long.
With our focus at GrowthFunders on providing tax efficient investment opportunities, we've put a clear focus on these for each of the three characteristics:
If you currently earn a high income, this is likely to impact on your tax efficient investment requirements in two ways.
The first is that investment products offering income tax relief are more likely to appeal to you.
All four products that offer income tax relief are illiquid, generally starting with investing in your pension - this offers income tax relief on annual contributions capped at between £10,000 and £40,000, depending on your income (in addition to a lifetime contribution cap of £1,000,000).
However, there are specific conditions attached to when you can access your pension.
The other three products form the UK Government’s suite of Venture Capital Schemes. All three – Venture Capital Trusts (VCTs), the Enterprise Investment Scheme (EIS), and the Seed EIS (SEIS) – offer income tax relief of either 30% (VCTs, EIS) or 50% (SEIS).
Although you are entitled to relinquish these whenever suits you, you forego the income tax incentive if you hold your investment for less than three years.
Furthermore, the secondary market for such investments is scarce and it therefore represents an illiquid investment.
Secondly, you are less likely to require your investment products to deliver income through regular dividend payments. As such, you can instead focus your investments on growth in value, particularly if you are confident that your high income will sustain.
This approach makes longer-term, illiquid investments a more viable proposition - achieving growth in value benefits from a longer-term outlook as assets are more likely to fluctuate in value in the short-term.
On this basis, investment products that are exempt from capital gains tax (CGT) are appealing. These include the suite of Venture Capital Schemes outlined above, along with a Stocks & Shares ISA.
If you are someone with significant assets, a tax efficient review offers a great opportunity to structure these in a way that enables you to achieve your financial objectives.
The profile of people with significant assets often determines that investments are geared towards those that offer an income and, potentially, relief from Inheritance Tax (IHT).
Firstly, any investment product with an annual contribution limit has the potential to delay your ability to protect your assets from tax.
However, a combination of ISA (£20,000 per financial year), SEIS (£100,000), VCTs (£200,000), and EIS (£1,000,000) investments could offer you the opportunity to achieve a combination of tax-free growth and income, depending on your time horizon and attitude to risk.
Secondly, people with significant assets have often accumulated these over a longer period of time. They may be approaching retirement or have taken early retirement.
If you are in this situation, you may want your assets to generate income to compensate for a (impending) reduction in your annual earnings.
In this case, all four products listed above offer tax free income through dividend payments. However, the Stocks & Shares ISA offers superior liquidity should you require access to your capital.
Thirdly, people at this life stage also start to think about estate planning and mitigating the impact of IHT. Two of the four investment products listed above (EIS and SEIS) offer IHT exemption after two years.
However, these products are illiquid and may be difficult to liquidise should you require cash for whatever reason.
One option to combine liquidity, tax-free income, and IHT exemption is through Business Property Relief (BPR) investments within a Stocks & Shares ISA.
The ISA wrapper provides tax exemption on any dividends paid and BPR-eligible investments are IHT exempt after two years.
3. Time horizon
Your investment portfolio should reflect when you would like to be able to access your capital.
If you would like to realise a return relatively quickly, you should consider making investments that offer more liquidity and less risk. This makes equity investments in early-stage companies a less suitable option, despite the superior tax incentives on offer.
Depending on your specific circumstances, this might include investing in a fixed-term savings product (which offers the additional benefit of FSCS protection), a main market tracker fund (which invests in the most established companies), or lending through a peer-to-peer platform (which involves a fixed-term loan to an individual or business, with capital at risk).
Retaining access to your capital should be a prime driver for this - the tax incentives available for investing in other asset classes can often be sufficiently generous to compensate for the additional risk.
For example, an EIS investment that retains its original value and offers tax relief at 30% will, after three years, be worth more than a savings product that offers 2.5% AER (realistic in the current market)
Conversely, if you are investing with a longer-term outlook, you can feel more comfortable incorporating more risk into your portfolio of investments.
A suitably diverse portfolio of equity investments has historically outperformed other investment options over the long-term. This is particularly relevant if you are seeking growth rather than income - a longer-term outlook enables you to incorporate slightly more risk into your portfolio, including more high-growth potential investments.
If you have a long-term view but prioritise income over growth, investing in a VCT (which can invest up to 30% in main market companies) offers greater prospect of dividends, all of which are exempt from tax (in addition to growth in value being exempt from CGT).
Headline for investors
If you are currently considering how to structure your investments, understanding the tax incentives available to you is an important piece of the jigsaw.
This summary is designed to provide you with an overview across three key considerations. Before making any investment, you should satisfy yourself that the product you are considering is suitable for you, taking into account your financial position and investment objectives.
If you are in any doubt, you should seek professional advice from an appropriately accredited financial advisor in advance of making investment decisions.