As an investor, is having a 'tax efficiency' mindset a necessity?
How you spend your money is entirely a personal decision. From pocket money as a teenager through to a pension once into retirement, for the most part you have full control over where every penny you receive is spent.
Whilst we are often restricted when we look at our regular or day-to-day expenditure - if we want a house, we're generally going to have to allocate some of our income towards rent or mortgage payments - things become a lot more open when we consider what we might do with our surplus income.
Some will spend it. Others will put it in a drawer or under their mattress. There are many who will add it into a low interest, high street savings account. Plenty more will invest it.
And none of them are wrong. It's personal preference. It's what you feel most comfortable with.
When we look at the specifics of each scenario, the personal preferences become even more apparent - and with the exception of those who put their cash in a drawer or under their mattress, people generally want to have their money do more for them; to do something that's going to bring them a return or some financial incentive.
For investors, this will usually mean investing a sum into an opportunity which they reckon will return a profit, generally after a number of years.
But receiving a return on an investment isn't the only way to gain financially from your investments if you have a tax efficiency mindset.
Investing for tax efficiencies
Now as with the above scenarios, personal preferences dictate your approach to investing.
As such, investors don't need to always be thinking about the tax efficiencies. It doesn't need to be a deal breaker or even something that you consider when assessing whether to invest - but there is merit in evaluating the opportunity and viewing tax incentives as a welcome extra.
If you can switch your focus to at least have tax efficient investing on your radar, you can start to benefit from some of the UK's most generous tax reliefs.
Take the Enterprise Investment Scheme (EIS) and its younger sister, the Seed Enterprise Investment Scheme (SEIS), as examples. Each focused on different (albeit closely aligned) areas of startup investment, they both offer:
- Immediate income tax relief
- Capital Gains Tax relief
- Loss relief
Simply being aware of the first in general can pique an investor's interest - and this interest only intensifies when it's realised SEIS investments offer income tax relief at a rate of 50%.
This effectively means that if you invest £1,000 into an SEIS eligible investment opportunity, its actual cost to you is only £500.
As great as this is, things get even more attractive when the other two points are taken into consideration - Capital Gains Tax relief is available at a rate of up to 14%, and should the business you invested in fail, you can claim loss relief at your marginal rate of income tax.
Combined together, a £1,000 investment into a SEIS eligible investment opportunity could actually leave you as little as £135 lighter, even in the worst case scenario that the business failed completely.
Is tax efficient investing just tax avoidance?
As Michael mentioned in a recent post of his, some can think schemes like the EIS and SEIS are too good to be true. And if they're too good to be true, there must be a catch - something that can easily lead you down the route of tax avoidance schemes.
Tax efficient investing is not tax avoidance. It's as plain and as simple as that.
What tax efficient investing is is in the name - it's specifically about investing in opportunities in such an efficient way that you are able to reduce your tax bill(s).
The UK Government supports this because it provides ambitious businesses with the investment they need to grow and generate wealth and jobs.
By being a tax efficient investor, you're investing intelligently. You're developing an understanding of your tax liabilities. You're starting to become aware of how you are able to reduce your tax bill by making full use of some of the most generous tax reliefs currently provided by the UK government.
Invest in the deals that are right for you
As much as we can talk about the immense benefits of tax efficient investing, the decision of how you spend any surplus money you have is completely your decision.
To help in your decision making process, we've created a range of guides to provide information on the various different tax efficient investment options available (we'd recommend starting with our general tax efficient investing guide, followed by our SEIS and EIS guides).
However, taking financial advice is always recommend when looking to make any form of financial commitment - including investments - so to ensure you're making the most informed and educated decision possible.