There are a number of ways investors can shield their money from the taxman. This British guide explains the various options starting with the most popular…
Isas
Individual Savings Accounts are the most common way of keeping your investments away from the taxman. They were introduced in April 1999 to replace Personal Equity Plans (PEPs) and can be used to protect unit trusts, bonds, investment trusts and Oeics. Peps’ tax-free status still applies for existing investments.
Each year, you can invest £7,000 in a stocks and shares ‘maxi’ Isa. The alternative, if you want to hold some money in a savings account tax-free, is to put up to £3,000 in a cash Isa or ‘mini’ Isa. You can then invest £3,000 in another stock and shares ‘mini’ Isa. (You can also invest another £1,000 in life insurance, although very few people have used this option). So you can hold two Mini Isas – one with funds and one as a cash accounts – or one maxi.
However, the limits are due to fall. From April 2006, the cash mini Isa limit will fall from £3,000 to £1,000. The mini stocks and shares Isa will rise from £3,000 to £4,000 (this is to cater for the scraping of the life insurance Isa element for new investors) but the overall maxi Isa allowance will fall from £7,000 to £5,000.
Any investment wrapped in an Isa is exempt from capital gains tax. With regards to income tax, the benefits became more complex in April 2004.
Anyone investing in shares, including share-based funds, through Peps or Isas lost a 10% tax credit they previously received on income. This credit previously boosted each £100 of income to £111.11.
In effect, there is no income tax benefit for a basic-rate taxpayer to hold a shares-based fund in an Isa.
Higher-rate taxpayers will still benefit because they would be charged an extra 32.5% tax on dividends from share-based investments held outside Peps and Isas.
But basic-rate taxpayers should consider whether there is any point in using a £7,000 maxi Isa for their share-based investments. Tax-wise, they may do better to use their £3,000 cash Isa allowance instead, because interest paid in cash Isas will remain tax-free. They would still have a £3,000 share Isa allowance available to them.
Corporate bond funds held in Isas or Peps still qualify the tax-credit on income.
Self-select Isas
These are largely used for sheltering individual shares in an Isa. However, stockbrokers tend to charge a monthly or annual fee for the wrapper. With the change in treatment of income dividends, it is unlikely that a self-select Isa is beneficial for most investors, unless you expect to face a large tax bill for any capital gains.
The friendly way
Friendly societies off tax-free investment schemes that let you put away up to £25 away each month or £270 as a lump sum each year. These are basically endowment policies, so you have to save for a minimum ten years for the proceeds to be tax-free. Charges are high and returns have previously been poor compared to stock market performance.
Offshore investing
Investing offshore provides opportunities for tax deferral, reduction and avoidance.
The attraction is ‘gross roll-up’. This means assets can grow without being taxed and could therefore outperform investments at home. However, gains or income are liable to tax in Britain when they are brought back to the UK. You will also need to pay tax of another country if you take the money there.
The trick is to take into account how long you are going to be away if you are emigrating, your residency for tax purposes, your will, property and more liquid assets such as savings. Always seek professional advice from an IFA or accountant as sheltering money from tax offshore can be fiendishly complicated.
Venture captial trusts
VCTs offer one of the best tax breaks available – if you can stand the risks involved. They are effectively companies quoted on the stock exchange which invest mainly in unquoted companies or ‘start-ups’. To encourage investors to back such riskier businesses, the Government will give you 40% tax relief on the investment you make as long as you keep the cash in place for three years.
It means that every £10,000 you invest will only cost you £6,000 because of the tax break. There is no income tax to pay on any dividends, nor capital gains tax to pay on the increase in your stake in the trust.
And you can stagger withdrawal of funds to avoid paying capital gains tax you might owe. You claim the up front tax relief by sending off a certificate to your tax office. For more, see our VCT guide.
Source: This is Money
Photo credit: Joe in DC via Visualhunt.com / CC BY-ND
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