One of the key reasons for investing is to grow your money and make a profit. When considering this, it’s important to understand that, in most cases, money from investments is seen as earned income and is therefore subject to capital gains tax.
Since 2016, the introduction of the personal savings allowance and dividend allowance have given savers much more leeway in investing before they have to pay income or capital gains tax.
The personal savings allowance lets you earn up to £1,000 from interest on your investments without having to pay tax. The dividend allowances let you earn up to £2,000 on your shares before you pay any tax. These forms of tax relief have been introduced to encourage people to save and invest their money.
In addition, certain financial products do not attract income tax or capital gains. These include ISAs or individual savings accounts, pensions and premium bonds.
Here we look at the top investment opportunities that come with tax relief if you are looking to make the most of your savings and investments.
Why are investments taxed?
You are essentially taxed on any income that you make whether that is through employment and your wages, profits you make as a business or the interest you make on investments such as stock and shares.
In general, tax on savings is paid through the normal income tax rates of 20%, 40% and 45% depending on your overall income.
If you earn money through dividends, then you pay 8.75%, 33.75% or 39.35%.
If you are a basic rate taxpayer, then you will get some tax relief on your investments. You are allowed to earn £1,000 on the savings until you start paying income tax.
If you are a higher rate tax payer, you also get a £500 tax-free allowance.
How does capital gains tax affect investments?
When you dispose or sell an asset and the value of it exceeds £6,000, then you are liable to pay capital gains tax.
If you are a basic rate taxpayer, that tax will be 10% of the profits you make. If you are a higher rate taxpayer, you will need to pay 20%.
For example, if you buy shares in a company for £1,000 and you sell them for £3,000 you will need to pay 10% of £2,000 if a basic rate taxpayer and 20% if a higher rate tax payer (£200 and £400 respectively).
If you are buying shares in a company, you can get further tax relief through the enterprise investment scheme. This was set up to encourage people to invest in businesses in the UK.
It offers tax relief of 30% on investments up to £1 million and, if this has been claimed, you don’t have to pay CTG.
Other, much smaller, investments, however, are not subject to capital gains tax, including ISAs, pensions and bonds which also have income tax relief associated with them.
Tax free investments
When looking at an investment’s suitability, it’s important to consider the tax implications. For most savers, tax relief can ensure that you retain more of your profits, including that vital pension pot.
The key areas to invest in are ISAs, premium bonds and pensions if you want to take advantage of tax relief and end up with more in your pocket.
Individual savings accounts
An individual savings account or ISA is a tax-efficient way to save money and boost your profits through investments.
There are generally two types: the cash ISA and stocks and shares ISA.
This is a savings account you can pay into from the age of 16 and you don’t have to pay tax on the profits. You can put £20,000 into a cash ISA making it one of the more tax efficient investment schemes in the UK today.
With a cash ISA, you earn straight interest on your investment.
You can also invest in a stocks and shares ISA which lets you use your money to invest in different areas and, hopefully, make more profit.
You need to be 18 or over to take part and the limit is the same as a cash ISA, £20,000.
In short, there is the potential to generate more income that comes tax free but there is greater risk involved as the price of stocks and shares can go down as well as up.
Many people decide on a mix of both cash and stocks and share ISAs as the most tax-efficient investing that is relatively risk free.
Over 21 million people in the UK save with premium bonds and they are appealing because you can invest small amounts and build up your savings.
Premium bonds have interest applied through a lottery system and this is decided by a monthly draw that can be as much as £1 million.
You can buy a premium bond for as little as £25 up to a maximum of £50,000 and if you win a prize and increase your earnings it is entirely tax free.
While premium bonds can be an attractive proposition, the chances of winning the £1 million top prize are 1 in 59 billion. Even for a prize of £25, the odds are 1 in nearly 25,000.
The most tax efficient investment schemes are pensions mainly because the Government wants us to save for our retirement. A private pension pot has many tax advantages.
For a start, you can get tax relief for any money that you invest that is then pushed back into your pension.
While you will pay tax on your pension when it is due and starts transferring into your account there is also the chance to take a tax free lump sum when you reach retirement age.
This can be up to 25% of your pension fund.
Of course, you can’t take from your pension scheme until you reach retirement but the tax benefits make it one of the best investments with income tax relief, especially if you start saving early.
Do I have to pay tax on my savings in the UK?
If you are a basic rate tax payer you will have a £1,000 allowance for savings interest. That means you do not pay tax until you exceed this limit.
What assets appreciate the most?
Stocks and bonds have the potential to appreciate most but they can also fall in value making them a bit of a gamble. If you are looking for a guaranteed savings plan, a cash ISA with a guaranteed interest payment is the best option.
Tax free savings leave you with more money in your pocket. The three best options in the UK are ISAs, premium bonds and your private pension.