Tax-efficient investing is a cornerstone of personal finance strategy for investors and their advisors. Minimising tax liabilities is a critical element of ensuring long term financial health by preserving more hard-earned money and maximising investment gains.
But investment into tax efficient vehicles isn’t just about investors. Reinvesting investment gains and maximising life savings also have strong upsides for the economy. Tax efficient investments are a key plank in the government’s broader strategy to encourage savings and certain economic behaviours among investors. This can help to achieve policy goals, such as increasing economic growth, job creation and innovation, and can lead to a reduction in future state liabilities, which can outweigh the loss of immediate tax revenues.
Below are featured some of the principal avenues available to individual UK investors seeking to invest in a tax-efficient manner, where a combination of these methods is used by many investors to maximise returns from a portfolio. However, some tax-efficient investments aren’t suitable for everyone, where the returns potential, benefits and tax treatment depend on the individual’s circumstances and risk profile. We always recommend that you seek financial advice if you have any doubt about which investments are most suitable for your needs.
ISAs are perhaps the best known tax-efficient investment option available due to their ease-of-access and flexibility. Whilst relatively limited in terms of annual investment options, ISAs enable investors to benefit from paying no income or capital gains tax on their investments/savings and offer cash or shares options to suit different risk profiles. They are used for all sorts of financial goals such as savings towards university fees, a house deposit or the cost of a wedding, as well as a way to build retirement savings alongside a pension.
The yearly allowance has steadily increased and now sits at £20,000, though it’s worth noting that you can’t carry this allowance over into another tax year if you don’t use it, so it is a ‘use-it-or-lose-it’ tax break.
There are several types of ISA available, including Cash ISAs, Stocks and Shares ISAs, offering flexibility for investors with varying risk appetites and financial goals.
Unlike pensions, which can be subject to income tax on taking lump sum benefits, withdrawals of capital from ISAs are generally tax-free. This means that investors can access their ISA savings at any time without incurring any income tax. It is important to note though that some additional rules apply for the Lifetime ISA, which allows tax free withdrawals but, as it has benefitted from government added bonuses each year, you will be subject to charges for withdrawing money for reasons that fall outside of the Lifetime ISA’s intended purpose of building savings for retirement savings and purchasing a first home.
Pensions are one of the most tax-efficient investment options available to UK investors, offering tax benefits that are specifically designed to encourage individuals to make regular savings for retirement, primarily through the availability of generous tax relief on their contributions.
The key tax advantage to pension savings is that they benefit from tax relief at the investor's marginal rate, meaning that for basic-rate taxpayers, every £1 invested costs just 80p, and that net costs can drop to as little as 60p if you’re a higher rate taxpayer or 55p if you pay additional rate tax (these rates vary slightly in Scotland). Additionally, investments within a pension grow tax-free, with no capital gains tax liability, which further enhances the potential growth of pension savings over the long term.
The recently announced abolition of the lifetime limit (previously set at just over £1 million) has been welcomed by pensions investors as a way of easing the previous restrictions that were a deterrent for some high earners. That said, an annual allowance still remains in force meaning that UK taxpayers are restricted to receiving relief on a maximum of £60,000 per year or 100% of their annual earnings (whichever is lower). Pensions also offer flexibility for those with variable earnings or financial commitments, by allowing the ‘Carry forward’ of any unused annual allowance from the previous three tax years for use in the current tax year – this allows investors to still make use of reliefs from years where they were unable to afford pension contributions.
When individuals reach the age of 55 (although this is set to rise to 57 from 2028), they can also take up to 25% of their pension fund as a tax-free lump sum. This lump sum is not subject to income tax, providing a valuable source of tax-free cash in retirement.
A Venture Capital Trust (VCT) is an investment vehicle listed on the London Stock Exchange, similar in structure to an investment trust and with a board of directors, which is designed to provide shareholders with returns by investing in a diverse portfolio of small, often private or AIM-listed companies. Funds raised from individual investors through new share issues are invested in a portfolio of businesses selected by a specialist fund manager, A shareholder in a VCT owns shares in the trust, as opposed to a direct stake in the underlying companies. VCTs focus on adding value to these companies and aiming for a profitable sale to trade buyers or private equity firms.
Notably, a large VCT portfolio means that investors can benefit from exposure to a range of industries and the UK regions, offering sector, geographic and asset class diversification in order to spread investment risk and maximise potential returns.
VCTs were introduced by the government in 1995, intended to attract capital from private investors to help fuel the growth of smaller British companies that would otherwise struggle to access the finance they need to grow. In total VCTs have now deployed around £12 billion in investments into thousands of emerging UK companies, demonstrating a strong track record in supporting innovation, job creation and economic development.
Given the inherent risks associated with investing in smaller businesses, VCTs offer substantial tax incentives to attract capital from private investors to back this vital sector. Investors can benefit from: up to 30% initial tax relief on investments in newly issued VCT shares, providing a significant reduction in the effective cost of investment; tax-free dividends, allowing investors to receive an income without the need to report them on their tax return; and Capital gains tax (CGT) exemption on any profits realised from the sale of VCT shares.
These incentives are limited to investments of up to £200,000 per tax year and are contingent upon the investor holding the shares for a minimum of five years but offer the potential for tax-efficient investment growth and income.
EIS is another government initiative designed to encourage investment in early-stage companies with high growth potential. Since its launch in 1994, investment through EIS has provided £30 billion of funding to early-stage businesses across the UK.
Unlike VCTs, where an investor owns shares in the listed investment vehicle, managed by an experienced fund manager, EIS investors get direct ownership in the shares of each early-stage company. Investment can be directly into the company, or through an EIS fund, which will invest on behalf of the individual in several qualifying companies.
EIS Investors can benefit from income tax relief of up to 30% on investments of up to £1 million per tax year (or £2 million for a knowledge intensive company), provided that shares are held for a minimum of three years and that the company remains EIS qualifying for that period. Additionally, any gains made on the disposal of EIS shares are exempt from capital gains tax after three years from investment, while it also benefits from exemption from inheritance tax, provided the investment has been held for at least two years as at the time of death.
EIS also has a couple of enhanced features providing both a safety net for potential losses and a tax-efficient way to reinvest gains. Firstly, Loss Relief enables investors to offset EIS shares sold at a loss against their capital gains or income tax bill in the year of disposal, helping to mitigate the financial impact of a poorly performing investment. Secondly, Capital Gains Deferral allows investors to defer paying Capital Gains Tax on the profits from EIS investments if they reinvest gains in other EIS eligible companies, subject to certain restrictions on when the reinvestment takes place.
Unlike its sister programme EIS, and VCTs, which support slightly more established private and AIM listed companies (those with up to seven years trading history and fewer than 250 employees), SEIS backs startups and very early stage businesses (with maximum gross assets of £200,000 immediately before investment and fewer than 25 employees at date of investment).
While SEIS investments carry a higher risk due to the embryonic stage of the businesses involved, this is reflected in more generous tax incentives available for SEIS-qualifying companies, including income tax relief of up to 50% on investments of up to £100,000 per tax year. Tax relief can also be carried back to the previous tax year, as long as the maximum investment under SEIS for that year has not already been reached.
SEIS offers several other tax benefits to investors. Firstly, there is no Capital Gains Tax on gains, provided the shares are held for at least three years, and 50% Capital Gains Tax relief can be claimed if the gains from an investment in a non-SEIS company are reinvested into an SEIS-eligible company. There is also no Inheritance Tax on SEIS shares as long as they are held for at least two years and, if the business does not perform well and the SEIS shares are sold at a loss, investors can claim SEIS loss relief.
By understanding the tax-efficient investment options available in the approach to the tax year-end, UK investors can not only grow their wealth whilst minimising tax but can also contribute to the growth of innovative businesses and the broader economy.
The investment options outlined above offer attractive tax benefits, suited to investors with a range of investment objectives and risk profiles. It is, however, essential for investors to conduct thorough research and seek professional advice to ensure that their chosen investments align with their financial goals and risk tolerance.
The information in this article is not exhaustive, is based on Maven’s understanding of current tax rules and product features and is not a recommendation of any specific investment. Investors are encouraged to seek advice from an authorised adviser if any doubt about the suitability of an investment to their own financial circumstances or tax position. Maven Capital Partners cannot provide taxation, investment, or financial advice.