6 ways to invest tax efficiently
As an investor, investing in a tax-efficient manner is crucial when aiming to minimise risk, maximise returns and reduce your tax bill.
With cuts to pension allowances and some forms of tax relief over the years, high earners, in particular, may feel that their capital is being eroded.
But various tax incentives made available to investors mean you could potentially:
- Receive income tax relief of up to 50%
- Pay no income tax on dividends
- Pass on your investment free of Inheritance tax
- Enjoy tax-free growth
These incentives include the Individual Savings Account (ISA), which has become a household name since its establishment in 1999, Venture Capital Trusts (VCTs), and the Enterprise Investment Scheme (EIS) and Seed Enterprise Investment Scheme (SEIS) – the two most generous tax incentives for investors into high-growth, early-stage businesses.
As well as these, the Self-Invested Personal Pension (SIPP) and Small Self Administered Scheme (SSAS) enable investors to grow their pension pot tax efficiently.
Enterprise Investment Scheme (EIS)
Established in 1994, the EIS offers tax reliefs that help investors into unlisted, early-stage companies offset the higher risks associated with investments of this kind.
This in turn maximises potential returns and can make investing into high-growth small and medium-sized businesses an important, tax-efficient consideration for investors.
Read more: a look back at 4 EIS opportunities
The tax reliefs available to investors through the EIS include:
- Claim back up to 30% of the value of your investment
- Dispose of shares without paying capital gains tax
- Defer the payment of capital gains tax
- Claim loss relief if the business fails
- Pass on your investment free of inheritance tax
To become EIS-eligible, businesses must:
- Be unquoted
- Have less than 250 full-time employees
- Have gross assets of less than £15 million
- Be within seven years of their first commercial sale
But the advantages of investing in EIS-eligible SMEs don’t stop at the headline-grabbing tax breaks.
For investors looking to take part in impact-investing, supporting small businesses – particularly now, during the current Coronavirus pandemic – can also be philanthropic.
In 2019, SMEs accounted for three-fifths of the employment and approximately half of the turnover of the private sector in the UK, proving that they will be crucial to the bounce-back of the economy post-COVID-19.
Seed Enterprise Investment Scheme (SEIS)
The SEIS is the younger sibling to the EIS, introduced in 2012.
Focusing on younger and smaller – and therefore higher risk – businesses than the EIS, the SEIS offers investors even more generous tax reliefs.
- Income tax relief of up to 50%
- 50% capital gains reinvestment relief
- No capital gains tax on profits
- Inheritance tax relief
- Loss relief
Again, these tax breaks are designed to help mitigate risk and enhance potential returns, and SEIS can also allow investors to invest for impact, similarly to the EIS.
To become SEIS-eligible, businesses must:
- Be unquoted and less than two years old
- Have less than 25 full-time employees
- Have gross assets of less than £200,000
Individual Savings Account (ISA)
Most people will be aware of the ISA and its tax wrapper which renders all returns held in the account free from income tax and capital gains tax.
Since its initial introduction in 1999, the ISA family has grown, now boasting four main account types.
- Cash ISA
- Stocks and Shares ISA
- Innovative Finance ISA (IFISA)
- Lifetime ISA
Each tax year, savers and investors benefit from an annual ISA allowance (£20,000 in 2020/21), making the account highly tax-efficient.
One of the latest additions to the family, the IFISA, was established in 2016 as a means of strengthening and accelerating the UK’s booming alternative finance market.
The account enables investors to hold peer-to-peer loans and debt-based securities under the generous ISA tax wrapper for the first time ever, with a number of underlying assets eligible, including:
- Green energy projects
- SME loans
- Consumer loans
Venture Capital Trust (VCT)
VCTs are companies listed on the London Stock Exchange (LSE) launched in 1995 to invest in small, UK businesses.
When investing in a VCT, investors acquire shares in the trust, rather than the individual companies, meaning exposure to a whole, diverse portfolio.
The tax reliefs available when investing in a VCT include:
- Income tax relief of up to 30%
- Tax-free dividends
- Tax-free growth
A company can qualify for VCT investment if:
- It has gross assets of £15 million or less
- It is less than seven years old
- It has less than 250 full-time employees
A VCT must invest a minimum of 80% of its assets into companies that are unlisted, or listed on the Alternative Investment Market (AIM).
Self-Invested Personal Pension (SIPP)
With a lifetime allowance of £1,073,100 (as of 2020/21) and tax relief on contributions, pensions are one of the most tax-efficient methods of saving for retirement.
And for experienced investors who are comfortable making their own investment decisions and are disillusioned with the standard personal pension, the SIPP is an important consideration.
The do-it-yourself pension allows investors to choose where they invest their pension savings, while benefiting from up to 45% tax relief on contributions depending on the marginal rate of tax.
Investments also grow free from income tax and capital gains tax within a SIPP, and you can usually withdraw up to 25% of the SIPP fund tax-free.
Though each SIPP provider ultimately controls which assets can be held, most SIPPs can invest into:
- Stocks and shares
- Investment trusts listed on any stock exchange
- UK government bonds
- Open-ended investment companies recognised by the Financial Conduct Authority (FCA)
- Gilts and bonds
- Exchange-traded funds traded on the London Stock Exchange or other European markets
- Bank deposit accounts
- Commercial property
- Real estate investment trusts listed on any stock exchange
- Offshore funds
Small Self Administered Scheme (SSAS)
For small and family-run business owners, in particular, the SSAS is a pension scheme that benefits from the usual pension tax reliefs – such as up to 45% tax relief on contributions, depending on your marginal rate of tax – while offering additional advantages.
A SSAS is an employer-sponsored, defined contribution workplace pension scheme designed to be independently managed by a company for 11 members or less.
One of the main benefits of a SSAS for business owners is that they can be used as a vehicle for business growth.
For example, they can be used to grant a secured loan to the sponsoring company – of up to 50% of the fund value of the SSAS – or to purchase shares in the business.
Each SSAS provider will have their own rules regarding which investments you can hold, but a SSAS pension has the ability to invest in a much wider range of investments than more traditional pension schemes. These include:
- Commercial property and land
- Industrial/retail units
- Agricultural land
- Loans back to the sponsoring employer
- Unit trusts or other regulated collective investments
- Investment trusts
- Direct quoted equities
- Trustee investment plans
- Shares in unquoted private companies
Exploring your tax-efficient investment options
Navigating through the many tax-efficient investments available to investors and selecting the right one for you can sometimes be an enduring task.
Whether it’s choosing between investing in an EIS-eligible company over an SEIS-eligible one, or choosing to set up a SIPP over a SSAS – it is crucial you know all you can before deciding on which investments are best suited to you, your investing experience, life stage, level of risk acceptance and personal & portfolio goals.
GCV’s latest Guide to Tax-Efficient Investing offers a comprehensive overview of the top tax-efficient investments currently available to investors, providing an in-depth insight into each option to ensure you are fully informed to make the investment decision that is right for you.